GROUP - I PAPER - 1 ACCOUNTING V1 CHAPTER 11

11 HIRE PURCHASE AND INSTALLMENT SALE TRANSACTIONS Learning Objectives After studying this chapter, you will be able to: ♦ Understand the salient features and nature of Hire purchase transactions. ♦ Journalise the Hire purchase entries both in the books of hire purchaser and the hire vendor. ♦ Learn various methods of accounting for hire purchase like Debtors method and Stock and Debtors method. ♦ Ascertain various missing values, required while accounting the hire purchase transactions, on the basis of given information. ♦ Calculate and record the value of repossessed goods and also to calculate the profit on re-sale of such goods. ♦ Draw the Hire-purchase Trading Account and calculate the profit on such transactions. ♦ Evaluate the profit on hire purchase of goods of small value. ♦ Understand the instalment payment system and also how it is different from hire purchase transactions. 1. Introduction With an increasing demand for better life, the consumption of goods has been on the expanding scale. But, this has not been backed up by adequate purchasing power, transforming it into effectual demand, i.e., actual sale at set or settled prices. This has created the market for what is called hire purchase. When a person wants to acquire an asset but is not sure to make payment within a stipulated period of time he may pay in instalments if the vendor agrees. This enables the purchaser to use the asset while paying for it in instalments over an agreed period of time. This type of a business deal is known as hire purchase transaction. Here, the customer pays the entire © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions amount either in monthly or quarterly or yearly instalments, while the asset remains the property of the seller until the buyer squares up his entire liability. For the seller, the agreed instalments include his interest on the assets given on credit to the purchaser. Therefore, when the total amount is paid in instalments over a period of time is certainly higher than the cash down price of the article because of interest charges. Obviously, both the parties gain in the bargain. By virtue of this, the purchaser has the right of immediate use of the asset. By this, he gets both credit and product from the same seller. From seller’s view point, he derives the benefit by increase in sale and also he recovers his own cost of credit. 2. Nature of Hire Purchase Agreement Under the Hire Purchase System the Hire Purchaser gets possession of the goods at the outset and can use it, while paying for it in instalments over a specified period of time as per the agreement. However, the ownership of the goods remains with the Hire Vendor until the hire purchaser has paid all the instalments. Each instalment paid by the hire purchaser is treated as hire charges for using the asset. In case he fails to pay any of the instalments (even the last one) the hire vendor will take back his goods without compensating the buyer, i.e., the hire vendor is not going to pay back a part or whole of the amount received through instalments till the date of default from the buyer. 3. Special Features of Hire Purchase Agreement 1. Possession: The hire vendor transfers only possession of the goods to the hire purchaser immediately after the contract for hire purchase is made. 2. Installments: The goods are delivered by the hire vendor on the condition that a hire purchaser should pay the amount in periodical instalments. 3. Down Payment: The hire purchaser generally makes a down payment i.e an amount on signing the agreement. 4. Constituents of Hire purchase instalments: Each instalment consists partly of a finance charge (interest) and partly of a capital payment. 5. Ownership: The property in goods is to pass to the hire purchaser on the payment of the last instalment and exercising the option conferred upon him under the agreement. 6. Repossession: In case of default in respect of payment of even the last instalment, the hire vendor has the right to take the goods back without making any compensation. 4. Accounting Arrangements of Hire Purchase Transaction The method of accounting for hire purchase transactions depends on the value of sales. If the goods have substantial sales value the accounting methods adapted may be (i) Cash price method or (ii) Interest suspense method. Hire purchase accounting methods for goods of small sales value may be (i) Debtors method or (ii) Stock and debtors method. Asset taken on hire purchase basis should be considered like ordinary purchase. However, it is necessary to disclose this fact by classifying it as “Asset on Hire Purchase”. 11.2 © The Institute of Chartered Accountants of India Accounting Accordingly, amount due to the hire vendor should also be shown in his books as a liability—“Hire Purchase Creditors” with additional such classifications of amount of hire purchase instalment due and amount of hire purchase instalment not yet due. 4.1 In the Books of Hire Purchaser 4.1.1. Cash price method Under this method, the full cash price of the asset is debited to the Asset Account and credited to the Hire Vendor Account. At the time of payment of instalment, Interest Account is debited and Hire Vendor Account is credited (with the interest on outstanding balance). When instalment is paid, the Hire Vendor Account is debited and Bank Account is credited. At the time of preparation of Final Accounts, interest is transferred to Profit and Loss Account and asset is shown in the Balance Sheet at cost less depreciation. The balance due to hire vendor is shown in the Balance Sheet as a liability (alternatively it can be shown as a deduction from Asset Account). Depreciation on asset acquired on hire purchase must be calculated on cash price. Accounting To have proper accounting record, one should know: (1) Date of purchase of the asset; (2) Cash price of the asset; (3) Hire purchase price of the asset; (4) The amount of down payment; (5) Number and amount of each instalment; (6) Rate of interest; (7) Method and rate of depreciation; (8) Date of payment of every instalment; and (9) Date of closing the books of account. Journal Entries 1. On entering into the agreement Asset Account Dr. [Full cash price] To Hire Vendor Account 2. When down payment is made Hire Vendor Account Dr. [Down payment] To Cash/Bank Account 3. When an instalment becomes due Interest Account Dr. [Interest on outstanding balance] To Hire Vendor Account 4. When an instalment is paid Hire Vendor Account Dr. [Amount of instalment] To Bank Account 5. When depreciation is charged on the asset Depreciation Account Dr. [Calculated on cash price] To Asset Account 11.3 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions 6. For closing interest and depreciation account Profit and Loss Account Dr. To Interest Account To Depreciation Account However, a firm may maintain Provision for Depreciation A/c instead of charging depreciation to Hire Purchase Asset A/c. In such case the journal entry is: Profit and Loss A/c Dr. To Provision for Depreciation for Asset on Hire Purchase A/c and naturally, Asset on Hire Purchase is shown at its historical cost. Disclosure in the balance sheet Assets Fixed Assets : Asset (at cash price) xxxxxxx.xx Less : Depreciation xxxx.xx xxxxxxx.xx Creditors : Hire Purchase Creditors : Balance in hire vendor's A/c xxxxx.xx Instalment due xxxxx.xx Instalment not yet due xxxxx.xx Illustration 1 On January 1, 2008 HP and Co. acquired a pick-up Van on hire purchase from FM & Co. Ltd. The terms of the contract were as follows: (a) The cash price of the van was ` 1,00,000. (b) ` 40,000 were to be paid on signing of the contract. (c) The balance was to be paid in annual instalments of ` 20,000 plus interest. (d) Interest chargeable on the outstanding balance was 6% p.a. (e) Depreciation at 20% p.a. is to be written-off using the straight-line method. You are required to: (a) Give Journal Entries and show the relevant accounts in the books of HP and Co. from January 1, 2008 to December 31, 2010; and (b) Show the relevant items in the Balance Sheet of the purchaser as on December 31, 2008 to 2010. 