Unit  4
HIRE – PURCHASE
If you purchase a TV for cash, you pay, say, Rs. 15,000. But if you wish to make the payment by instalments of say, Rs. 3,000 each, every year, you may be required to pay four instalments, that is Rs. 20,000 in all. The extra amount of Rs. 3,000 is for interest. If you choose the latter mode of the payment, you should debit Rs. 5,000 to interest and treat the TV as valued at Rs. 15,000 (and not at Rs. 20,000). In case payment is to be made by instalments, there may be two kinds of arrangements. Each instalment may be treated as a ‘hire’ the purchaser becoming the owner only if he pays all the instalments. In other words, property does not pass to him even if one instalment remains unpaid. The seller will have the right to take away the goods in case of default in respect of any instalment. This is known as ‘Hire Purchase’ system.
The other arrangement may be that property passes immediately on the signing of the contract. The seller will not have the right to repossess the goods in case an instalment is not paid. His right will be to sue the purchaser for the money due. This is known as the Instalment System.
Interest: In either case (hire purchase or instalment) interest must be separated from the principal sum due. Since payments continue over two or more financial year’s interest must be calculated for each year separately. Usually information is available regarding cash price and the rate of interest. Calculation of interest then becomes easy. Just prepare the account of one of the parties on ordinary lines and charge interest on the balance due. Suppose on 1st January, 2000 A purchases from B machinery whose cash price is Rs. 15,000; Rs. 5,000 is to be paid down, that is on signing of the contract, and Rs.4,000 is to be paid at the end of each year for 3 years. Rate of interest is 10% p.a. If we prepare B’s account (on a memorandum basis) in A’s books, we shall know the interest for each year.
A’s Books
Dr. 

 B’s Account 
 Cr. 

 Rs. 

 Rs. 
2000 

 2000 


Jan.1  To Cash  5,000  Jan.1  By Machinery A/c  15,000 
Dec.31  To Cash  4,000  Dec.31  By Interest A/c  1,000 
’’  To balance c/d  7,000 
 (10% on Rs. 10,000) 


 16,000 

 16,000 
2001 

 2001 


Dec.31  To Cash  4,000  Jan.1  By Balance b/d  7,000 
 To Balance c/d  3,700  Dec.31  By Interest A/c 




 (10% on Rs. 7,000)  700 

 7,700 

 7,700 
2002 

 2002 


Dec.31  To Cash  4,000  Jan.1  By Balance b/d  3,700 


 Dec.31  By Interest A/c*  300 

 4,000 

 4,000 
* As it is the last year of installment, interest amount will be the difference between the Outstanding balance and the actual amount of installment. [Students should note that if you calculate interest for the last year as per the given percentage on the O/S amount (3700 x 10%=370), total amount payable becomes (3700+370=4070) which is greater than the installment paid. So there will be again Rs. 70 payable even after the last installment being paid.]
If the rate of interest is not given, the interest for each year will be in proportion to amount outstanding in each year. In the example given above, the total sum payable is Rs. 17,000 out of which Rs. 5,000 is paid immediately. This leaves Rs. 12,000 as outstanding throughout the first year at the end of which Rs. 4,000 is paid. In the second year Rs. 8,000 is outstanding and in the third year Rs. 4,000 is due. The total interest is Rs. 2,000. i.e., Rs. 17,000. Minus Rs. 15,000. The interest should be apportioned over the 3 years in the ratio of amounts outstanding, that Rs. 12,000; Rs. 8,000 and Rs. 4,000 or in the ratio of 3 : 2 :1. The interest for the first year is Rs.1,000 : for the second year it is Rs.670 and for the third year it is Rs.333. Note that the amount cannot be the same as worked out when the rate of interest is given.
To ascertain Cash Price, rate of interest and instalments being given. Sometimes the cash price is not given. Since the asset cannot be debited with more than the cash price, it must be ascertained. The process is to take the last year first and separate interest from principal out of the total sum due. In the example given above, Rs. 4,000 is due at the end of 2002. The rate of interest is 10%. If in the beginning of 2001 Rs.100 was due, Rs.10 would be added making Rs.110 as due at the end of 2002. Thus, out of the sum due at the end of the year, oneeleventh is interest; rest is principal. We can proceed year by year like this.
Thus: —
 Rs. 
Amount due on 31122001  4,000 
Interest @ 1/11  364 
Amount due on 112002 or 31122001  3,636 
Paid on 31122001  4,000 
Total amount due on 31122001  7,636 
Interest @ 1/11  694 
Amount due on 1196 or 31122000  6,942 
Paid on 31122000  4,000 
Total amount due on 31122000  10,942 
Interest @ 1/11  995 
Amount due on 112000  9,947 
Paid Cash down on 112000  5,000 
Cash Price  14,947 
The interest for three years is Rs.995, Rs.694 and Rs.364 respectively. 
This method follows a technical approach and does not treat the hire purchaser as owner until he makes the payment of last instalment. Under this method, the asset is recorded at the cash price actually paid.
* In the last year, the interest is equal to the difference between the amount due and the opening balance. It is not calculated in the usual way.
Journal Entries Under Actual Cash Price Paid Method
The various accounting entries in the books of the hire purchaser and hire vendor are shown below.
Journal Entries Under Actual Cash Price Paid Method
 Case  In the Books of Hire Purchaser 
 In the Books of Hire Vendor 
 Amount with which debited or credited 
 
