{m}.{s}.1Hire purchase

A hire purchase contract is a contract for the hire of an asset with a provision for the hirer to acquire ownership, usually by payment of a small acceptance fee, with the last instalment. Legal title does not actually pass to the hirer until all instalments have been paid.

Though legally the hirer does not actually own the asset until the end of the agreement, in effect hire purchase is analogous to buying an asset and receiving a loan at the date the agreement is signed.

Accounting for buying an asset on hire purchase follows the substance rather than the legal form of the transaction with the item being included as an asset of the business hiring it. This is an example of the concept of substance over form.

The required accounting entries at the date a hire purchase agreement is signed are:

  1. The asset is capitalised as with any normal asset purchase. (It will subsequently be depreciated in the normal way).
  2. The amount of the hire purchase "loan" is included as a hire purchase creditor.

Payments, usually monthly, will be made to the hire purchase company to pay off the "loan". In addition to the capital element of the monthly instalment, hire purchase charges, (equivalent to loan interest) must also be paid. These will be an expense of the business and will be debited to an expense account for Hire purchase charges. Note that, as with bank interest, no VAT is charged on HP interest.

{m}.{s}.2Hire purchase example: Agreement

On 30 June 2008 Mr Waterman enters into a hire purchase agreement with the Weller Finance Co for a new car for use in his plumber's business. Below the numbers on the agreement are described:

8260 The basic price of the car. This figure includes VAT (which cannot be reclaimed by Mr Waterman).
1420 The deposit paid at the outset by Mr Waterman.
7200 The hire purchase "loan".
1728 The HP interest/charges. (Note that the true rate of interest is a lot higher than 8% as this is applied to the original, not the reducing balance of capital).
8928 Total of capital and interest to be paid over the next 3 years in 36 instalments.
248 The monthly instalment to be paid to the HP company. This will be partly repayment of capital and partly the repayment of interest/charges.

There are various ways of allocating the interest over the 36 instalments. The easiest way is to assume that it is spread evenly over the 3 years i.e. each instalment contains an equal amount of interest:

Capital to be repaid:
£7200/36 = £200 per instalment
Interest to be paid in total:
£1728/36 = £48 per instalment
Total instalment = £248
Weller Finance Co
Leasing Agreement
  Lesee:  
  Mr Waterman, plumber
Canal St
Wellingborough
 
 
  Agreement date 30/06/08    
  Cash price (inc VAT)- Car 8,620    
  less: Deposit 1,420    
  Amount of credit 7,200    
  add interest 3 years @ 8% 1,728    
         
    8,928    
  Repayable by 36 monthly payments of 248    
  Commencing 30/07/08    
 
[{m}.{s}a]

{m}.{s}.3

Hire purchase example: Double entry

We must make postings to the asset account and the Bank account.

We will also need 2 new accounts:

  • HP creditor (a liability)
  • HP interest (an expense)
HP Details
 £
Cash price 
Deposit 
  
Interest 
  
  
Each instalment 
  Capital 
  Interest 
  
  
Motor car - cost
     
       
       
      
HP Creditor
     
       
       
      
Bank
     
       
       
      
HP interest
     
       
       
      
[{m}.{s}b]

Hire purchase example: Payment of deposit

[{m}.{s}c]

Hire purchase example: Outstanding liability

[{m}.{s}d]

Hire purchase example: Asset balance

HP Details
 £
Cash price8,620
Deposit1,420
 7,200
Interest1,728
 8,928
  
Each instalment 
  Capital200
  Interest48
 248
  
Motor car - cost
30 Jun Bank1,420  
30 Jun HP7,200    
       
      
HP Creditor
   30 Jun Car7,200
       
       
      
Bank
   30 Jun Car1,420
       
       
      
HP interest
     
       
       
      

[{m}.{s}e]

Note that the full cash price is now recorded in the asset account: £1,420 + £7,200 = £8,620

This will be treated just like any other asset of the business, even though it is not actually legally owned until the last payment is made.

It will be depreciated in the normal way, and will appear in the balance sheet along with the other assets of the business.

Hire purchase example: HP Creditor balance

HP Details
 £
Cash price8,620
Deposit1,420
 7,200
Interest1,728
 8,928
  
Each instalment 
  Capital200
  Interest48
 248
  
Motor car - cost
30 Jun Bank1,420  
30 Jun HP7,200    
       
      
HP Creditor
   30 Jun Car7,200
       
       
      
Bank
   30 Jun Car1,420
       
       
      
HP interest
     
       
       
      

[{m}.{s}f]

The amount now recorded in the HP creditor account is the amount of credit obtained from the HP company.