11.4 © The Institute of Chartered Accountants of India Accounting Solution In the books of HP & Co. Journal Date Particulars Dr. Cr. ` ` 2008 Pick-up Van A/c Dr. 1,00,000 Jan. 1 To FM & Co. Ltd. A/c 1,00,000 (Being the purchase of a pick-up van on hire purchase from FM & Co. Ltd.) “ FM & Co. Ltd. A/c Dr. 40,000 To Bank A/c 40,000 (Being the amount paid on signing the H.P. contract) Dec. 31 Interest A/c Dr. 3,600 To FM & Co. Ltd. A/c 3,600 (Being the interest payable @ 6% on ` 60,000 “ FM & Co. Ltd. A/c (` 20,000+` 3,600) Dr. 23,600 To Bank A/c 23,600 (Being the payment of 1st instalment along with interest) “ Depreciation A/c Dr. 10,000 To Pick-up Van A/c 10,000 (Being the depreciation charged @ 10% p.a. on ` 1,00,000) “ Profit & Loss A/c Dr. 13,600 To Depreciation A/c 10,000 To Interest A/c 3,600 (Being the depreciation and interest transferred to Profit and Loss Account) 2009 Interest A/c Dr. 2,400 Dec. 31 To FM & Co. Ltd. A/c 2,400 (Being the interest payable @ 6% on ` 40,000) FM & Co. Ltd. A/c (` 20,000 + ` 2,400) Dr. 22,400 To Bank A/c 22,400 (Being the payment of 2nd instalment along with interest) 11.5 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions Depreciation A/c Dr. 10,000 To Pick-up Van A/c 10,000 (Being the depreciation charged @ 10% p.a.) Profit & Loss A/c Dr. 12,400 To Depreciation A/c 10,000 To Interest A/c 2,400 (Being the depreciation and interest charged to Profit and Loss Account) 2010 Interest A/c Dr. 1,200 Dec. 31 To FM & Co. Ltd.A/c 1,200 (Being the interest payable @ 6% on ` 20,000) FM & Co. Ltd. A/c (` 20,000 + ` 1,200) Dr. 21,200 To Bank A/c 21,200 (Being the payment of final instalment along with interest) Depreciation A/c Dr. 10,000 To Pick-up Van A/c 10,000 (Being the depreciation charged @ 10% p.a. on ` 1,00,000) Profit & Loss A/c Dr. 11,200 To Depreciation A/c 10,000 To Interest A/c 1,200 (Being the interest and depreciation charged to Profit and Loss Account) Ledger of HP & Co. Ltd. Pick-up Van Account Date Particulars ` Date Particulars ` 1.1.2008 To FM & Co. Ltd. 1,00,000 31.12.2008 By Depreciation A/c 10,000 A/c 31.12.2009 By Balance c/d 90,000 1,00,000 1,00,000 1.1.2009 To Balance b/d 90,000 31.12.2009 By Depreciation A/c 10,000 31.12.2009 By Balance c/d 80,000 90,000 90,000 1.1.2010 To Balance b/d 80,000 31.12.2010 By Depreciation A/c 10,000 31.12.2010 By Balance c/d 70,000 80,000 80,000 11.6 © The Institute of Chartered Accountants of India Accounting Dr. FM & Co. Ltd. Account Cr. Date Particulars ` Date Particulars ` 1.1.08 To Bank A/c 40,000 1.1.08 By Pick-up Van A/c 1,00,000 31.12.08 To Bank A/c 23,600 By Interest c/d 3,600 31.12.08 To Balance c/d 40,000 1,03,600 1,03,600 31.12.09 To Bank A/c 22,400 1.1.09 By Balance b/d 40,000 31.12.09 To Balance c/d 20,000 31.12.09 By Interest A/c 2,400 42,400 42,400 31.12.10 To Bank A/c 21,200 1.1.10 By Balance b/d 20,000 31.12.10 By Interest A/c 1,200 21,200 21,200 Depreciation Account Dr. Cr. Date Particulars ` Date Particulars ` 31.12.2008 To Pick-up Van A/c 10,000 31.12.2008 By Profit & Loss A/c 10,000 31.12.2009 To Pick-up Van A/c 10,000 31.12.2009 By Profit & Loss A/c 10,000 31.12.2010 To Pick-up Van A/c 10,000 31.12.2010 By Profit & Loss A/c 10,000 Dr. Interest Account Cr. Date Particulars ` Date Particulars ` 31.12.2008 To FM & Co. Ltd. A/c 3,600 31.12.2008 By Profit & Loss A/c 3,600 31.12.2009 To FM & Co. Ltd. A/c 2,400 31.12.2009 By Profit & Loss A/c 2,400 31.12.2010 To FM & Co. Ltd. A/c 1,200 31.12.2010 By Profit & Loss A/c 1,200 Balance Sheet of Gopinath & Co. as at 31st December, 2008 Liabilities ` Assets ` FM & Co. Ltd. 40,000 Pick-up Van 90,000 Balance Sheet of Gopinath & Co. as at 31st December, 2009 Liabilities ` Assets ` FM & Co. Ltd. 20,000 Pick-up Van 80,000 11.7 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions Balance Sheet of Gopinath & Co. as at 31st December, 2010 Liabilities ` Assets ` FM & Co. Ltd. 20,000 Pick-up Van 70,000 4.1.2 Interest suspense method: Under this method, at the time of transfer of possession of asset, the total interest unaccrued is transferred to interest suspense account. At latter years, as and when interest becomes due, interest account debited and interest suspense account is credited. Journal Entries 1. When the asset is acquired on hire purchase Asset Account Dr. [Full cash price] To Hire Vendor Account 2. For total interest payment is made H.P. Interest Suspense Account Dr. [Total interest] To Hire Vendor Account 3. When down payment is made Hire Vendor Account Dr. To Bank Account 4. For Interest of the relevant period Interest Account Dr. [Interest of the relevant period] To H.P. Interest Suspense Account 5. When an instalment is paid Hire Vendor Account Dr. To Bank Account 6. When depreciation is charged on the asset Depreciation Account Dr. [Calculated on cash price] To Asset Account 7. For closing interest and depreciation account Profit and Loss Account Dr. To Interest Account To Depreciation Account Illustration 2 If we apply this method to the figures from Illustration 1, the H.P. Interest Suspense Account, Interest Account and FM & Co. Ltd. Accounts and Balance Sheets will appear as follows: 11.8 © The Institute of Chartered Accountants of India Accounting Solution H.P. Interest Suspense Account Date Particulars ` Date Particulars ` 1.1.2008 To FM & Co. Ltd. A/c 7,200 31.12.2008 By Interest A/c 3,600 (Note 1) 31.12.2008 By Balance c/d 3,600 7,200 7,200 1.1.2009 To Balance b/d 3,600 31.12.2009 By Interest A/c 2,400 31.12.2009 By Balance c/d 1,200 3,600 3,600 1.1.2010 To Balance b/d 1,200 31.12.2010 By Interest A/c 1,200 Dr. Interest Account Cr. Date Particulars ` Date Particulars ` 31.12.2008 To H.P. Interest 3,600 31.12.2008 By Profit & Loss A/c 3,600 Suspense A/c 31.12.2009 To H.P. Interest 2,400 31.12.2009 By Profit & Loss A/c 2,400 Suspense a/c 31.12.2010 To H.P. Interest 1,200 31.12.2010 By Profit & Loss A/c 1,200 Suspense A/c Dr. FM & Co. Ltd. Account Cr. Date Particulars ` Date Particulars ` 1.1.2008 To Bank A/c 40,000 1.1.2008 By Pick-up Van A/c 1,00,000 31.12.2008 To Bank A/c 23,600 1.1.2008 By H.P. Interest 7,200 Suspense A/c 31.12.2008 To Balance c/d 43,600 1,07,200 1,07,200 31.12.2009 To Bank A/c 22,400 1.1.2009 By Balance b/d 43,600 31.12.2009 To Balance c/d 21,200 43,600 43,600 31.12.2010 To Bank A/c 21,200 1.1.2010 By Balance b/d 21,200 Balance Sheet of HP & Co. Ltd. as at 31st December, 2008 Liabilities ` Assets ` FM & Co. Ltd. 43,600 Pick-up Van 1,00,000 Less: H.P. Interest Suspense 3,600 40,000 Less: Depreciation 10,000 90,000 11.9 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions Balance Sheet of HP & Co. Ltd. as at 31st December, 2009 Liabilities ` Assets ` FM & Co. Ltd. 21,200 Pick-up Van 90,000 Less: H.P. Interest 1,200 20,000 Less: Depreciation 10,000 80,000 Suspense Balance Sheet of HP & Co. Ltd.. as at 31st December, 2010 Liabilities ` Assets ` Pick-up Van 80,000 Less: Depreciation 10,000 70,000 Working Notes: (1) Total Interest = ` 3,600 + ` 2,400 + ` 1,200 = ` 7,200. 4.2 Books of the Hire Vendor There are different methods of recording hire purchase transactions in the books of the hire vendor. It is selected according to the type and value of goods sold, volume of transactions, the length of the period of purchase, etc. The different methods are discussed below: 4.2.1 Sales Method: A business that sells relatively large items on hire purchase may adopt this method. Under this method, hire purchase sale is treated as a credit sale. The only exception is that the vendor agrees to accept payments in instalments and for that he charges interest. Generally, a special Sales Day Book is maintained for recording all sales under hire purchase agreement. The amount due from the hire purchaser at the end of the year is shown in the Balance sheet on the assets side as Hire Purchase Debtors. Journal Entries 1. When goods are sold and delivered under hire purchase Hire Purchaser Account Dr. [Full cash price] To H.P. Sales Account 2. When the down payment is received Bank Account Dr. To Hire Purchaser Account 3. When an instalment becomes due Hire Purchaser Account Dr. To Interest Account 4. When the amount of instalment is received Bank Account Dr. To Hire Purchaser Account 11.10 © The Institute of Chartered Accountants of India Accounting 5. For closing interest Account Interest Account Dr. To Profit and Loss Account 6. For closing Hire Purchase Sales Account H.P. Sales Account Dr. To Trading Account In this connection, the student should note the following: (i) The entire profit on sale under hire purchase agreement is credited to the Profit and Loss account of the year in which the sale has taken place. (ii) Interest pertaining to each accounting period is credited to the Profit and Loss Account of that year. 4.2.2 Interest Suspense Method: This method is almost similar to the sales method, except the accounting for interest. Under this method, the hire purchaser is debited with full cash price and interest (total) included in the hire selling price. Credit is given to the H.P. Sales Account and Interest Suspense Account. When the instalment is received, the Bank Account is debited and the Hire Purchaser Account is credited. At the same time an appropriate amount of interest (i.e., interest for the relevant accounting period) is removed from the Interest Suspense Account and credited to the Interest Account. At the time of preparation of Final Accounts, interest is transferred to the credit of the Profit and Loss Account. The balance of the Interest Suspense Account is shown in the Balance Sheet as a deduction from Hire Purchase Debtors. Journal Entries 1. When goods are sold and delivered under hire purchase Hire Purchase Account Dr. [Full cash price + total interest] To H.P. Sales Account [Full cash price] To Interest Suspense Account [Total Interest] 2. When down payment/instalment is received Bank Account Dr. To Hire Purchaser