Thursday, July 24, 2008

Early settlement of hire purchase accounts

One of our readers, Rosli, asked about the accounting treatment when hire purchase accounts are settled early.

In a previous post, we discussed the how to handle hire purchase transactions, but did not touch on the topic posed by Rosli.

If a hire purchase account is settled early, the only accounting impact will be on the HP Creditor liability account and the Hire Purchase Interest Suspense asset account.

Taking the example from our previous discussion, say the hire purchase amount was settled early after 24 months.

Our hire purchase account would now look like this:

<---- Per instalment ---->
Repayments Interest Principal Total Total
24 instalments paid 33.33 208.33 241.66 5,799.84
23 repayments due 33.33 208.33 241.66 5,558.18
Final payment due 33.49 208.49 241.98 241.98
Grand total


We would have paid off 5,799.84 of the 11,600.00 due, and our ledger accounts would look like this:

The balance outstanding would therefore be RM5,800.16, but this includes an interest amount that is payable only if you continue with the hire purchase arrangement.

For an early settlement therefore the interest would be reduced from the amount payable, which in our example would be RM5,800.16 less RM800.08 leaving a balance of RM5,000.08.

So, when we make payment, we would credit the bank account and debit the Hire Purchase creditor's account. We would then need to journalise the interest amount. The result would be as shown below:

Hire Purchase creditor's account


Date Description Amount
Date Description Amount

Early settlement payment 5,000.08

Balance b/fwd 5,800.16

HP interest account 800.08



Hire Purchase interest suspense account


Date Description Amount
Date Description Amount

Balance b/fwd 800.08

HP creditor's account 800.08



In reality, of course, the hire purchase company would not cancel all the interest. They would also charge an "admin fee" for early settlement. Just charge out the interest to the relevant expense account and journalise the balance.

Do note that early settlement of hire purchase accounts do not impact on the actual asset account.