Week 4: Hire-purchase accounting

• Introduction
Hire purchase is a means of buying assets that avoids the need to pay in full either at the time
of purchase or very soon thereafter.
The characteristics of hire purchase are as follows:
✓ The assets purchased do not belong to the purchaser. The rights will be transferred at
the end of the instalment period. The owner will have a right to confiscate the assets if
instalment is not paid by the buyer.
✓ The purchaser will pay for the item by instalments over a specific period e.g., 3 years,
5 years or more.
✓ Higher purchase price is higher than cash price. The extra cash is for interest charged.
✓ Deposit will be charged when the agreement is signed.
✓ The assets become assets of the purchaser once the purchaser pays all the instalments
agreed upon or the purchaser agrees to a legal option to buy the asset.
In addition, each payment made on hire purchase contract consists of:
i. Capital – paying off some of the amount owing for the cash price of the asset.
ii. Interest – paying off some of the interest that has accrued since the last instalment was
paid.

Instalment Sale: in an instalment sale, the contract of sale is entered into, the goods are
delivered, and the ownership is transferred to the buyer, but the price is paid in specified
instalments over a period of time. The ownership of the goods is transferred immediately at the
time of entering the contract.

• In the buyers’ books.

Dr. asset a/c with full price
Dr. interest suspense a/c with difference between full cash price and full instalment price.
Cr. Vendor a/c with full instalment price.
✓ Interest is debited to the interest suspense account because it includes interest in respect of
several years.
✓ The interest account is debited, and the interest suspense account credited with the interest
of the current year annually. Interest account at the end of every year is closed off through
transfer to the income statement.
✓ The balance of the interest suspense account i.e., debit balance is shown in the statement of
the financial position on the asset side. The vendor is paid the instalment due to him and the
depreciation entry passed in the usual way.
• In the sellers’ books.
Dr. Purchaser a/c with full instalment price payable by him.
Cr. Interest suspense a/c with difference between full cash price and full instalment price
Cr. Sales a/c with full cash price.
The seller transfers the amount of interest due from the interest suspense account to the interest
account annually. Interest account is closed by transferring to the income statement and the
balance of interest suspense account is shown in the statement of financial position on the
liability side.
On receiving the instalment:
Dr. Cash/bank a/c
Cr. Purchase a/c
Accounting for hire purchase
Accounting treats assets bought on hire purchase as though they belonged immediately to the
purchaser. One buys assets on hire purchase with the intention of paying all instalments so as
to own the asset in the end. The total purchase price is split into two parts for the financial
statements:
1. Cash price – is the amount to be debited to the fixed assets a/c.
2. Interest – is an expense of borrowing money and needs charging to an expense a/c (hire
purchase interest a/c).
Note: the main challenge in hire purchase transactions is writing off of the hire purchase
interest.

Accounts maintained in buyers’ books.

i. Asset a/c
ii. Hire purchase liability a/c or hire purchase vendor a/c or hire purchase sellers a/c
iii. Interest expense a/c
iv. Depreciation a/c (provision).
Accounting entries in the books of the buyer:
a. On purchase of the asset on hire purchase
Dr. Asset a/c xx
Cr. Hire purchase liability xx
b. To record deposit on hire purchase transaction.
Dr. hire purchase liability a/c xx
Cr. Bank a/c xx
c. To recognise interest expense on hire purchase.
Dr. Interest expense a/c xx
Cr. Hire purchase liability/vendor a/c xx
d. To record instalment paid when due.
Dr. hire purchase liability/vendor a/c xx
Cr. Bank/cash a/c xxx
e. To record depreciation expense for the period.
Dr. depreciation a/c xx
Cr. Asset a/c xx
f. To close the interest expense a/c to income statement
Dr. Income statement xx
Cr. Interest expense a/c xx
g. To recognise depreciation expense in the income statement
Dr. income statement a/c xx
Cr. Depreciation expense a/c xx

Accounts maintained in sellers’ books.