Account 3. For interest of the relevant accounting period Interest Suspense Account Dr. To Interest Account 4. For closing interest Account Interest Account Dr. To Profit and Loss Account 5. For closing Hire Purchase Sales Account H.P. Sales Account Dr. To Trading Account 11.11 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions The disclosure in balance sheet of the respective parties will be: Balance Sheet of Hire Purchaser Balance Sheet of Vendor Assets Assets Fixed assets : Current assets : Asset on Hire purchase Hire purchase debtors Add : Balance in Interest suspense A/c Less : Balance in Interest suspense A/c Less : Depreciation Illustration 3 X Ltd. purchased 3 milk vans from Super Motors costing ` 75,000 each on hire purchase system. Payment was to be made: ` 45,000 down and the remainder in 3 equal instalments together with interest @ 9%. X Ltd. writes off depreciation @ 20% on the diminishing balance. It paid the instalment at the end of the 1st year but could not pay the next. Super Motor agreed to leave one milk van with the purchaser, adjusting the value of the other two milk vans against the amount due. The milk vans were valued on the basis of 30% depreciation annually on written down value basis. X Ltd. settled the seller’s dues after three months. Solution In the Books of X Ltd. Dr. (` ) Cr. (` ) I Year Milk Vans purchased: Milk Vans A/c Dr. 2,25,000 To Vendor A/c 2,25,000 On down payment: Vendor A/c Dr. 45,000 To Bank 45,000 I Year end Interest A/c Dr. 16,200 (` 1,80,000 @ 9%) To Vendor A/c 16,200 Vendor A/c Dr. 76,200 To Bank A/c 76,200 Depreciation @ 20% Depreciation A/c Dr. 45,000 To Milk Vans A/c 45,000 II Year end Depreciation @ 20% Depreciation A/c Dr. 36,000 To Milk Vans A/c 36,000 11.12 © The Institute of Chartered Accountants of India Accounting Interest A/c Dr. 10,800 (1,20,000 @ 9%) To Vendor A/c 10,800 Return of goods endor A/c Dr. 73,500 To Milk Vans A/c 73,500 For Loss in Repossession Profit/Loss A/c Dr. 22,500 To Milk Vans A/c 22,500 IIIrd Year Depreciation Depreciation A/c Dr. 9,600 To Milk Vans A/c 9,600 Settlement of A/cs Vendor A/c Dr. 57,300 To Bank 57,300 Milk Vans Account Year ` Year ` 1 To Super Motors A/c 2,25,000 1 end By Depreciation A/c 45,000 ” By Balance c/d 1,80,000 2,25,000 2,25,000 2 To Balance b/d 1,80,000 2 end By Depreciation 36,000 ” Super Motors (value of 2 vans after depreciation for 2 years @ 30%) 73,500 ” P & L A/c (balancing figure) 22,500 ” Balance c/d (one van less depre- ciation for 2 years) 48,000 1,80,000 1,80,000 Super Motors Account Year ` Year ` 1 To Bank 45,000 1 By Milk Vans A/c 2,25,000 ” Bank 76,200 ” Interest @ 9% ” Balance c/d 1,20,000 on ` 1,80,000 16,200 2,41,200 2,41,200 11.13 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions 2 To Milk Van A/c 73,500 2 By Balance b/d 1,20,000 ” Balance c/d 57,300 ” Interest 10,800 1,30,800 1,30,800 3 To Bank 57,300 3 By Balance b/d 57,300 Illustration 4 A firm acquired two tractors under hire purchase agreements, details of which were as follows: Tractor A Tractor B Date of Purchase 1st April, 2009 1st Oct., 2009 ` ` Cash price 14,000 19,000 Deposit 2,000 2,680 Interest (deemed to accrue evenly over the period of agreement) 2,400 2,880 Both agreements provided for payment to be made in twenty-four monthly instalments, commencing on the last day of the month following purchase, all instalments being paid on due dates. On 30th June, 2010, Tractor B was completely destroyed by fire. In full settlement, on 10th July, 2010 an insurance company paid ` 15,000 under a comprehensive policy out of which ` 10,000 was paid to the hire purchase company in termination of the agreement. Any balance on the hire purchase company’s account in respect of these transactions was to be written off. The firm prepared accounts annually to 31st December and provided depreciation on tractors on a straight-line basis at a rate of 20 per cent per annum rounded off to nearest ten rupees, apportioned as from the date of purchase and up to the date of disposal. You are required to record these transactions in the following accounts, carrying down the balances on 31st December, 2009 and 31st December, 2010: (a) Tractors on hire purchase. (b) Provision for depreciation of tractors. (c) Disposal of tractors. (d) Hire purchase company. 11.14 © The Institute of Chartered Accountants of India Accounting Solution Hire Purchase accounts in the buyer’s books (a) Tractors on Hire Purchase A/c 2009 ` 2009 ` April 1 To HP Co. - Cash price 14,000 Dec. 31 By Balance c/d Tractor A 14,000 Oct. 1 ” HP Co. - Cash price Tractor B 19,000 33,000 Tractor B 19,000 33,000 33,000 2010 ` 2010 ` Jan. 1 To Balance b/d June30 By Disposal of Tractor A 14,000 Tractor A/c - Transfer 19,000 Tractor B 19,000 33,000 Dec. 31 ” Balance c/d 14,000 33,000 33,000 2011 Jan. 1 To Balance b/d 14,000 (b) Provision for Depreciation of Tractors A/c 2009 ` 2009 ` Dec. 31 To Balance c/d 3,050 Dec. 31 By P & L A/c : Tractor A 2,100 Tractor B 950 3,050 3,050 3,050 2010 ` 2010 ` June 30 To Disposal of Tractor Jan. 1 By Balance b/d 3,050 account—Transfer 2,850 Jun. 30 ” P & L A/c Dec. 31 ” Balance c/d 4,900 (Depn. for Tractor B) 1,900 Dec. 31 ” P & L A/c (Depn. for Tractor A) 2,800 7,750 7,750 2011 ` Jan. 1 By Balance b/d 4,900 (c) Disposal of Tractor A/c 2010 ` 2010 ` June 30 To Tractors on hire June30 By Provision for purchase—Tractor B 19,000 Depn. of Tractors A/c 2,850 July 10 ” Cash : Insurance 15,000 Dec. 31 ” P & L A/c : Loss 1,150 19,000 19,000 11.15 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions Hire Purchase Co. A/c 2009 ` 2009 ` April 1 To Cash (deposit April 1 By Tractors on for Tractor A) 2,000 Hire Purchase A/c April ” Cash—6 instal- - Tractor A 14,000 Sept. ments @ ` 600 3,600 Oct. 1 ” Tractors on Oct. 1 ” Cash—deposit Hire Purchase A/c for Tractor B 2,680 —Tractor B 19,000 Oct. - ” Cash—3 instal- Dec. 31 ” Interest A/c : Dec. ments @ ` 600 for For Tractor A Tractor A 1,800 @ ` 100 for ” Cash—3 instal- 9 months ` 900 ments @ ` 800 2,400 For Tractor B Dec. 31 ” Balance c/d 21,780 @ ` 120 for 3 months ` 360 1,260 34,260 34,260 2010 2010 Jan. To Cash—6 instalments Jan. 1 By Balance b/d 21,780 @ ` 600 for Tractor A 3,600 Jun. 30 ” Interest A/c—for June ” Cash—6 instalments Tractor B @ ` 120 @ ` 800 for Tractor B 4,800 for 6 months 720 July 10 ” Cash - final instalment Dec. 31 ” Interest - for for Tractor B 10,000 Tractor A @ ` 100 July- ” Cash - 6 instalments @ for 12 months 1,200 ` 600 for Tractor A 3,600 Dec. ” Balance c/d 1,500 ” P & L A/c—unpaid amount 200 23,700 23,700 Illustration 5 A machinery is sold on hire purchase. The terms of payment is four annual instalments of ` 6,000 at the end of each year commencing from the date of agreement. Interest is charged @ 20% and is included in the annual payment of ` 6,000. Show Machinery Account and Hire Vendor Account in the books of the purchaser who defaulted in the payment of the third yearly payment whereupon the vendor re-possessed the machinery. The purchaser provides depreciation on the machinery @ 10% per annum. All workings should form part of your answers. 11.16 © The Institute of Chartered Accountants of India Accounting Solution Machinery Account ` ` I Yr. To Hire Vendor A/c 15,533 I Yr. By Depreciation A/c 1,553 ” Balance c/d 13,980 15,533 15,533 II Yr. To Balance b/d 13,980 II Yr. By Depreciation A/c* 1,398 ” Balance c/d 12,582 13,980 13,980 III Yr. To Balance b/d 12,582 III Yr. By Depreciation A/c* 1,258 ” Hire Vendor 11,000 ” Profit & Loss A/c 324 (Loss on Surrender) 12,582 12,582 *It has been assumed that depreciation has been written off on written down value method. Alternatively straight line method may be assumed. Depreciation has been directly credited to the Machinery Account; it could have been accumulated in provision for depreciation account. Hire Vendor Account ` ` I Yr. To Bank A/c 6,000 I Yr. By Machinery A/c 15,533 ” Balance c/d 12,639 ” Interest A/c 3,106 18,639 18,639 II Yr. To Bank A/c 6,000 II Yr. By Balance b/d 12,639 ” Balance c/d 9,167 ” Interest A/c 2,528 15,167 15,167 III Yr. To Machinery A/c 11,000 III Yr. By Balance b/d 9,167 (transfer) ” Interest A/c 1,833 11,000 11,000 Note : Alternatively, total interest could have been debited to Interest Suspense A/c and credited to Hire Vendor A/c with consequential changes. Working Notes: Instalment Amount Interest Principal 4th Instalment 6,000 ` ` 20 Interest 6,000 x 1,000 1,000 5,000 120 5,000 11.17 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions Add : 3rd Instalment 6,000 11,000 20 Interest 11,000 x 1,833 1,833 4,167 120 9,167 Add : 2nd Instalment 6,000 15,167 20 Interest 15,167 x 2,528 2,528 3,472 120 12,639 Add : Ist Instalment 6,000 18,639 20 Interest 18,639 x 3,106 3,106 2,894 120 15,533 8,467 15,533 Illustration 6 X Transport Ltd. purchased from Delhi Motors 3 Tempos costing ` 50,000 each on the hire purchase system on 1-1-2008. Payment was to be made ` 30,000 down and the remainder in 3 equal annual instalments payable on 31-12-2008, 31-12-2009 and 31-12-2010 