Chapter 5.1: Accounting for Hire Purchase and Installment Payment Systems

2.1 Hire Purchase System

 

 2.1.1 Concept of Hire Purchase

The hire purchase system is a method of acquiring assets where the buyer agrees to pay for the goods in installments. The buyer gets possession and use of the asset immediately but does not become the owner until all installments have been paid. The ownership of the asset remains with the seller until the final payment is made. If the buyer defaults on any installment, the seller has the right to repossess the asset.

 

 2.1.2 Features of Hire Purchase

- Immediate Possession: The buyer gets immediate possession and use of the asset upon agreement.

- Ownership Transfer: Ownership of the asset transfers to the buyer only after all installments are paid.

- Installment Payments: The total cost of the asset is paid in installments, which include both the principal amount and interest.

- Right to Repossess: The seller has the right to repossess the asset if the buyer defaults on any installment.

- Depreciation: Depreciation is charged by the buyer as they use the asset during the hire purchase period.

 

In India, the hire purchase system is commonly used for the sale of consumer durables such as vehicles, electronics, and home appliances. It provides a convenient financing option for consumers who may not have the immediate funds to purchase these items outright. The legal framework for hire purchase agreements in India is governed by the Hire Purchase Act, 1972, which outlines the rights and obligations of both the buyer and the seller.

 

 2.2 Installment Payment System

 

 2.2.1 Concept of Installment Payment System

The installment payment system is a method of acquiring assets where the buyer agrees to pay for the goods in regular installments. Unlike hire purchase, the ownership of the asset transfers to the buyer immediately upon signing the agreement. The seller retains a security interest in the asset until the buyer completes all payments.

 

 2.2.2 Features of Installment Payment System

- Immediate Ownership: Ownership of the asset transfers to the buyer immediately upon agreement.

- Installment Payments: The cost of the asset is paid in installments over a period.

- Security Interest: The seller retains a security interest in the asset until all installments are paid.

- Depreciation: The buyer charges depreciation on the asset as they become the owner upon purchase.

 

In India, the installment payment system is widely used for the purchase of real estate properties, vehicles, and high-value consumer goods. Financial institutions, such as banks and non-banking financial companies (NBFCs), often provide installment payment plans to consumers, making it easier for them to manage their finances while acquiring necessary assets.

 

 2.3 Accounting Treatment of Hire Purchase

 

 2.3.1 Accounting Entries in the Books of the Buyer

1. At the Time of Agreement:

   - No entry is made at this stage as the buyer does not yet own the asset.

 

2. On Payment of Each Installment:

   - Interest Component: The interest portion of the installment is treated as an expense and debited to the interest account.

   - Principal Component: The principal portion of the installment is debited to the asset account.

 

   Example Entries:

  

   Interest Account          Dr.

   Asset Account             Dr.

       To Hire Vendor Account

   (Being the installment paid including interest and principal)

  

 

3. Depreciation:

   - Depreciation is charged on the asset based on the buyer's accounting policy.

 

   Example Entry:

  

   Depreciation Account      Dr.

       To Asset Account

   (Being depreciation charged on the asset)

  

 

4. Final Payment and Transfer of Ownership:

   - On payment of the final installment, the buyer gains ownership, and the hire vendor account is settled.

 

   Example Entry:

  

   Hire Vendor Account       Dr.

       To Cash/Bank Account

   (Being the final installment paid, ownership transferred)

  

 

 2.3.2 Accounting Entries in the Books of the Seller

1. At the Time of Agreement:

   - The seller records the sale and recognizes the asset as hire purchase debtors.

 

   Example Entry:

  

   Hire Purchase Debtors Account   Dr.

       To Sales Account

   (Being the asset sold on hire purchase)

  

 

2. On Receipt of Each Installment:

   - Interest Component: Recognized as revenue.

   - Principal Component: Reduces the hire purchase debtors account.

 

   Example Entries:

  

   Cash/Bank Account         Dr.

       To Interest Account

       To Hire Purchase Debtors Account

   (Being the installment received including interest and principal)

  

 

3. Repossession (if buyer defaults):

   - The asset is brought back into inventory, and any loss/gain is recognized.

 

   Example Entry:

  

   Asset Account             Dr.

       To Hire Purchase Debtors Account

       To Repossession Loss/Gain Account

   (Being the asset repossessed upon default)

  

 

 2.4 Stock and Debtors System in Hire Purchase

 

 2.4.1 Concept of Stock and Debtors System

Under the stock and debtors system, the seller maintains control over the stock (goods on hire purchase) and treats it as an asset until it is fully paid for by the buyer. The hire purchase transactions are recorded using the stock and debtors account, hire purchase adjustment account, and the hire purchase debtors account.