A.  On making down payment due  Asset A/c To Hire Vendor’s A/c  Dr.  Hire Purchaser’s A/c To Hire Purchase Sales A/c  Dr.  (With the amount of down payment) 
B.  On making Down Payment  Hire Vendor’s A/c To Bank A/c  Dr.  Bank A/c To Hire Purchaser’s A/c  Dr.  (With the amount of down payment) 
C.  On making principal part of the instalment due  Asset A/c To Hire Vendor’s A/c  Dr.  Hire Purchaser’s A/c To Hire Purchase Sales A/c  Dr.  (With the amount of principal part of the instalment) 
D.  On making Interest due on Unpaid balance  Interest A/c To Hire Vendor’s A/c  Dr.  Hire Purchaser’s A/c To Interest A/c  Dr.  (With the interest Due on unpaid Balance) 
E.  On making payment of instalment  To Hire Vendor’s A/c To Bank A/c  Dr.  Bank A/c To Hire Purchaser’s A/c  Dr.  (With the amount of instalment) 
F.  On providing Depreciation  Depreciation A/c To Asset A/c  Dr.  No Entry 
 (With the amount of (depreciation) 
G.  On closure of Depreciation A/c  Profit & Loss A/c To Depreciation A/c  Dr.  No entry 
 (With the amount Of depreciation) 
H.  On closure of Interest A/c  Profit & Loss A/c To Interest A/c  Dr.  Interest A/c To Profit & Loss A/c  Dr.  (With the amount Of interests) 
Note: Depreciation is charged on full cash price of the asset and Interest is calculated on total outstanding balance.
At the end each accounting period, the relevant accounts appear in the Balance Sheet as shown below:
Disclosure In Balance Sheet Under Actual Cash Price Paid Method
Balance Sheet of Hire Purchaser 
 Balance Sheet of Hire Vendor  
Liabilities  Rs. Assets  Rs.  Liabilities  Rs. Assets  Rs. 
 Fixed Assets : 


 
 Asset (at actual cash) 

 No disclosure is  
 Price paid)  Xxx 
 Required 

 Less : Depreciation till date  Xxx 




 Xxx 



Books of the Vendor: The vendor follows no special method for recording sales on hire purchase, especially in case of sale of large items. He debits the purchaser with the cash price and credits him with the amount received. Every year the interest due is debited. We illustrate this below.
Illustration1
Based on particulars given below calculate Interest under the hire purchase system
(a) X & Co.—purchaser Y & Co.Seller Date of purchase—Jan. 1, 1999
Cash price—Rs. 74,500.
Installments Rs. 20,000 on signing of the agreement. Rest in three instalments of Rs. 20,000 each. Rate of Interest—5%. Depreciation 10% on the diminishing Balance.
(b) All particulars as above except that the rate of interest is not given.
(c) All particulars as in (a) above except that the cash price is not given.
Solution :
(a) Calculation of Interest  