a. Hire purchase debtors a/c
b. Hire purchase sales a/c
c. Hire purchase trading a/c
d. Interest income/receivable a/c
e. Repossession a/c
f. Provision for unrealised profit a/c
Accounting entries in the books of the seller:
1. To record sale of items on hire purchase with the cash price:
Dr. Hire purchase debtor’ a/c xx
Cr. Hire purchase sales a/c xx
2. To record deposits received from buyer:
Dr. bank a/c xx
Cr. Hire purchase debtor’ a/c xx
3. To account for interest income receivable:
Dr. Hire purchase debtor’ a/c xx
Cr. Interest income receivable a/c xx
4. To record instalments received when due:
Dr. Bank a/c xx
Cr. Hire purchase debtor’s a/c xx
5. Close the interest income a/c to income statement:
Dr. interest income/Receivable a/c xx
Cr. Income statement xx
6. Close the hire purchase sales a/c to the trading a/c
Dr. Hire purchase sales a/c xx
Cr. Hire purchase trading a/c xx

• Methods of computing Hire Purchase interest.

Hire purchase interest is an element of the hire purchase price which must be written off as an
expense over the life of the contract. The interest should be written off during the contract
period in such a way as to produce a constant periodic rate of return on the remaining balance
of the interest exclusive liability for each period.
Methods used to apportion interest:
a. Actuarial method – interest percentage rate has to be obtained from the actuarial tables,
or by using a mathematical model or by trial and error.
b. Sum of digits method – interest is written off over accounting periods on a reducing
method based on digits. To arrive at the total digits for each period end, the remaining
number of individual periods over which the contract is then outstanding are added
together. The interest written off in any period is that period’ proportion of the total.

Illustration:
BFK bought an asset on hire purchase terms. Instalments were due each quarter for 3 years.
The hire purchase interest included in the hire purchase price was sh.780,000.
Required: Calculate the amount of interest to be written off in each quarterly period assuming:
1. Instalments were paid at the end of quarter.
2. Instalments were paid at the beginning of each quarter.
Solution:
1. Instalments paid end of quarter:
Quarter Number of periods Hire purchase
Number outstanding (digits) Fraction interest written off
1 120 120/780 x 780,000 120,000.00
2 110 110/780 x 780,000 110,000.00
3 100 100/780 x 780,000 100,000.00
4 90 90/780 x 780,000 90,000.00
5 80 80/780 x 780,000 80,000.00
6 70 70/780 x 780,000 70,000.00
7 60 60/780 x 780,000 60,000.00
8 50 50/780 x 780,000 50,000.00
9 40 40/780 x 780,000 40,000.00
10 30 30/780 x 780,000 30,000.00
11 20 20/780 x 780,000 20,000.00
12 10 10/780 x 780,000 10,000.00
780 780,000.00

2. Instalments paid at beginning of quarter:

Quarter Number of periods Hire purchase
Number outstanding (digits) Fraction interest written off
1 110 110/660 x 780,000 130,000.00
2 100 100/660 x 780,000 118,181.82
3 90 90/660 x 780,000 106,363.64
4 80 80/660 x 780,000 94,545.45
5 70 70/660 x 780,000 82,727.27
6 60 60/660 x 780,000 70,909.09
7 50 50/660 x 780,000 59,090.91
8 40 40/660 x 780,000 47,272.73
9 30 30/660 x 780,000 35,454.55
10 20 20/660 x 780,000 23,636.36
11 10 10/660 x 780,000 11,818.18
12 0 10/660 x 780,000 -
660 780,000.00
Example 1:
MK bought equipment from QN on hire purchase system on 1 January 2019. The cash price
was sh.500,000. The hire purchase terms provided for a deposit of sh.200,000 and the balance
in 3 equal annual instalments of sh.150,000 payable on 31 December each year. Assume the
interest rate to be 10%.
Required:
Prepare the necessary accounts in the books of the buyer and seller. Apportion interest using:
1. Sum of year digits
2. Actuarial method
Solution.
Cash price = sh. 500,000
Deposit = sh.200,000
Instalments = sh. 150,000x3 = sh.450,000
Interest = hire purchase price – cash price
Hire purchase price = deposit + instalments = 200,000+450,000 = 650,000
Interest = sh. 650,000-500,000 = sh.150,000

1. Sum of digits method in computing interest.

Quarter Number of periods outstanding Hire purchase
Number (digits) Fraction interest written off
1 3 3/6 x 150,000 75,000.00
2 2 2/6 x 150,000 50,000.00
3 1 1/6 x 150,000 25,000.00
6 150,000.00