together with interest @ 9%. X Transport Ltd. write off depreciation at the rate of 20% on the diminishing balance. It paid the instalment due at the end of the first year i.e. 31-12-2008 but could not pay the next on 31-12-2009. Delhi Motors agreed to leave one Tempo with the purchaser on 1-1-2010 adjusting the value of the other 2 Tempos against the amount due on 31-12-2009. The Tempos were valued on the basis of 30% depreciation annually. Show the necessary accounts in the books of X Transport Ltd. for the years 2008, 2009 and 2010. Solution X Transport Ltd. Tempo Account 2008 ` 2008 ` Jan. 1 To Delhi Motors 1,50,000 Dec. 31 By Depreciation A/c : 20% on 1,50,000 30,000 ” Balance c/d 1,20,000 1,50,000 1,50,000 2009 2009 Jan. 1 To Balance b/d 1,20,000 Dec. 31 By Depreciation A/c 24,000 ” Delhi Motors A/c (Value of 2 tempos taken away) 49,000 ” Profit and Loss A/c (balancing figure) 15,000 11.18 © The Institute of Chartered Accountants of India Accounting ” Balance c/d (Value of one tempo left) 32,000 1,20,000 1,20,000 2010 2010 Jan. 1 To Balance b/d 32,000 Dec. 31 By Depreciation A/c 6,400 ” Balance b/d 25,600 32,000 32,000 Delhi Motors Account 2008 ` 2008 ` Jan. 1 To Bank (Down Payment) 30,000 Jan. 1 By Tempos A/c 1,50,000 Dec. 31 ” Bank 50,800 Dec. 31 ” Interest (9% on ” Balance c/d 80,000 ` 1,20,000) 10,800 1,60,800 1,60,800 2009 2009 Jan. 1 To Tempo 49,000 Jan. 1 By Balance b/d 80,000 Dec. 31 ” Balance c/d 38,200 Dec. 31 ” Interest (9% on ` 80,000) 7,200 87,200 87,200 2010 ` 2010 ` Dec. 31 To Bank 41,638 Jan. 1 By Balance b/d 38,200 Dec. 31 ” Interest (9% on ` 38,200) 3,438 41,638 41,638 Alternative Method Tempo Account 2008 ` 2008 ` Jan. 1 To Bank A/c (down Dec. 31 By Depreciation payment) 30,000 @ 20% on Dec. 31 ” Delhi Motors A/c ` 1,50,000 30,000 (Ist instalment) 40,000 ” Balance c/d 40,000 70,000 70,000 2009 ` 2009 ` Jan. 1 To Balance b/d 40,000 Dec. 31 By Depreciation A/c 24,000 Dec. 31 ” Delhi Motors A/c ” Profit & Loss A/c - creating a liability for (balancing figure) 22,200 ` 38,200, amount due ” Balance c/d (see 1st method) 38,200 (Value of tempo left) 32,000 78,200 78,200 11.19 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions 2010 ` 2010 ` Jan. 1 To Balance b/d 32,000 Dec. 31 By Depreciation A/c 6,400 ” Balance b/d 25,600 32,000 32,000 Delhi Motors 2008 ` 2008 ` Dec. 31 To Bank A/c 50,800 Dec. 31 By Tempo A/c 40,000 By Interest A/c 10,800 50,800 50,800 2009 ` 2009 ` Dec. 31 To Balance c/d 38,200 Dec. 31 By Tempos A/c 38,200 2010 2010 Dec. 31 To Bank A/c 41,638 Jan. 1 By Balance b/d 38,200 Dec. 31 ” Interest (9% on ` 38,200) 3,438 41,638 41,638 Working Notes : (1) Value of a Tempo left with the buyer: ` Cost 50,000 Depreciation @ 20% p.a. under WDV method for 2 years i.e. ` 10,000 + ` 8,000 18,000 Value of the Tempo left with the buyer at the end of 2nd year 32,000 (2) Value of Tempos taken away by the seller: No. of tempos Two ` Cost ` 50,000 × 2 = 1,00,000 Depreciation @ 30% Under WDV method for 2 years i.e. ` 30,000 + ` 21,000 51,000 Value of tempos taken away at the end of 2nd year 49,000 Illustration 7 M/s Delhi Electronics sells colour TVs., on hire purchase basis. Cost per set is ` 14,000, Cash sale price ` 15,500 and hire purchase sale price is ` 16,800 for 12 monthly instalments payable by 10th of every month. However, the buyer has to make cash down ` 1,800 at the time of purchase. Hire Purchase transactions (No. of sets) in 2010 - Jan. 10, Feb. 12, March 10, April 12, May 10, June 10, July 10, August 15, Sept. 11, Oct. 20, Nov. 20, Dec. 10. Let us suppose all instalments are duly collected. Show necessary Journal Entries. 11.20 © The Institute of Chartered Accountants of India Accounting Solution Various relevant accounting information in relation to hire purchase transactions are computed as follows : Total No. of Transactions : 150 Cash down : ` 1,800 × 150 = ` 2,70,000 Installments Collected/Due Transactions No. of Installments collected No. of Installments Due Jan. 10 × 11 = 110 10 × 1 = 10 Feb. 12 × 10 = 120 12 × 2 = 24 March 10 × 9 = 90 10 × 3 = 30 April 12 × 8 = 96 12 × 4 = 48 May 10 × 7 = 70 10 × 5 = 50 June 10 × 6 = 60 10 × 6 = 60 July 10 × 5 = 50 10 × 7 = 70 Aug. 15 × 4 = 60 15 × 8 = 120 Sept. 11 × 3 = 33 11 × 9 = 99 Oct. 20 × 2 = 40 20 × 10 = 200 Nov. 20 × 1 = 20 20 × 11 = 220 Dec. 10 × 0 = — 10 × 12 = 120 150 749 150 1051 Check: Total Instalments for 150 hire purchase transactions are 1800. (150×12) of which 749 instalments fell due and collected and the balance 1051 instalments are not yet paid. Amount collected for 749 instalments Rs. 16,800 − Rs. 1,800 ×749=` 9,36,250 12 Amount not yet due Rs. 16,800 – Rs. 1,800 ×1,051=` 13,13,750 12 Cash Down = ` 2,70,000 Total (` 16,800 × 150) = ` 25,20,000 Hire Vendor should recognise the amount of instalments collected and cash down value (i.e. ` 2,70,000 + ` 9,36,250) ` 12,06,250 as sale. Balance ` 13,13,750 is value of goods lying with the customer at hire purchase price. Stock Reserve should be computed and deducted from such amount to show the Hire Purchase Stock at cost. 11.21 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions Cost Goods lying with Hire Purchaser at Hire Purchase Price × Hire Purchase Price Rs.14,000 Stock at cost =Rs. 13,13,750 × Rs.16,800 = ` 10,94,792 Stock Reserve = (` 13,13,750 – 10,94,792) = ` 2,18,958 Journal Entries ` ` (1) For Cash down at the Cash/Bank A/c Dr. 2,70,000 time of hire transaction To Hire Purchase Sale A/c 2,70,000 (2) When instalments Instalment Due A/c Dr. 9,36,250 fall due To Hire Purchase Sales 9,36,250 (3) On collection of Cash/Bank A/c Dr. 9,36,250 instalments To Instalment Due A/c 9,36,250 (4) For instalment not Hire Purchase Stock A/c Dr. 13,13,750 due at the year To Trading A/c 13,13,750 (5) For Stock Reserve Stock Reserve A/c Dr. 2,18,958 To Hire Purchase Stock A/c 2,18,958 If some instalments become due but not collected at the year end, such would appear in the Balance Sheet as an asset just like Sundry Debtors. 5. Debtors Method In this method the Hire purchase Trading account is prepared. The objective of preparing Hire Purchase Trading Account is to measure the profitability of the Hire Purchase division separately. Let us see how to prepare Hire Purchase Trading Account. (1) Credit all down payments and instalments falling due to hire purchase sales account. Transfer balance in Hire Purchase Sales Account to Hire Purchase Trading Account. (2) Transfer cost of all transactions to Hire Purchase Trading Account. Hire Purchase Trading A/c Dr. To Shop Stock A/c (3) Charge any special expenses to Hire Purchase Trading Account. (4) Treat instalments not yet due as stock lying with customers and transfer to Hire Purchase Trading Account. 11.22 © The Institute of Chartered Accountants of India Accounting (5) Charge appropriate stock reserve. Illustration 8 With the information given in Illustration 6, prepare Hire Purchase Trading A/c. Solution Hire Purchase Trading A/c ` ` To Shop Stock 21,00,000 By Hire Purchase (14,000 × 150) Sales A/c 12,06,250 ” Stock Reserve 2,18,958 ” Stock (with ” Profit—transferred customers)—at hire to P & L A/c 2,01,042 purchase price 13,13,750 25,20,000 25,20,000 Illustration 9 M/s Wye & Co. sell goods on hire purchase, adding 50% to cost. From the following figures prepare the Hire Purchase Trading Account: ` Goods with customers in Jan. 2010, instalments not yet due 5,400 Goods sold on hire purchase during 2010 25,500 Cash received from customers during 2010 20,100 Instalments due but not yet received at the end of the year, customers paying 1,800 All figures are on the basis of hire purchase price. Solution Hire-purchase Trading Account for the year ending 31st Dec., 2010 Dr. Cr. ` ` To Stock with Customers on By Cash 20,100 1-1-2010 - hire purchase ” Instalments due 1,800 price 5,400 ” Goods sold on Hire ” Goods sold on Hire- Purchase A/c - loading 8,500 purchase A/c 25,500 ” Stock Reserve (Opening) 1,800 ” Stock Reserve required 3000 ” Stock with customers 9,000* ” Profit & Loss A/c 7,300 41,200 41,200 *Stock with Customers on 31-12-2010 ` Instalment not due on 1-1-2010 5,400 Goods sold on H.P. 25,500 11.23 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions 30,900 Less : Cash received 20,100 Instalments due 1,800 21,900 9,000 6. Ascertainment of Total Cash Price We know that the basis for accounting in the books of the hire purchaser is the total cash price. Sometimes, the total cash price may not be given. For the purpose of ascertaining the total cash price we can use any of the following methods according to the need. (1) Calculation of total cash price when no annuity table is given. (2) Calculation of total cash price when annuity table is given. 