 Rs. 
Jan.1, 1999  Cash Price  74,500 
 LessCash down  20,000 
 Balance Due  54,500 
 Interest @ 5% for 1999  2,725 
Dec.31, 1999  Total  57,225 
 Amount paid  20,000 
Jan.1, 2000  Balance Due  37,225 
 Interest for 2000 @ 5%  1,861 
Dec.31, 2000  Total  39,086 
 Amount paid  20,000 
Jan.1,2001  Balance due 2001  19,086 
 Interest for (balancing figure) 2001  914 
Jan.1,2002  Amount paid  20,000 
(b) Calculation of interest when the rate of interest is not given :
Hire Purchase Price  80,000  
Cash Price  74,500  
Total interest  5,500  






Year  Amount Outstanding  Ratio  Interest  Rs.  
1  60,000 
 3  3/6 x 5,500  2,750 
2  40,000 
 2  2/6 x 5,500  1,833 
3  20,000 
 1  1/6 x 5,500  917 
(c) Calculation of cash price, rate of interest being given:
Instalment  Amount due at the end of the year (after payment of Installment)  Instalment Paid  Total amount due at the end of the Year (before payment of instalment)  Interest @ 1/21  Principal due in the beginning  
 Rs.  Rs. 
 Rs.  Rs.  Rs. 
3  Nil  20,000 
 20,000  952  19,408 
2  19,048  20,000 
 39,048  1,859  37,189 
1  37,189  20,000 
 57,189  2,723  54,466 




 5,534 

Cash Price: 54,466 + cash down, Rs. 20,000 or Rs. 74,466.
Illustration2
Y & Co. Sold machinery whose cash price is Rs. 74,500. To X and Co., on hire purchase basis on 1st January, 2000. Payment was to be made as Rs. 20,000 down and Rs. 20,000 every year for three years. Rate of interest was 5% & Co. Charged depreciation @ 10% p.a. On the diminishing balance. Give ledger accounts in the books of Y & Co.
Ledger of Y & Co.  
Dr. 

 X & Co. 
 Cr. 

 Rs. 

 Rs. 
2000 

 2000 


Jan.1  To Sales  74,500  Jan.1  By Cash  20,000 
Dec.31  To Interest A/c 
 Dec.31  By Cash  20,000 
 (5% on Rs. 54,500)  2,725 
 By Balance c/d  37,225 

 77,225 

 77,225 
2001 

 2001 


Jan.1  To Balance b/d  37,225  Dec.31  By Cash  20,000 
Dec.31  To Interest A/c  1,861 
 By Balance c/d  19,086 

 39,086 

 39,086 
2002 

 2002 


Jan.1  To Balance b/d  19,086  Dec.31  By Cash  20,000 
Dec.31  To Interest A/c  914 




 20,000 

 20,000 
Dr.  Sales Account  Cr.  

 2000 



 Jan. 1  By X & Co.  Rs. 15,000. 
Interest Account  
Dr. 


 Cr. 
2000 
 2000 


Dec.31 to P & L A/c  2,725  Dec.31  By X & Co.  2,725 
2001 
 2001 


Dec.31 to P & L A/c  1,861  Dec.31  By X & Co.  1,861 
2002 
 2002 


Dec.31 to P & L A/c  914  Dec.31  By X & Co.  914 
Books of Purchaser—First Method. The purchaser can also follow the system adopted by the vendor and make entries like ordinary purchase of an asset. Only, he should credit the vendor with interest due every year and debit him with cash as and when paid. The above given example can be worked out in the following way (ledger accounts.) :—
Dr. 
 Machinery account 
 Cr.  

 Rs. 