2. Actuarial method in computing interest.

Cash price 500,000.00
Less: Deposit - 200,000.00
Loan amount 300,000.00
Add interest rate 10% (300,000x10%) 30,000.00
Less 1st instalment plus interest - 150,000.00
Balance 180,000.00
Add 2nd interest at 10% 18,000.00
Less 2nd instalment p - 150,000.00
48,000.00
Add 3rd interest rate 10% 4,800.00
Less 3rd instlamnet - 150,000.00
Balance - 97,200.00

In the books of the buyer

Equipment Account
Sh. Sh.
2019 2019
Hire purchase vendor a/c 500,000.00 Balance c/d 500,000.00
2020 2020
Balance b/d 500,000.00 Balance c/d 500,000.00
2021 2021
Balance b/d 500,000.00 Balance c/d 500,000.00
 Hire Purchase Vendor/Liability Account
Sh. Sh.
2019 2019
Bank deposit 200,000 Equipment a/c 500,000
Bank (instalment) 150,000 Interest suspense a/c 150,000
Balance c/d 300,000
650,000 650,000
2020 2020
Bank (instalment) 150,000 Balance b/d 300,000
Balance c/d 150,000
300,000 300,000
2021 2021
Bank (instalment) 150,000 Balance b/d 150,000

Interest Suspense Account

Sh. Sh.
2019 2019
Hire purchase vendor/liability a/c 150,000 Interest suspense a/c 75,000
Balance c/d 75,000
150,000 150,000
2020 2020
Balance b/d 75,000 Interest suspense a/c 50,000
Balance c/d 25,000
75,000 75,000
2021 2021
Balance b/d 25,000 Interest suspense a/c 25,000

Interest Expense Account

Sh. Sh.
2019 2019
Interest expense a/c 75,000.00 Profit and loss a/c 75,000.00
2020 2020
Interest expense a/c 50,000.00 Profit and loss a/c 50,000.00
2021 2021
Interest expense a/c 25,000.00 Profit and loss a/c 25,000.00

Books of the seller

Hire purchase debtor’s account
Sh. Sh.
2019 2019
Hire purchase sales a/c 500,000 Bank (deposit) 200,000
Interest suspense a/c 150,000 Bank instalment 150,000
Balance c/d 300,000
650,000 650,000
2020 2020
Balance b/d 300,000 Bank (instalment) 150,000
Balance c/d 150,000
300,000 300,000
2021 2021
Balance b/d 150,000 Balance c/d 150,000
 Hire purchase sales account
Sh. Sh.
Hire purchase trading a/c 500,000 Hire purchase debtors 500,000

Interest Suspense Account

Sh. Sh.
2019 2019
Interest expense a/c 75,000 Hire purchase debtors a/c 150,000
Balance c/d 75,000
150,000 150,000
2020 2020
Interest expense a/c 50,000 Balance b/d 75,000
Balance c/d 25,000
75,000 75,000
2021 2021
Interest expense a/c 25,000 Balance b/d 25,000

Interest Expense Account

Sh. Sh.
2019 2019
Profit and loss a/c 75,000.00 Interest expense a/c 75,000.00
2020 2020
Profit and loss a/c 50,000.00 Interest expense a/c 50,000.00
2021 2021
Profit and loss a/c 25,000.00 Interest expense a/c 25,000.00

Example 2:
Posha bought two cars on 1 January 2018 from Kay Ltd on hire purchase system. The cost for
each car was sh.800,000 which was payable with a deposit of sh.170,000 and the balance in
three equal instalments plus interest at a rate of 10%. The original cost of each of the vehicles
from the manufacturer was sh.640,000. Prepare the necessary accounts in the books of both the
buyer and the seller (the actuarial method is used to apportion interest and instalment method
to recognise interest).
Cash price = sh.1,600,000
Hire purchase price = deposit + instalment
Instalment = (cash price-deposit)/3
=(1,600,000-340,000)/3
=sh.420,000
Interest by use of actuarial method:
Sh.
Loaned amount 1,260,000
Add: instalment interest @10% 126,000
1,386,000
Less: 1st instalment paid (420,000+126,000) (546,000)
Amount balance 840,000
Add 2nd instalment interest @10% 84,000
924,000
Less: 2nd instalment paid (420,000+84,000) (504,000)
Amount owing 420,000
 Add 3rd instalment interest @10% 42,000
462,000
Less: 3rd instalment paid – final (420,000+42,000) (462,000)
0