7. Calculation of Total Cash Price when Annuity Table is not given In this method, the interest included in the last instalment is to be calculated first with the help of the appropriate formula (explained below). For example in a hire purchase transaction, apart from down payment, four other instalments are payable. The interest will be calculated first on the 4th instalment, then on the 3rd instalment, then on the 2nd instalment and lastly on the 1st instalment. Interest on down payment will be nil. In this connection, it should be noted that the amount of interest will go on increasing from the 4th instalment to the 3rd instalment, from the 3rd instalment to the 2nd instalment and from the 2nd instalment to the 1st instalment. We know that interest is to be calculated on the outstanding balance of cash price. In this case, we will have to calculate the interest with the help of the total amount due on hire purchase price since the cash price is not known. For the purpose of calculating the interest, the following steps should be followed: Step 1: Calculation the ratio between interest and the amount due with the help of the following formula: Rateofinterest Ratioofinterestandamountdue= 100+Rateofinterest Step 2: Calculate the interest included in the last instalment by applying the following formula: Interest = Total amount due at the time of instalment x Ratio of interest and amount due (as calculated in step 1) Step 3: Subtract the interest (as calculated in step 2) from this instalment to get the amount of outstanding cash price at the time of last instalment. Step 4: Add the cash price calculated in Step 3 to the amount of instalment due at the end of the third year. 11.24 © The Institute of Chartered Accountants of India Accounting Step 5: Calculate the interest on the entire sum (cash price included in the 4th instalment + amount of 3rd instalment). Deduct this interest from the total amount due at the end of 3rd year to get the outstanding cash price at the time of 3rd instalment. Step 6: Add the cash price calculated in step 5 to the amount of instalment due at the end of 2nd year. Step 7: Calculate the interest on the entire sum so obtained in Step 6. Deduct this interest from the total amount due at the end of 2nd year to get the outstanding cash price at the time of 2nd instalment. Step 8: Add the cash price calculated in Step 7 to the amount of instalment due at the end of 1st year. Step 9: Calculate the interest on the entire sum so obtained in Step 8. Deduct this interest from the total amount due at the end of 1st year to get the outstanding cash price at the time of 1st instalment. Step 10: Add the cash price calculated in Step 9 to the amount of down payment, if any. The sum so obtained will be the total cash price. Illustration 10 A & Co. purchased a truck on hire purchase system. As per terms he is required to pay ` 70,000 down, ` 53,000 at the end of first year, ` 49,000 at the end of second year and ` 55,000 at the end of third year. Interest is charged @ 10% p.a. You are required to calculate the total cash price of the truck and the interest paid with each instalment. Solution Rateofinterest 10 (1) Ratio of interest and amount due = = = 1 100+Rateofinterest 110 11 (2) Calculation of Interest and Cash Price No. of Amount due at the Interest Cash price instalments time of instalment [1] [2] [3] [4] 3rd 55,000 1/11 of ` 55,000 =` 5,000 50,000 2nd *99,000 1/11 of ` 99,000 = ` 9,000 90,000 1st **1,43,000 1/11of ` 1,43,000 = ` 13,000 1,30,000 Total cash price = ` 1,30,000+ 70,000 (down payment) =` 2,00,000. *` 50,000 + 2nd instalment of ` 49,000 = ` 99,000. ** ` 90,000 + 1st instalment of ` 53,000 = ` 1,43,000. 11.25 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions 8. Ascertainment of Interest We know that the hire purchase price consists of two elements: (i) cash price; and (ii) interest. Cash price is the capital expenditure incurred for the acquisition of an asset and (ii) interest is the revenue expense for the delay in making the full payment. Ascertainment of any of these two gives the answer for the other, e.g., if we ascertain the total amount of interest, it becomes very simple to ascertain the cash price just by deducting the interest from the hire purchase price. Interest is charged on the amount outstanding. Therefore, if the hire purchaser makes a down payment on signing the contract, it will not include any amount of interest. It should be noted that though the instalments of a hire purchase agreement may be equal, the interest element in each instalment is not the same. At the time of calculating interest, students may face the following two situations: (a) When the cash price, rate of interest and the amount of instalments are given; and (b) When the cash price and the amount of instalments are given, but the rate of interest is not given. Now, let us consider the above two situations. 8.1 When the cash price, rate of interest and the amount of instalments are given: In this situation, the total amount of interest is to be ascertained first. It is the difference between the hire purchase price (down payment + total instalments) and the cash price. To calculate the amount of interest involved in each instalment the following steps are followed: Step 1: Deduct down payment from the cash price. Calculate the interest at the given rate on the remaining balance. This represents the amount of interest included in the first instalment. Step 2: Deduct the interest of Step 1 from the amount of first instalment. The resultant figure is the cash price included in the first instalment. Step 3: Deduct the cash price of the 1st instalment (Step 2) from the balance due after down payment. It represents the amount outstanding after the 1st instalment is paid. Step 4: Calculate the interest at the given rate on the balance outstanding after the 1st instalment. Deduct this interest from the amount of the 2nd instalment to get the cash price included in the 2nd instalment. Step 5: Deduct the cash price of the 2nd instalment (Step 4) from the balance due after the 1st instalment. It represents the amount outstanding after the 2nd instalment is paid. Repeat the above steps till the last instalment is paid. 8.2 When the cash price and the amount of instalments are given, but the rate of interest is not given. When the rate of interest is not given, but the cash price and the amount of instalments are given, the following steps are followed to calculate the interest: 11.26 © The Institute of Chartered Accountants of India Accounting Step 1: Calculate the total interest by deducting the cash price from the hire purchase price (i.e., down payment + amount of instalment x number of instalments). Step 2: Deduct down payment from the hire purchase price. Step 3: Calculate the amount of outstanding balance of the hire purchase price at the beginning of each year. Step 4: Calculate the ratio of outstanding balance of Step 3. Step 5: Calculate the amount of interest of each instalment on the basis of the ratio of Step 4. 9. Repossession In a hire purchase agreement the hire purchaser has to pay up to the last instalment to obtain the ownership of goods. If the hire purchaser fails to pay any of the instalments, the hire vendor takes the asset back in its actual form without any refund of the earlier payments to the hire purchaser. The amounts received from the hire purchaser through down payment and instalments are treated as the hire charges by the hire vendor. This act of recovery of possession of the asset is termed as repossession. Repossessed assets are resold to any other customer after repairing or reconditioning (if necessary). Accounting figures relating to repossessed assets are segregated from the normal hire purchase entries. Repossessions are then accounted for in a separate “Goods Repossessed Account”. So far as the repossession of assets are concerned, the hire vendor can take back the whole of the asset or a part thereof depending on the agreement between the parties. The former is called “Complete Repossession” and the latter “Partial Repossession”. 