Monday, June 18, 2007

Treatment of hire purchase transactions

Hire purchase transactions require the:
  1. Capitalisation of the asset
  2. recording of the liability to the hire purchase company
This in itself is straight forward:
  1. Debit Asset account
  2. Credit Hire purchase company
But, in book-keeping, we need to capitalise the asset at cost (i.e. net of the interests) and state the liability to the hire purchase company in full (i.e. cost + interest). Assuming that we purchase an asset as follows:





Cost of asset 10,000.00

Period of hire purchase 4 years

Hire purchase interest . 4% p.a





The total would therefore be:


Cost of asset 10,000.00

Interest over 4 years 1,600.00

Total hire purchase amount 11,600.00
















<---- Per instalment ---->

Grand

Repayments Interest
Principal
Total
Total

47 payments 33.33
208.33
241.66
11,358.02

Final payment 33.49
208.49
241.98
241.98

Total





11,600.00




















The accounting entry for this would then be:



Account Type
Debit
Credit

Asset account
Asset
10,000.00



HP Interest account Asset
1,600.00



Hire purchase co Liability


11,600.00




11,600.00
11,600.00











Note on calculating the interest and principal components of repayments:

1. Cost of asset / number of repayments (10,000/48)
2. Total interest / number of repayments (1,600/48)

Round off the amounts and ensure that the interest + principal = repayments as specified in the hire purchase company's repayment schedule.



The HP interest account and Hire purchase company account will reduce as we make the periodical payments and will be become zero when all payments have been made.

We will need one other account to expense off the hire purchase interest as we make progressive payments. Let's call this the HP Interest Expense account.

There are two ways to record payments to the Hire Purchase company:

  1. Credit the full amount paid (in this case 241.66) to the hire purchase company liability account and create a journal to reduce and expense off the hire purchase interest







    The accounting effect of payment made is as follows:


    Debit Credit


    Hire Purchase company 241.66



    Bank
    241.66








    The journal entry would be:




    Debit Credit


    HP Interest Expense 33.33



    HP Interest Account
    33.33








  2. Make all the relevant entries at the time of recording the payment. Our payment screen would therefore look like this:






    Hire purchase company 241.66


    HP interest expense 33.33


    HP interest (33.33)



    241.66







    Accounting impact:



    Bank
    241.66

    Hire purchase company 241.66


    HP interest expense 33.33


    HP interest
    33.33


    274.99 274.99






    The advantage to this is that you make both entries simultaneously and there is a lesser chance of overlooking the interest journal.

With some accounting software like MYOB and QuickBooks, we can save transaction templates. In MYOB it's called a recurring transaction, while in QuickBooks it's called memorizing a transaction. With this feature, you can save the template with all the necessary details and recall the template every time you need to make payment. Recording the transaction using the second method therefore allows you to recall and record in one step.


14 comments:

Rosli said...

Hi..Is there anoyne out there can help me...How to treat jouranal for early settlement of hire purchase..Its impact to Fixed assets account & hire purchase account, loss / gain of fixed assets

DeltaTech said...

Hi Rosli

Early settlement of Hire Purchase accounts do not have an impact on fixed assets accounts, and there are no loss or gain as the asset is not disposed.

I will be posting on the treatment of early settlement soon.

Regards
Jeff

stayphas said...

I might be wrong or just didn't understand the final posting for this transaction.

But why not

Cr Bank 241.66

Dr Dr Hire Purch Co 208.33

Dr HP interest expense 33.33

Cr HP interest 33.33


Instead of what he did, as bellow:

Cr Bank 241.66

Dr Hire Purch Co 241.66

Dr HP interest expense 33.33

Cr HP interest 33.33

I just think that there's something amiss here, or not?

Thanks in advance for your help.

DeltaTech said...

Hi Stayphas

If you look at your first entry, you will realise that it is not balanced:

Cr Bank 241.66
Dr Hire Purch Co 208.33

But, I can understand your confusion.

First off, we need to reduce the amount owing to the hire purchase company. This amount would include the principal and interest (208.33 + 33.33).

The second entry would reduce the interest portion from the suspense account.

Anonymous said...

You're right, in fact.

Can you post the doble entry for the depreciation for this example?

DeltaTech said...

Hire purchase accounts do not attract depreciation.

However, if you mean depreciation on the fixed asset acquired through hire purchase, then the journal for depreciation would be:

Debit Depreciation Account
Credit Accumulated Depreciation Account.

Anonymous said...

How to treat jouranal for early settlement of hire purchase..Its impact to Fixed assets account & hire purchase account, loss / gain of fixed assets

cLoVer said...

Hi there..correct me if i'm wrong.i still confuse with the treatment of "Dr Hire Purchase Interest(Asset)". why should we dr HPI(Asset) as we didn't settle yet the payment. so HPI should be our liability.oh! i'm so confuse.anyone help me please

Anonymous said...

cLoVer said...

Hi there..correct me if i'm wrong.i still confuse with the treatment of "Dr Hire Purchase Interest(Asset)". why should we dr HPI(Asset) as we didn't settle yet the payment. so HPI should be our liability.oh! i'm so confuse.anyone help me please

ANSWER
if you want to use the liability account, you will need to post it as negative.

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Narcissus said...

this explanation is AWESOMEEE!!!
now i can practice this to my Fixed Asset.
thx buddy for sharing this knowledge.

Anonymous said...

If there is a GST including this Assets, How can we account that

Peprah Afriyie said...

How do you treat a high purchase transaction that has been financed fully from equity