In the books of the buyer

Motor vehicle a/c
Sh. Sh.
2018 2018
Hire purchase liability a/c 1,600,000 Balance c/d 1,600,000
2019 2019
Balance b/d 1,600,000 Balance c/d 1,600,000
2020 2020
Balance b/d 1,600,000 Balance c/d 1,600,000
Hire purchase liability a/c
Sh. Sh.
2018 2018
Bank (deposit) 340,000 Motor vehicle a/c 1,600,000
Bank (instalment) 546,000 Interest expense a/c 126,000
Balance c/d 840,000
1,726,000 1,726,000
2019 2019
Bank (instalment) 504,000 Balance b/d 840,000
Balance c/d 420,000 Interest expense a/c 84,000
924,000 924,000
2020 2020
Bank (instalment) 462,000 Balance b/d 420,000
Interest expense a/c 42,000
462,000 462,000
Interest expense a/c
Sh. Sh.
2018 2018
Hire purchase liability a/c 126,000 Profit and loss 126,000
2019 2019
Balance b/d 84,000 Profit and loss 84,000
2020 2020
Balance b/d 42,000 Profit and loss 42,000
In the books of the buyer
Hire purchase debtors a/c
Sh. Sh.
2018 2018
Hire purchase sales a/c 1,600,000 Bank (deposit) 340,000
Interest income a/c 126,000 Bank (instalment) 546,000
Balance c/d 840,000
1,726,000 1,726,000
2019 2019
Balance b/d 840,000 Bank (instalment) 504,000
Interest income a/c 84,000 Balance c/d 420,000
924,000 924,000
2020 2020
 Balance b/d 420,000 Bank (instalment) 462,000
Interest expense a/c 42,000
462,000 462,000

Hire purchase sales a/c

Sh. Sh.
2018 2018
Hire purchase trading a/c 1,600,000 Hire purchase debtor’ a/c 1,600,000

Interest income a/c

Sh. Sh.
2018 2018
Profit and loss a/c 126,000 Hire purchase debtor’ a/c 126,000
2019 2019
Profit and loss a/c 84,000 Hire purchase debtor’ a/c 84,000
2020 2020
Profit and loss a/c 42,000 Hire purchase debtor’ a/c 42,000

Hire purchase trading a/c (vertical format)

Sh.
Hire purchase sales 1,600,000
Less: cost of sales (640,000x2) (1,280,000)
Gross profit 320,000

Realised profits:
2018
Realised profit = HP sales-HP debtors x Gross profit
HP sales
= (1,600,000-840,000) x 320,000
1,600,000
= 152,000

2019 = (1,600,000-420,000) x 320,000

1,600,000
= 236,000

2020 = (1,600,000-0) x 320,000

1,600,000
= 320,000
Unrealised profits:
2018
Unrealised profit = HP debtors x Gross profit
HP sales
= 840,000/1,600,000 X 320,000 = 168,000

2019 =420,000/1,600,000 X 320,000 = 84,000

2020 - 0
Provision for unrealised profits a/c
Sh. Sh.
2018 2018
Income statement-realised profit 152,000 Balance c/d 0
Balance c/d 168,000 Hire purchase trading a/c 320,000
320,000 320,000
2019 2019
Income statement -realised profit (236-152) 84,000
Balance b/d 84,000 Balance c/d 168,000
168,000 168,000
2020 2020
Income statement – realised 84,000 Balance c/d 84,000

Statement of financial position extract

Sh. Sh.
Assets:
Current assets
2018
Hire purchase debtors 840,000
Less provision for unrealised profits (168,000) 672,000
2019
Hire purchase debtors 420,000
Less provision for unrealised profits (84,000) 336,000

• Accounting for Repossession.

Under hire purchase agreement the vendor transfers the possession of goods and not ownership.
If the purchaser fails to pay to the last instalment, the vendor has the legal right to recover the
possession of the goods. The act of recovery is called repossession. The amount paid by the
purchaser will be retained by the vendor. The repossessed items should be entered in the books
of the seller because they are part of his stock but would not be valued as new stock. The items
must be valued as used goods.