9.1 Complete Repossession The hire vendor closes Hire Purchaser’s Account by transferring balance of Hire Purchaser Account to Goods Repossessed Account. The hire purchaser closes the Hire Vendor’s Account by transferring the balance of Hire Vendor Account to Hire Purchase Asset Account and then finding the profit and loss on repossession in Asset Account. Particulars Books of hire purchaser Books of hire vendor Purchase/Sales Asset A/c …Dr. Hire Purchaser A/c …Dr. To Hire Vendor A/c To Sales A/c Installment Hire Vendor A/c …Dr Cash A/c …Dr. To Cash A/c To Hire Purchaser A/c Interest Interest A/c …Dr Hire Purchaser A/c …Dr. To Hire Vendor To Interest A/c Repossession Hire Vendor A/c …Dr Goods Repossessed A/c ..Dr. To Asset A/c To Hire Purchaser 11.27 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions 9.2 Partial Repossession In case of a partial repossession, only apart of the asset is taken back by the hire vendor and other part is left with the hire purchaser. The Journal Entries are as usual up to the date of default (excepting entry for payment) in the books of both the parties. As a portion of the asset is still left with the hire purchaser, neither party closes the account of the other in their respective books. Assets are repossessed at a mutually agreed value (based on agreed rate of depreciation which is an enhanced rate). The hire vendor debits the Goods Repossessed Account and credit the Hire Purchaser Account with the value as agreed upon on the repossession. Similarly, the hire purchaser debits the Hire Vendor Account and credits the Assets Account with the same amount. If the repossessed value is less than the book value of the asset, the difference is charged to the Profit and Loss Account of the hire purchaser as ‘loss on surrender’. For the remaining portion of the asset lying with the hire purchaser, the (Hire Purchaser) applies the usual rate of depreciation and shows the Asset Account at its usual written-down value. Illustration 11 From the following prepare Hire Purchase Trading Account of M/s Kolkata Traders who sells goods on hire purchase basis at cost plus 25%. ` Instalments not due on 31-12-2009 3,00,000 Instalments due and collected during 2010 8,00,000 Instalments due but not collected during 2010 including ` 10,000 for which goods were repossessed 50,000 Instalments not due on 31-12-2010 including ` 20,000 for which goods were repossessed 3,70,000 Instalments collected on repossessed stock 15,000 M/s Kolkata Traders valued repossessed stock at 60% of original cost. Solution Working Notes: (1) Hire Purchase Sales: ` Instalments due and collected 8,00,000 Add: Instalments due but not collected 50,000 8,50,000 (2) Loss on Repossessed stock: Hire Purchase Price of Repossessed Stock 11.28 © The Institute of Chartered Accountants of India Accounting Instalments Collected 15,000 Instalments Due 10,000 Instalments Not Due 20,000 45,000 100 Cost Rs. 45,000 × 36,000 125 60 Valuation on repossessionRs. 36,000 × 21,600 100 Cost of instalments due + Instalments not yet due 100 (Rs. 10,000 + 20,000) × 24,000 125 Loss (` 24,000 – ` 21,600) 2,400 (3) Goods taken from shop stock at cost: H.P. Sales at cost ⎡8,50,000×100 ⎤ 6,80,000 ⎣ 125⎦ Stock with customers 31-12-2010 at cost ⎡ 100⎤ Rs. 3,50,000 × 2,80,000 ⎢ ⎥ ⎣ 125⎦ 9,60,000 Less : Stock with customers 31-12-2009 at Cost 2,40,000 ⎡ 100⎤ Rs. 3,00,000 × 7,20,000 ⎢ ⎥ ⎣ 125⎦ (4) Bad Debt : Instalment due but not collected 10,000 Instalment not yet due at cost ⎡ 100 ⎤ Rs. 20,000× 16,000 ⎢ ⎥ ⎣ 125 ⎦ 26,000 Less: Cost of instalments due and instalments not yet due 24,000 2,000 Hire Purchase Trading A/c ` ` To Goods with customers at By Hire Purchase Sale 8,50,000 cost (31-12-2009) 2,40,000 ” Goods with customers at ” Shop Stock 7,20,000 cost (31-12-2010) 2,80,000 11.29 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions ” Bad Debt 2,000 ” Loss on Repossession 2,400 ” Profit & Loss A/c Transfer of H.P. Profit 1,65,600 11,30,000 11,30,000 10. Stock and Debtors Method In this method, Hire Purchase Stock Account, Hire Purchase Adjustment Account is maintained. Following are the entries to be made. (i) When goods are sold on hire purchase Hire purchase stock A/c Dr. Full H.P. Price To Stock A/c Actual cost price To Hire Purchase Adjustment A/c (Being the difference between cost and H.P. price) (ii) When instalments become due for payment Hire purchase Debtors A/c Dr. To Hire purchase Stock A/c (iii) When cash is received Cash A/c Dr. To Hire Purchase Debtors A/c (iv) Stock Reserve on opening Stock Stock Reserve A/c Dr. To Hire Purchase Adjustment A/c (v) Stock Reserve on closing Stock Hire Purchase Adjustment A/c Dr. To Stock Reserve A/c Hire purchase Debtors Account will consist of opening balance instalment due on goods sold on hire purchase on the debit side while cash received and closing balance on the credit side. Hire purchase stock account will consist of opening balance and goods sold on hire purchase during the year in the debit side, while instalments due from debtors and closing balance on the credit side. The stock values are recorded at hire purchase price (i.e. cost + profit on H.P. Sales). Hire purchase adjustment account will consist of stock reserve on opening stock and closing stock in the credit side and debit side respectively. Further the loading element in goods sold on hire purchase (profit) will be credited in this account. This account shows the actual profit earned by means of hire purchase system. 11.30 © The Institute of Chartered Accountants of India Accounting Illustration 12 The hire purchase department of B.G. Ltd. sells television sets and room coolers. This department was newly started in 2010. The relevant information is as follows: Television Room set coolers ` ` Cost 5,400 2,000 Cash Price 6,300 2,400 Cash down payment 900 400 Monthly instalment 600 200 Number of instalments 10 12 During the year, 100 television sets and 120 room coolers were sold on hire purchase basis. Two television sets on which 3 instalments only could be collected and 4 room coolers on which 5 instalments had been collected were repossessed. These were valued at ` 10,000 and after reconditioning at a cost of ` 1,000 were sold outright for ` 14,000. Other instalments collected and those due (customer still paying) were respectively as follows : Television sets 270 and 20 Room coolers 400 and 30 Prepare Accounts on stocks and debtors system to reveal the profit of the Department. Solution B.G. Limited Hire Purchase Stock A/c ` ` To Goods sold on H.P. 10,26,000 By H.P. Debtors A/c 4,05,600 ” Goods Repossessed A/c (Instalments not due on repossessed goods) 14,000 ” Balance c/d (Instalment not yet due) 6,06,400 10,26,000 10,26,000 Hire Purchase Debtors A/c To Hire Purchase Stock A/c 4,05,600 By Bank A/c 3,87,600 By Balance c/d 18,000 4,05,600 4,05,600 11.31 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions Goods Repossessed A/c To Hire Purchase Stock A/c 14,000 By Hire Purchase Adjustment A/c (Balancing Figure) 4,000 ” Balance c/d 10,000 14,000 14,000 To Balance b/d 10,000 By Bank (Sales) 14,000 ” Bank (Exp.) 1,000 ” Hire Purchase Adjustment A/c (Profit) 3,000 14,000 14,000 Goods sold on Hire Purchase A/c To Hire Purhcase By Hire Purchase Stock A/c 10,26,000 ” Adjustment A/c (loading) 2,46,000 ” Profit 7,80,000 10,26,000 10,26,000 Hire Purchase Adjustment A/c To Goods repossessed A/c (Loss) 4,000 By Goods sold on Hire ” Stock Reserve 1,44,971 Purchase (Loading) 2,46,000 ” Profit 1,00,029 ” Goods Repossessed (Profit on sale) 3,000 2,49,000 2,49,000 Working Notes : (i) Hire Purchase Price is ` 6,900 for each television set and ` 2,800 for each room cooler. Total cost and sales on this basis are as follows: H.P. Price Cost ` ` Television sets (100) 6,90,000 5,40,000 Room Coolers (120) 3,36,000 2,40,000 10,26,000 7,80,000 Television sets Room Coolers ` ` (ii) Cash collected Down payment (900 × 100) 90,000 48,000 (400 × 120) Instalments collected (600 × 270) 1,62,000 80,000 (400 × 200) 11.32 © The Institute of Chartered Accountants of India Accounting Amount collected on Repossessed goods (3 × 2 × 600) 3,600 4,000 (5 × 4 × 200) 2,55,600 1,32,000 (iii) Instalment not yet due: ` Television: Total instalments on 98 sets 980 Instalments collected & due 290 690 Amount of 690 instalments @ ` 600 each 4,14,000 Room Coolers: Total instalment on 116 Room Coolers 1,392 Less : Instalments collected & due 430 962 Amount of 962 instalments @ ` 200 each = ` 1,92,400 Total amount (4,14,000 + 1,92,400) = ` 6,06,400 (iv) Stock Reserve : 1,500 Television sets ×4,14,000 90,000 6,900 800 Room Coolers ×1,92,400 54,971 2,800 1,44,971 (v) Instalment not due on repossessed goods: ` 2 Television sets 7 instalments on each @ ` 600 8,400 4 Room Coolers 7 instalments on each @ ` 200 5,600 14,000 (vi) Instalment due but not collected : ` Television sets (20 × ` 600) 12,000 Room Cooler (30 × ` 200) 6,000 18,000 Illustration 13 Y Ltd. sells products on hire purchase terms, the price being cost plus 33-1/3%. From the following particulars for 2010, prepare Hire Purchase Stock Account, Shop Stock Account, Hire Purchase Debtors Account, Stock Reserve Account and Hire Purchase Adjustment Account (for profit) : 2010 ` Jan. 1 Stock out on hire at Hire Purchase Price 1,20,000 11.33 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions Stock in hand, at Shop 15,000 Instalment due (Customers still paying) 9,000 Dec. 31 Stock out on hire at Hire Purchase Price 1,38,000 Stock in hand, at Shop 21,000 Instalments due (Customers still paying) 15,000 Cash received during the year 2,40,000 Solution Hire Purchase stock Account 2010 ` 2010 ` Jan. 1 To Balance b/d 9,000 Jan. 1 By Bank A/c 2,40,000 ” Hire Purchase Stock A/c ” Balance c/d 15,000 (instalments due during the year) (Balancing fig.) 2,46,000 2,55,000 2,55,000 Hire Purchase Stock Account 2010 ` 2010 ` Jan. 1 To Balance b/d 1,20,000 Jan. - ” ” Goods sold on Hire Dec. By H.P. Debtors A/c 2,46,000 Purchase (75%) 1,98,000 Dec. 31 ” Balance c/d 1,38,000 ” ” H.P., Adj. A/c (25%) 66,000 3,84,000 3,84,000 Shop Stock Account 2010 ` 2010 ` Jan. 1 To Balance b/d 15,000 By H.P. Stock A/c ” Purchases A/c (Cost of Goods sold) 1,98,000 (Balancing fig.) 2,04,000 ” Balance c/d 21,000 2,19,000 2,19,000 Stock Reserve Account 2010 ` 2010 ` To Hire Purchase Adjustment By Balance b/d (transfer) 30,000 (25% on 1,20,000) 30,000 ” Balance c/d 34,500 “ Hire Purchase Adjustment A/c 34,500 64,500 64,500 11.34 © The Institute of Chartered Accountants of India Accounting Hire Purchase Adjustment Account 2010 ` 2010 ` To Stock Reserve-Closing 34,500 By Stock Reserve-Opening 30,000 ” Profit & Loss Account 61,500 “ H.P. Stock 66,000 96,000 96,000 11. Hire Purchase Agreement for Goods of Small Value Till now, we have discussed on the hire purchase transactions for goods of substantial sales value – generally the fixed assets and the transactions were between two business units. Now, we should discuss on the transactions between a retailer and the consumers and the hire purchase of consumer durable. Here, it should be noted that accounting is important only from the point of view of the seller and not the buyer. Due to numerous transactions on the sale of such items and that too of small value, it becomes practically inconvenient for a particular retailer to maintain separate accounts for each transaction. Also, the retailer does not want to know the profit earned or losses incurred on each transaction – rather he will be interested in knowing the overall profit or loss arising from all the transactions in a particular accounting period. When the hire purchase transactions are numerous and value of the items is small, it is preferable to open separate memorandum hire purchase books. A Hire Purchase Sales Register is kept, to disclose both the hire purchase price and the cost price of the goods. This register should also show the number of instalments payable amount of down payment and the number of hire purchase agreement. In memorandum Hire Purchase Ledger accounts of the customers are kept. The sale price is debited to the individual customers’ accounts and these accounts being credited with all instalments paid. The total of the “sale price” column is credited to a Control Account, which is debited with the total instalments received. It must be noted that above entries are of a memorandum nature only, and do not form a part of the double entry system. In the general ledger, personal aspect is ignored, the entries being recorded in total only. A specimen of the Hire Purchase Sales Register is given below: Hire Purchase Sales Register S.No. Date of Name Name Cost H.P. Price Down No. of Instalments Total Instalments Instalment Agree- of of Price Payment install- Due Instalments due but not not yet due ment Customer Article ments Received received 1 2 3 4 The book keeper should be very alert in recording the different items in the register and casting (totaling) of the individual column, because these are the basis for the ascertainment of the profit or loss from hire purchase business. 11.35 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions 12. Ascertainment of Profit/Loss There are two common methods of ascertaining profit/loss of goods of small value sold on hire purchase. These are: (a) the Hire Purchase Trading Account Method. (b) The Stock and Debtors Method. 12.1 Hire Purchase Trading Account Method Under this method, a Hire Purchase Trading Account is prepared as follows: (a) Debit the Hire Purchase Trading Account by (i) Opening balance of H.P. Stock (Instalments not yet due) brought forward from the previous year. Generally, it is shown at hire purchase price. If it is given at cost, convert that into Hire Purchase price by adding loading. (ii) Opening balance of H.P. Debtors (Instalment due but not yet paid) brought forward from the previous year. (i) Value of goods sold on Hire Purchase during the accounting period. (ii) Expenses incurred during the accounting period. (iii) Loss on repossession of goods. (b) Credit the Hire Purchase Trading Account by (i) Cash received from hire purchase customers during the accounting period. It includes down payment, hire purchase instalments of the previous year as well as of the current year collected during the accounting period. (ii) Instalments due but not paid on goods repossessed. (iii) Closing balance of H.P. Stock (Instalment not yet due) at hire purchase price carried forward to the next period. If it is not given in the problem, it can be calculated by preparing Memorandum Goods with H.P. Customers Account. (iv) The closing balance of H.P. Debtors (Instalments due but not yet paid) is carried forward to next period. If the closing balance of H.P. Debtors is not given in the problem, it can be calculated by preparing Memorandum H.P. Debtors Account. Pass adjustment entries for the following: (i) For loading on opening balance of Hire Purchase Stock (Instalments not yet due/Goods with H.P. Customers) Stock Reserve Account Dr. To Hire Purchase Trading Account 11.36 © The Institute of Chartered Accountants of India Accounting (ii) For loading on goods sold on Hire Purchase during the year Goods sold on Hire Purchase Account Dr. To Hire Purchase Trading (iii) For loading on closing balance of Hire Purchase Stock (Instalments not yet due/Goods with H.P. Customers) Hire Purchase Trading Account Dr. To Stock Reserve Account The proforma of a Hire Purchase Trading Account is given below: Dr. Hire Purchase Trading Account Cr. Date Particulars ` Date Particulars ` To Balance b/d: By Cash A/c Hire Purchase Stock By Goods Repossessed (at H.P. price) A/c (Instalments due but not paid) Hire Purchase By Stock Reserve A/c Debtors To Goods Sold on H.P. (Loading on opening A/c (H.P. price) H.P. stock) To Loss on Goods By Goods sold on H.P. Repossessed A/c A/c To Expenses A/c (Loading on goods sold) To Stock Reserve A/c By Balance c/d: (Loading on closing H.P. Stock (at H.P. H.P. stock) price) To Profit & Loss A/c H.P. Debtors 12.1.1 Repossession: When goods are repossessed for default in payment, the number of instalments due but not yet received on the goods are not recoverable. The amounts of these instalments in respect to the repossessed goods are transferred from the Memorandum Hire Purchase Debtors Account to the Goods Repossessed Account by debiting the latter and crediting the former in the Memorandum Hire Purchase Ledger. The following are the Journal Entries for repossession (1) When the goods are repossessed Goods Repossessed Account Dr. [Instalments due but not yet paid] To Hire Purchase Trading Account 11.37 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions (2) When there is a loss on repossession [Selling price/market price is less than Instalments due but not yet paid] Hire Purchase Trading Account Dr. To Loss on Repossession Account (3) When there is a profit on repossession [Selling price/market price is greater than Instalments due but not yet paid] Profit on Repossession Account Dr. To Hire Purchase Trading Account 13. Calculation of Missing Figures Sometimes in the examination, some figures required to calculate profit/loss are not given. These may be: (i) Hire Purchase Stock; (ii) Hire Purchase Debtors; (iii) Purchases; or (iv) Cash received, etc., Before preparing the Hire Purchase Trading Account, the missing item(s) should be calculated first. The following steps are followed: Step 1: Draw up the following Memorandum Accounts. (a) Memorandum Stock at Shop Account. (b) Memorandum H.P. Stock Account/Stock with H.P. Customers Account. (c) Memorandum H.P. Debtors Account/Instalments Due Account Step 2: Place the available figures in the respective accounts. Step 3: Balance the account having maximum figures available. It will be helpful in finding out the missing figure of that account. Step 4: Place the figures so calculated in Step 3 to the relevant account. Step 5: Continue the process of transfer until all the figures are available. The proforma of these accounts are given below: Dr. Memorandum Stock at Shop Account Cr. Particulars ` Particulars ` To Balance b/d (at cost) By Goods sold on Hire Purchase A/c (at cost) To Purchases By Balance c/d Dr. Memorandum Hire Purchase Stock Cr. Particulars ` Particulars ` To Balance b/d (at H.P. Price) By Cash A/c To H.P. Stock A/c (total By Goods Repossessed A/c instalments due) (instalments not yet due) By Balance c/d 11.38 © The Institute of Chartered Accountants of India Accounting Dr. Memorandum Hire Purchases Debtors Account Cr. Particulars ` Particulars ` To Balance b/d (at H.P. price) By Cash A/c To H.P. Stock A/c (total By Goods Repossessed A/c instalments due) (install, due but not yet recd.) By Balance c/d 14. Instalment Payment System In instalment payment system the ownership of the goods is passed immediately to the buyer on the signing the agreement. Because of this basic difference the accounting entries under instalment payment system are slightly different from those passed under the hire-purchase system. The scheme of entries is as under: Books of buyer: Buyer debits asset account with full cash price, credits vendor’s account with full instalment price and debits interest suspense account with the difference between full cash price and full instalment price. Interest is debited to interest suspense account (not interest account) because it includes interest in respect of a number of years. Every year interest account is debited and interest suspense account is credited with the interest of current year. Interest account, at the end of the year, is closed by transferring to profit and loss account. The balance of interest suspense account (this is a debit balance) is shown in the balance sheet on the asset side. Vendor is paid the instalment due to him and entry for the depreciation is passed in the usual way. Books of Seller: The seller debits the purchaser with the full amount (instalment price) payable by him and credits sales account by the full cash price and credits interest suspense account by the difference between the total instalment price and total cash price. Seller, like the buyer, also transfers the amount of interest due from the interest suspense account interest account every year. Interest account is closed by transferring to profit and loss account and the balance of interest suspense account is shown in the balance sheet on the liability side. On receiving the instalment the vendor debits cash/bank account and credits purchaser’s account. 