 Rs. 
2000 

 2000 


Jan.1  To Y & Co.  74,500  Dec.31  By Depreciation A/c  7,450 



 By Balance c/d  67,050 

 74,500 

 74,500 
2001 

 2001 


Jan.1  To Balance b/d  67,050  Dec.31  By Depreciation A/c  6,705 



 By Balance c/d  60,345 

 67,050 

 67,050 
2002 

 2002 


Jan.1  To Balance b/d  60,345  Dec.31  By Depreciation A/c  6,035 



 By Balance c/d  54,310 

 60,345 

 60,345 
2003 





Jan.1  To Balance b/d  54,310 



Y & Co. A/c  
2000 
 Rs. 
2000 
 Rs. 
Jan.31  To bank A/c  20,000  Jan.1  By Machinery A/c  74,500 
Dec.31  To Bank A/c  20,000  Dec.31  By Interest A/c  2,725 
’’  To Balance c/d  37,225 




 77,225 

 77,225 
2001 

 2001 


Dec.31  To Bank A/c  20,000  Jan.1  By Balance b/d  37,225 
’’  To balance c/d  19,086  Dec.31  By Interest A/c  1,861 

 39,086 

 39,086 
2002 Dec.31 
To Bank A/c 
20,000  2002 Jan.1 
By Balance b/d 
19,086 


 Dec.31  By Interest A/c  914 

 20,000 

 20,000 
The student should prepare accounts relating to Interest and Depreciation.
Second Method. Under the second method, entries are passed only when payment is due or made. At this time, the vendor is credited with the amount due. Interest for the period is debited to interest Account and the balance (principal) is debited to the Asset Account. On payment, of course, the vendor is debited and Cash (or Bank) credited. The two entries are:
 Debit Asset Account, Debit Interest Account, Credit (hire) Vendor
 Debit (Hire) Vendor, Credit Cash or (Bank)
Depreciation has to be charged according to the cash price of the asset
We give below the journal entries and ledger accounts in the books of X & Co., the purchaser, in the example given above.
Journal of X & Co.


 Debit (Rs)  Credit (Rs) 
2000 




Jan.1  Machinery Account  Dr.  20,000  
 To Y & Co. 
 20,000  
 (Amount due to Y & Co. As down payment for purchase of machinery on hire purchase basis.) 

 



 
Jan.1  Y & Co.  Dr.  20,000  
 To Bank Account 
 20,000  
 (Payment made to Y & Co. Down) 

 



 
Dec.31  Machinery Account  Dr.  17,275  
 Interest Account  Dr.  2,725  
 To Y & Co. 
 20,000  
 (The amount due to Y & Co. Under the hire purchase Contract for interest (and debited as such) and the balance treated as payment for machinery) 

 
 
Dec.31  Y & Co.  Dr.  20,000  
 To Bank A/c 
 20,000  
 (Payment made to Y & Co.) 

 



 
Dec.31  Depreciation Account  Dr.  7,450  
 To Machinery Account 
 7,450  
 (Depreciation for 1st year10% on Rs.74,500) 

 



 
Dec 31  Profit & Loss Account  Dr.  10,175  
 To Interest Account 
 2,725  
 To Depreciation Account 
 7,450  
 (Being interest and depreciation transferred to P/L A/c) 

 
2001  
Dec.31  Machinery Account  Dr.  18,139  
 Interest Account  Dr.  1,861  
 To Y & Co. 
 20,000  
 (Amount due to Y & Co. For interest the balance charged to Machinery A/c.) 

 
 
Dec.31  Y & Co.  Dr.  20,000  
 To Bank Account 
 20,000  
 (Payment made to Y & Co.) 

 



 
Dec. 31  Depreciation  Dr.  6,705  
 To Machinery Account 
 6,705  
 (Depreciation for the second year 10% on Rs. 67,050; i.e. Rs. 74,500  Rs. 7,450). 

 



 
Dec 31  Profit & Loss Account  Dr.  8,566  
 To Interest Account 
 1,861  
 To Depreciation Account 
 6,705  
 (Being interest and depreciation transferred to P/L A/c) 

 
2002  
Dec.31  Machinery Account  Dr.  19,086  
 Interest Account  Dr.  914  
 To Y & Co. 
 20,000  
 (Amount due to Y & Co. In respect of interest and the principal sum.) 

 
 
Dec.31  Y & Co.  Dr.  20,000  
 To Bank Account 
 20,000  
 (Payment made to Y & Co.) 

 



 
Dec.31  Depreciation Account  Dr.  6,035  
 To Machinery Account 
 6,035  
 (Depreciation @ 10% of the diminishing balance charged for the third years). 