Rights of the hire purchase vendor

1. To terminate hire purchase agreement: where the buyer makes more than one default in
instalment payment as provided in the agreement, the seller shall be entitled to
terminate the agreement by giving notice of termination in writing.
2. On termination: where a hire purchase agreement is terminated, the seller shall be
entitled to:
✓ Enter the premises of the buyer and seize the goods.
✓ Retain the hire charges paid and to recover the arrears of hire charges due.
✓ Claim damages for non-delivery of the goods.

Restrictions of the owner

1. Rights of hirer in case of seizure of goods by the owner – where the owner seizes the
goods lent under hire purchase agreement, the hirer may recover from the owner
amount, if any, by which the hire purchase price falls short of the aggregate of two
amounts:
✓ The amounts paid in respect of the hire purchase price up to the date of seizure;
and
 ✓ The value of the goods on the date of seizure.
2. Restrictions on owner’ right to repossess - where goods have been let under a hire
purchase agreement, and the statutory amount of the hire purchase price has been paid,
the owner shall not enforce any right to recover possession of the goods from the hirer
otherwise than by verdict of any competent court.
If the buyer fails to pay any of the instalments, the hire vendor can take back the possession of
the goods. The amount already paid to the vendor as part payment for the asset is treated as the
hire charge. The vendor can either repossess the asset in whole or partially.

Types of repossession:
a. Complete repossession
b. Partial repossession

Books of the hire purchaser:

a. Complete repossession
The entries of hire purchase interest would be passed as usual to the date of default. The buyer
will close the account of the seller b transferring the balance in the asset account:
Dr. Hire purchase vendor a/c xx
Cr. Asset a/c xx
The buyer will also close the accumulated depreciation a/c by transferring it to the account:
Dr. Accumulated depreciation a/c xx
Cr. Assets a/c xx
Any remaining balance in the asset a/c will be closed to the income statement as either a profit
or loss.
b. Partial repossession
The entries will be passed to the books of the buyer and the buyer will close the account of the
seller. The buyer will adjust the asset at cost to reflect a balance to be carried forward which
should be equal to the historical cost of the not repossessed. All account balances will be closed
to the asset a/c and profit or loss ascertained.

Books of the hire purchase vendor

On repossession, the seller will close the a/c of the buyer by transferring the balance to goods
repossessed a/c or repossession a/c.
Dr. Repossession a/c xx
Cr. Hire purchase debtor’ a/c with balance amount unpaid xx

The repossession a/c will further be debited with repair overhaul or reconditioning expenses
and it will also be credited with a resale if any.
With repair cost overhaul/reconditioning
Dr. Repossession a/c xx
Cr. Bank a/c xx
With cash proceeds on resale
Dr. bank a/c xx
Cr. Repossession a/c xx

Illustration:
Ruby purchased from Kiki four cars costing sh.1,500,000 each on hire purchase system.
Payment was to be made: sh.900,000 as down payment and balance in three equal instalments
together with interest at 10% p.a. Ruby provided depreciation at 20% p.a. on reducing balance
method. Ruby paid the first instalment at the end of the first year but could not pay the second
instalment. Kiki took possession of all the four cars and spent sh.300,000 on repairs and sold
them for sh.1,800,000.

Required: Show the necessary ledger accounts in the books of both parties.

Solution:
In the Books of Hire Purchaser:
Workings:
1. Depreciation:
Sh.
Year 1.: Cost of 4 cars 6,000,000
Depreciation @20%p.a. 1,200,000
Write down value 4,800,000
Year 2: write down value 4,800,000
Depreciation @20%p.a. 960,000
Write down value 3,840,000
2. Instalment per annum:
Cost – down payment = instalment value
6,000,000 – 900,000 = sh.5,100,000
5,100,000= 1,700,000
3
3. Interest:
Sh.
Year 1: total instalments 5,100,000
Interest @10% 510,000

Year 2: instalments 3,400,000

Interest @10% 340,000

Cars a/c
Sh. Sh.
Year 1: hire purchase vendor a/c 6,000,000 Depreciation 1,200,000
Balance c/d 4,800,000
6,000,000 6,000,000