 

 2.4.2 Accounting Treatment

1. At the Time of Sale:

   - Record the sale at the hire purchase price.

 

   Example Entry:

  

   Hire Purchase Stock Account   Dr.

       To Stock Account

   (Being the goods transferred to hire purchase stock)

  

 

2. Installment Due:

   - Record the amount due from the buyer.

 

   Example Entry:

  

   Hire Purchase Debtors Account Dr.

       To Hire Purchase Stock Account

   (Being the installment due from hire purchase debtors)

  

 

3. Installment Received:

   - Record the receipt of the installment.

 

   Example Entry:

  

   Cash/Bank Account             Dr.

       To Hire Purchase Debtors Account

   (Being the installment received from hire purchase debtors)

  

 

4. Interest Accrued:

   - Record the interest accrued on the installment.

 

   Example Entry:

  

   Hire Purchase Debtors Account Dr.

       To Interest Account

   (Being the interest accrued on hire purchase installment)

  

 

5. Reconciliation:

   - Regularly reconcile the hire purchase stock account, debtors account, and the adjustment account to ensure accuracy.

 

 2.5 Legal Framework and Practices in India

 

In India, the hire purchase and installment payment systems are governed by various legal provisions and regulatory guidelines to protect the interests of both buyers and sellers. The key legislation includes:

 

 2.5.1 The Hire Purchase Act, 1972

The Hire Purchase Act, 1972, governs hire purchase agreements in India. It outlines the rights and duties of both the hire purchaser and the hire vendor. Key provisions include:

- Hire Purchase Agreement: The Act requires that hire purchase agreements be in writing and signed by both parties.

- Statements of Hire Purchase: The seller must provide a statement to the buyer detailing the cash price, hire purchase price, and the amounts of installments.

- Repossession: The Act outlines the conditions under which the seller can repossess the goods and the buyer's right to recover any excess payments made.

 

 2.5.2 Indian Contract Act, 1872

The Indian Contract Act, 1872, governs the formation and enforcement of contracts in India, including hire purchase and installment payment agreements. It ensures that such agreements are legally binding and enforceable.

 

 2.5.3 Consumer Protection Act, 2019

The Consumer Protection Act, 2019, provides safeguards to consumers against unfair trade practices, including those related to hire purchase and installment payment systems. It ensures that consumers are well-informed and protected against exploitation.

 

 2.6 Impact on Financial Statements

 

 2.6.1 Buyer’s Perspective

- Balance Sheet: The asset acquired under hire purchase is recognized in the balance sheet, initially at the cash price. The corresponding liability is recorded under hire purchase creditors.

- Profit and Loss Account: Installments paid include both interest and principal components. Interest is charged to the profit and loss account, while the principal reduces the liability.

 

 2.6.2 Seller’s Perspective

- Balance Sheet: Hire purchase receivables are recorded as an asset. The value of the receivables reduces as installments are received.

- Profit and Loss Account: Interest income from installments is recognized as revenue over the hire purchase period.

 

 2.7 Advantages and Limitations

 

 2.7.1 Advantages

- For Buyers:

  - Immediate use of the asset without full payment upfront.

  - Flexibility in managing cash flows with installment payments.

  - Option to purchase high-value items that may be otherwise unaffordable.

 

- For Sellers:

  - Increased sales by offering flexible payment options.

  - Earn additional income through interest charged on installments.

  - Retain ownership and control over the asset until full payment is made.

 

 2.7.2 Limitations

- For Buyers:

  - Higher overall cost due to interest charges.

  - Risk of asset repossession in case of default on installments.

  - Financial burden of regular installment payments.

 

- For Sellers:

  - Risk of default by buyers, leading

 

 to potential financial losses.

  - Administrative burden of managing hire purchase agreements and tracking payments.

  - Depreciation of the asset over the hire purchase period, reducing its resale value.

 

 References

 

1. Institute of Chartered Accountants of India (ICAI). (2020). "Indian Accounting Standards (Ind AS)." ICAI.

2. Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2019). "Intermediate Accounting." John Wiley & Sons.

3. Wild, J. J., Shaw, K. W., & Chiappetta, B. (2018). "Fundamental Accounting Principles." McGraw-Hill Education.

4. Ministry of Corporate Affairs (MCA), Government of India. (2013). "Companies Act, 2013."

5. Bhabatosh Banerjee. (2021). "Financial Accounting." PHI Learning Pvt. Ltd.

6. The Hire Purchase Act, 1972. Government of India.

7. The Indian Contract Act, 1872. Government of India.

8. The Consumer Protection Act, 2019. Government of India.