Hire purchase is an agreement between two parties in which one party purchase any asset from other party. Because he has no money to pay, so he pays per month hire charges. Vendor has the possession of asset. When buyer pays total price of assets in the form of hire charges, then asset is transferred to its purchaser. Vendor may also transfer asset before last payment of installment on his own risk. If buyer will become defaulter, vendor has right to get his asset from hire purchaser.
Accounting Methods for Hire Purchase Transaction
For accounting point of view both hire purchase and instalment payment system are same. Before accounting, we should know following things
a) Cash price is that price which will be paid if any asset is purchased on cash without installment.
b) Hire price = cash price + interest for risk of giving asset on instalment.
c) Down payment = Payment at the beginning of deal of hire purchase.
There are four methods of accounting for hire purchase.
1st Method : Cash Price Method
Under cash price method, we are deal hire purchase transactions just like normal transactions. When transactions or event happen, we record them.
Journal Entries in the books of Purchaser
a) For buying assets on hire purchase
Asset on hire purchase account Dr.
Vendor account Cr.
b) For paying the down payment to vendor
Vendor account Dr
c) When Interest is Due on unpaid installments
Interest on Hire Purchase account Dr.
Vendor Account Cr.
d) For Instalment Payment ( Interest payment will be also included in it)
Vendor Account Dr
Cash / Bank account Cr
e) For transferring interest to profit and loss account
Profit and Loss account Dr.
Interest on hire purchase account Cr.
f) For depreciation charge
Depreciation account Dr.
Assets on hire purchase account Dr.
g) If Asset is returned
Hire Vendor account Dr.
Asset on hire purchase account Cr.
In the books of Hire Vendor
a) For giving assets on hire
Hire purchaser account Dr.
b) For down payment received
Bank account Dr.
c) For Interest receivable
Hire purchaser account Dr.
Interest account Cr.
d) For installment due
Installment due account Dr.
e) For installment received
Bank account Dr.
Hire purchaser account Cr.
f) For installment not due at the year
Hire purchase stock account Dr.
Trading account Cr.
g) For stock reserve
Stock Reserve account Dr.
Hire purchase stock account Cr.
Disclosure in balance sheet
Hire purchase debtor XXXX
2nd Method Interest Suspense Method
In this method, we open interest suspense account. All the interest which is not paid on hire purchase asset will go to interest suspense account. When interest will become due, interest account will be debit and interest suspense account will credit.
following entries will pass in the books of hire buyer
a) For transferring total interest payable on hire purchase deal
Interest suspense account Dr.
Hire purchase account Cr.
b) When interest is due
interest account Dr.
interest suspense account Cr.
all other entries will be same as first method.
In the books of hire vendor
a) For transferring total interest payable to interest suspense account
hire purchaser account Dr..
interest suspense account Cr.
b) when interest is due
interest suspense account Dr.
interest account Cr.
all journal entries will be same of first method
Disclosure in the balance sheet
Hire purchase debtors
Less balance in interest suspense account
3rd Method : Trading Method
In this method, the hire purchase trading account is prepared in the book of vendor of asset in the form of hire purchase system.
4th Method : Stock and Debtor Method
In this method, hire purchase stock, hire purchase debtor and hire purchase adjustment account are maintained. Following entries will pass in the books of vendor
a) When goods are sold on hire purchase
hire purchase stock account Dr. ( Hire purchase price)
stock account Cr. ( Actual cost of sale of goods )
hire purchase adjustment account Cr. ( difference between hire purchase price and actual cost )
b)When installments become due for payment
hire purchase debtors account Dr.
hire purchase stock account Cr.
c) When cash is received
Cash account Dr.
Hire purchase debtor account Cr.
d) stock reserve account on opening stock
stock reserve account Dr.
hire purchase adjustment account Cr.
e) Stock reserve on closing stock
Hire purchase adjustment account Dr.
Stock reserve account Cr.
But which method I should follow while solving the problem? Wll it be given in exam or I ve to understand as per my knowledge? Let me know Reply Delete
if in the case of interest suspense account, if the installment of a particular month was not paid, whether interest relating that month can be debited to interest expense account or interest relating to only the months for which installments were actually paid need to be expensed out. Reply Delete
The theory part was nice but there should have been some problems to know very well about this thank you. Reply Delete
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Journal Entries Made Easy Book is helpful all those who want to learn every journal entries relating to current business transactions.
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