Year 2: balance b/d 4,800,000 Depreciation 960,000

Hire purchase vendor a/c 3,740,000
Income statement: loss 100,000
4,800,000 4,800,000
Depreciation a/c
Sh. Sh.
Year 1: Cars a/c 1,200,000 Balance c/d 1,200,000
Year 2: Balance b/d 1,200,000
Cars a/c 960,000 Balance c/d 2,160,000
Hire purchase vendor a/c
Sh. Sh.
Year 1: Cash a/c 900,000 Cars a/c 6,000,000
Cash a/c (instalment + interest). 2,210,000 Interest a/c 510,000
 Balance c/d 3,400,000
6,510,000 6,510,000
Year 2: Cars a/c 3,740,000 Balance b/d 3,400,000
Interest a/c 340,000
3,740,000 3,740,000

Interest a/c
Sh. Sh.
Year 1: hire purchase vendor a/c 510,000 Income statement 510,000
Year 2: hire purchase vendor a/c 340,000 Income statement 340,000

In the books of hire purchase vendor:

Hire purchaser a/c
Sh. Sh.
Year 1: Cars a/c 6,000,000 Cash a/c 900,000
Interest a/c 510,000 Cash a/c – instalment + interest 2,210,000
Balance c/d 3,400,000
6,510,000 6,510,000
Year 2: balance b/d 3,400,000
Interest a/c 340,000 Goods repossessed a/c 3,740,000
3,740,000 3,740,000

Goods repossessed a/c

Sh. Sh.
Hire purchase a/c 3,740,000 Cash – sales 1,800,000
Cash a/c – repairs 300,000 Income statement loss 2,240,000
4,040,000 4,040,000

Illustration: Partial repossession

Keiyo Ltd purchased 2 tractors of sh.900,000 each on hire purchase system paying a deposit of
sh.300,000 and remainder in three equal instalments of sh.650,000 each together with interest
at 5% p.a. The company writes off depreciation at 10% p.a. on reducing balance method. Keiyo
Ltd could not pay the second instalment. The vendor left one tractor with Keiyo Ltd adjusting
the value of the other against amount due taking the tractor at 20% depreciation at reducing
balance method.
Required: show the necessary ledger account in the books of Keiyo Ltd.

Solution:
Workings:

1. Depreciation
Sh.
Year 1: cost 1,800,000
Depreciation @10% (180,000)
Written down value 1,620,000
Year 2: Written down value 1,620,000
Depreciation @10% (162,000)
Written down value 1,458,000
 2. Instalment p.a.
Instalment value = cost – down payment
=1,800,000-300,000 = 1,500,000
=1,500,000/3 yrs = 500,000
3. Interest
Sh.
Year 1: Total instalments 1,500,000
Interest at 5% 75,000

Year 2: Instalments due 1,000,000

Interest at 5% 50,000
4. Revised price of repossessed tractor
Sh.
Cash price 900,000
Depreciation @20% (180,000)
Written down value 720,000
Year 2: Written down value 720,000
Depreciation @20% (144,000)
Written down value 576,000
5. Value of retained tractor
Sh.
Cash price 900,000
Depreciation @10% (90,000)
Written down value 810,000
Year 2: Written down value 810,000
Depreciation @10% (81,000)
Written down value 729,000

In the books of hire purchaser:

Tractor a/c
Sh. Sh.
Year 1: Hire purchase vendor a/c 1,800,000 Depreciation 180,000
Balance c/d 1,620,000
1,800,000 1,800,000

Year 2: Balance b/d 1,620,000 Depreciation 144,000

HP vendor a/c – repo. tractor 576,000
Income statement: loss 171,000
Balance c/d – retained tractor 729,000
1,620,000 1,620,000
Depreciation a/c
Sh.’000 Sh.’000
Year 1: Tractor a/c 180,000 Balance c/d 180,000

Year 2: Balance b/d 180,000 Balance c/d 342,000

Tractors a/c 162,000
342,000 342,000
 Hire purchase vendor a/c
Sh. Sh.
Year 1: Cash a/c 300,000 Tractor a/c 1,800,000
Cash a/c (instalment +interest) 725,000 Interest a/c 75,000
Balance c/d 850,000
1,875,000 1,875,000
Year 2: Tractor a/c-rep. tractor 576,000 Balance b/d 850,000
Balance c/d 324,000 Interest a/c 50,000
900,000 900,000

Interest a/c
Sh. Sh.
Year 1: hire purchase vendor a/c 75,000 Income statement 75,000
Year 2: hire purchase vendor a/c 50,000 Income statement 50,000