This is the amount of capital that will be repaid over the period of the agreement.

Over the same period, interest will also be paid. This, however, has nothing to do with the capital outstanding and does not affect the HP creditor account.

Hire purchase example: First instalment

[{m}.{s}g]

Hire purchase example: Further repayments

Similar repayments will be recorded on 30 August and 30 September, when Mr Waterman will be ready to prepare his annual accounts.

HP Details
 £
Cash price8,620
Deposit1,420
 7,200
Interest1,728
 8,928
  
Each instalment 
  Capital200
  Interest48
 248
  
Motor car - cost
30 Jun Bank1,420  
30 Jun HP7,200    
       
      
      
HP Creditor
30 Jul Bank20030 Jun Car7,200
30 Aug Bank200    
30 Sep Bank200    
      
      
Bank
   30 Jun Car1,420
    30 Jul HP 248
    30 Aug HP 248
    30 Sep HP 248
      
HP interest
30 Jul Bank48  
30 Aug Bank48   
30 Sep Bank 48    
      
      

[{m}.{s}h]

Hire purchase example: HP interest balance

[{m}.{s}i]

Hire purchase example: HP Creditor balance

Motor car - cost
30 Jun Bank1,420  
30 Jun HP7,200    
       
      
      
      
HP Creditor
30 Jul Bank20030 Jun Car7,200
30 Aug Bank200    
30 Sep Bank200    
30 Sep Bal c/d 6,600   
  7,200  7,200
    1 Oct Bal b/d 6,600
Bank
   30 Jun Car1,420
    30 Jul HP 248
    30 Aug HP 248
    30 Sep HP 248
      
      
HP interest
30 Jul Bank4830 Sep P&L144
30 Aug Bank48   
30 Sep Bank 48    
  144  144
      
      

[{m}.{s}j]

The balance in the HP creditor account will show in the balance sheet as a liability.

Technically, part of this balance is a current liability:
(12 x £200 = £2,400 which will be repaid inside the next year),

and part is a long-term liability:
(21 x £200 = £4,200 which will be repaid later than one year).

This split will be necessary for company accounts, but for the sole trader the balance will probably just be shown as a long-term liability.

Balance sheet
LONG-TERM LIABILITIES  
Bank loan 14,222
HP Creditor 6,600
  20,822
   
[{m}.{s}k]

Hire purchase: Asset balance

Motor car - cost
30 Jun Bank1,42010 Oct Bal b/d8,620
30 Jun HP7,200    
  8,620  8,620
30 Sep Bal c/d 8,620   
      
      
HP Creditor
30 Jul Bank20030 Jun Car7,200
30 Aug Bank200    
30 Sep Bank200    
30 Sep Bal c/d 6,600   
  7,200  7,200
    1 Oct Bal b/d 6,600
Bank
   30 Jun Car1,420
    30 Jul HP 248
    30 Aug HP 248
    30 Sep HP 248
      
      
HP interest
30 Jul Bank4830 Sep P&L144
30 Aug Bank48   
30 Sep Bank 48    
  144  144
      
      

[{m}.{s}l]

The motor car will show as an asset, at the cash price of £8,620. This will be depreciated in the same way as other assets in its class.

{m}.{s}.4Hire purchase: VAT

Note that, if we are purchasing an asset on which we can claim back the VAT, the deposit will usually be treated as including the full VAT charge. For example, purchase of a van [right].

The payment of the deposit will be treated as including the VAT of £600. The balance of £900 will be payment of part of the cash price.

This will be recorded:

2008   Dr Cr
June 30 Motor van 900  
  VAT 600  
  Bank   1,500
Payment of deposit on van
[{m}.{s}m]

The HP creditor will be recorded:

2008   Dr Cr
June 30 Motor van 5,100  
  HP creditor   5,100
Balance of cost of van on hire purchase
[{m}.{s}n]

Note that we now have the full cash price recorded in the Motor van account:
£900 + £5,100 = £6,000.

Weller Finance Co
Hire Purchase Agreement
  Customer:  
  Mr Whitehouse, builder
South St Yard
Northampton
 
 
  Agreement date 30/06/08    
  Cash price - Van 6,000    
  VAT 600    
    6,600    
  less: Deposit 1,500    
  Amount of credit 5,100    
  add: Interest 1,400    
    6,500    
         
  Repayable by monthly payments of 180    
  Commencing 30/07/08    
 
[{m}.{s}o]