 



 
Dec 31  Profit & Loss Account  Dr.  6,949  
 To Interest Account 
 914  
 To Depreciation Account 
 6,035  
 (Being interest and depreciation transferred to P/L A/c) 


Ledger Accounts  
Dr. 
 Machinery Account 
 Cr.  
2000 
 Rs.  2000 
 Rs. 
Jan.1  To Y & Co.  20,000  Dec.31  By Depreciation  7,450 
Dec.31  To Y & Co. 
 Dec.31  By Balance c/d  29,825 
 (20,000—2,725)  17,275 




 37,275 

 37,275 
2001 

 2001 


Jan.1  To balance b/d  29,825  Dec.31  By Depreciation A/c  6,705 
Dec.31  To Y & Co. 
 Dec.31  By Balance c/d  41,259 
 (20,000—1,861)  18,139 




 47,964 

 47,964 
2002 

 2002 


Jan.1  To Balance b/d  41,259  Dec.31  By Depreciation A/c  6,035 
Dec.31  To Y & Co.  19,086  Dec.31  By Balance c/d  54,310 

 60,345 

 60,345 
2003 





Jan.1  To Balance b/d  54,310 



Dr. 
 Interest Account  Cr.  
2000 
 Rs.  2000 
 Rs. 
Dec.31  To Y & Co.  2,725  Dec.31  By P & L A/c  2,725 
2001 

 2001 


Dec.31  To Y & Co.  1,861  Dec.31  By P & L A/c  1,861 
2002 

 2002 


Dec.31  To Y & Co.  914  Dec.31  By P & L A/c  914 
Dr. 

 Y & Co. 

 Cr. 
2000 
 Rs. 
 2000 
 Rs. 
Jan.1  To Bank A/c  20,000  Jan.1  By Machinery A/c  20,000  
Dec.31  To Bank A/c  20,000  Dec.31  By Sundries— 





 Machinery  17,275 




 Interest  2,725  20,000 

 40,000 

 40,000  
2001 

 2001 



Dec.31  To Bank A/c  20,000  Dec.31  By Machinery A/c  18,139  



 By Interest A/c  1,861  

 20,000 

 20,000  
2002 

 2002 

 
Dec.31  To Bank A/c  20,000  Dec.31  By Machinery A/c  19,086  



 By Interest A/c  914  

 20,000 

 20,000 
Depreciation Account
2000 
 Rs.  2000 
 Rs. 
Dec.31  To Machinery A/c  7,450  Dec.31  By P & L A/c  7,450 
2001 
 2001 

 
Dec.31  To machinery A/c  6,705  Dec.31  By P & L A/c  6,705 
2002 
 2002 

 
Dec.31  To Machinery A/c  6,035  Dec.31  By P & L A/c  6,035 
Hire Purchase: Property does not pass to him even if one instalment remains unpaid. The seller will have the right to take away the goods in case of default in respect of any instalment. This is known as ‘Hire Purchase’ system. The other arrangement may be that property passes immediately on the signing of the contract. The seller will not have the right to repossess the goods in case an instalment is not paid. His right will be to sue the purchaser for the money due. This is known as the Instalment System.
To ascertain Cash Price, rate of interest and instalments being given. Sometimes the cash price is not given. Since the asset cannot be debited with more than the cash price, it must be ascertained. The process is to take the last year first and separate interest from principal out of the total sum due.
Entries In Books : Actual Cash Price Paid Method : This method follows a technical approach and does not treat the hire purchaser as owner until he makes the payment of last instalment. Under this method, the asset is recorded at the cash price actually paid.
Books of the Vendor. The vendor follows no special method for recording sales on hire purchase, specially in case of sale of large items. He debits the purchaser with the cash price and credits him with the amount received. Every year the interest due is debited.
Books of Purchaser
First Method. The purchaser can also follow the system adopted by the vendor and make entries like ordinary purchase of an asset. Only, he should credit the vendor with interest due every year and debit him with cash as and when paid. The above given example can be worked out in the following way (ledger accounts.) :—
Second Method. Under the second method, entries are passed only when payment is due or made. At this time, the vendor is credited with the amount due. Interest for the period is debited to interest Account and the balance (principal) is debited to the Asset Account. On payment, of course, the vendor is debited and Cash (or Bank) credited.