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

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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.

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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.

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