15. Difference of Hire Purchase Agreement and Instalment Payment Agreement A hire purchase agreement is a contract of bailment coupled with an option to the hire purchaser to acquire the goods delivered to him under such an agreement. By the delivery of goods to the hire purchaser, the hire vendor merely parts with their possession, but not the ownership. The property or title to the goods is transferred to the hire-purchaser, on his paying the last instalment of the hire price or complying with some other conditions stipulated in the contract. At any time before that the hire-purchaser has the option to return the goods and, if 11.39 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions he does so, he has only to pay the instalments of price that by then have fallen due. The right or option to purchase is the essence of hire-purchase agreement. In the event of a default by the buyer (hire purchaser) in the payment of any of the instalments of hire price, the vendor can take back the goods into his possession. This is legally permissible since the property in the goods is still with the vendor. On the other hand, it may have been agreed between the buyer and the seller that the price of the goods would be payable by instalments and the property would immediately pass to the buyer; in the event of a default of instalments, it would not be possible for the vendor to recover back the goods. He, however, would have the right to bring an action against the purchaser for the recovery of the part of the price that has not been paid to him. Analysis of the hire purchase price : The hire purchase price is always greater than the cash price, since it includes interest payable over and above the price of the goods to compensate the seller for the sacrifice he has made by agreeing to receive the price by instalments and the risk that he thereby undertakes. It is thus made up of following elements: (a) cash price; (b) interest on unpaid instalments; and (c) a charge to cover the risk involved in the buyer defaulting to pay one or more of instalments of price or that of his returning the goods in a damaged condition. Interest is the charge for the facility to pay the price for the goods by instalments after they have been delivered. The rate of interest is generally higher than that payable in respect of an advance or a loan since it also includes a charge to cover the risk that the hirer may fail to pay any of the instalments and, in such an event, the goods may have to be taken back into possession in whatever condition they are at the time. A separate charge on this account is not made as that would not be in keeping with the fundamental character of the hire-purchase sale. Illustration 14 Krishna Agencies started business on 1st April, 2010. During the year ended 31st March, 2011, they sold under-mentioned durables under two schemes — Cash Price Scheme (CPS) and Hire-Purchase Scheme (HPS). Under the CPS they priced the goods at cost plus 25% and collected it on delivery. Under the HPS the buyers were required to sign a Hire-purchase Agreement undertaking to pay for the value of the goods including finance charges in 30 instalments, the value being calculated at Cash Price plus 50%. The following are the details available at the end of 31st March, 2011 with regard to the products : 11.40 © The Institute of Chartered Accountants of India Accounting No. of No. of Nos. sold Cost per instalments Nos. Nos. sold instalments Product under unit received purchased under CPS due during HPS ` during the the year year TV sets 90 20 60 16,000 1,080 1,000 Washing 70 20 40 12,000 840 800 Machines The following were the expenses during the year : ` Rent 1,20,000 Salaries 1,44,000 Commission to Salesmen 12,000 Office Expenses 1,20,000 From the above information, you are required to prepare : (a) Hire-purchase Trading Account, and (b) Trading and Profit & Loss Account. Solution In the books of Krishna Agencies Hire-Purchase Trading Account for the year ended 31st March, 2011 ` ` ` ` To Goods sold on H.P. A/c: By Bank A/c cash received TVs TVs (60×` 30,000) 18,00,000 (1,000×` 1,000) 10,00,000 Washing Machines Washing Machines (40 × ` 22,500) 9,00,000 27,00,000 (800 ×` 750) 6,00,000 16,00,000 To H.P. Stock Reserve By Instalment Due A/c: 87.5 4,62,000 TVs ` 9,90,000× 187.5 (80×` 1,000) 80,000 To Profit & Loss A/c 7,98,000 Washing Machines 30,000 1,10,000 (H.P.profit transferred) (40×` 750) By Goods sold on HP A/c: (Cancellation of loading) 87.5 ` 27,00,000 × 187.5 12,60,000 By H.P. Stock (W.N 2) 9,90,000 39,60,000 39,60,000 11.41 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions Trading and Profit & Loss Account for the year ended 31st March, 2011 ` ` ` ` To Purchases: By Sales: TVs TVs (90×` 16,000) 14,40,000 (20×` 20,000) 4,00,000 Washing Machines Washing Machines (70 × ` 12,000) 8,40,000 22,80,000 (20 ×` 15,000) 3,00,000 7,00,000 To Gross profit c/d 1,40,000 By Goods sold on H.P. 14,40,000 A/c (27,00,000– 2,80,000 12,60,000) By Shop Stock (W. N 3) 24,20,000 24,20,000 To Salaries 1,44,000 By Gross profit b/d 1,40,000 To Rent 1,20,000 By H.P. Trading A/c To Commission 12,000 (H.P. Profit) 7,98,000 To Office expenses 1,20,000 To Net Profit 5,42,000 9,38,000 9,38,000 Working Notes: (1) Calculation of per unit cash price, H.P. price and Instalment Amount: Product Cost Cash Price H.P. price Instalment ` ` (Cost × 1.25) ` (Cash Amount (` ) Price×1.50) (H.P. price/No. of instalments) TV sets 16,000 20,000 30,000 1,000 Washing Machines 12,000 15,000 22,500 750 (2) Calculation of H.P. Stock as on 31st March, 2011: Product Total No. of Instalments Instalments Amount Instalments Due in 2007- not due in 2007- ` (Nos.) 2008 2008 (Nos.) (Nos.) TV sets 1800 1080 720 7,20,000 Washing Machines 1,200 840 360 2,70,000 9,90,000 11.42 © The Institute of Chartered Accountants of India Accounting (3) Calculation of Shop Stock as on 31st March, 2011: Product Purchased(Nos.) Sold (Nos.) Balance (Nos.) Amount ` TV sets 90 80 10 1,60,000 Washing Machines 70 60 10 1,20,000 2,80,000 Illustration 15 A acquired on 1st January, 2010 a machine under a Hire-Purchase agreement which provides for 5 half-yearly instalments of ` 6,000 each, the first instalment being due on 1st July, 2010. Assuming that the applicable rate of interest is 10 per cent per annum, calculate the cash value of the machine. All working should form part of the answer. Solution Statement showing cash value of the machine acquired on hire-purchase basis Instalment Interest @ 5% half Principal Amount (in Amount yearly (10% p.a.) = each instalment) 5/105 = 1/21 (in each instalment) ` ` ` 5th Instalment 6,000 286 5,714 Less: Interest – 286 5,714 Add: 4th Instalment 6,000 11,714 558 5,442 Less: Interest 558 (11,156–5,714) 11,156 Add: 3rd instalment 6,000 17,156 817 5,183 Less: Interest 817 (16,339–11,156) 16,339 Add: 2nd instalment 6,000 22,339 1,063 4,937 Less: Interest 1,063 (21,276–16,339) 21,276 Add: 1st instalment 6,000 27,276 1,299 4,701 Less: Interest 1,299 (25,977–21,276) 25,977 4,023 25,977 The cash purchase price of machinery is ` 25,977. 11.43 © The Institute of Chartered Accountants of India Hire Purchase and Instalment Sale Transactions Summary • Under Hire Purchase System, hire purchaser will pay cost of purchased asset in installments. The ownership of the goods will be transferred by the Hire Vendor only after payment of outstanding balance. • Under installment system, ownership of the goods is transferred by owner on the date of delivery of goods. • Accounting Method when goods have substantial sales under Hire Purchase System (cid:57) Cash price Method (cid:57) Interest suspense method • Accounting Method when goods have small sales under Hire Purchase System (cid:57) Debtor method (cid:57) Stock & Debtor Method 11.44 © The Institute of Chartered Accountants of India