FA - HP - Unit 5 Notes

1.
Hire Purchase
A hire purchase (HP), also known as an installment plan, is an arrangement whereby a

customer agrees to a contract to acquire an asset by paying an initial installment (e.g., 40% of
the total) and repays the balance of the price of the asset plus interest over a period of time.
Other analogous practices are described as closed-end leasing or rent to own.
2. Characteristics of Hire Purchase System

Goods are delivered by the seller to the buyer.
Buyer agrees to pay hire purchase price (i.e., cash price + interest) in
Instalments paid are treated as hire charges till the payment of the last instalment.
After the payment of the last instalment, ownership is transferred in the name of the buyer.
3. Term Used in Hire Purchase agreement;
Hire Purchaser: He is a buyer in hire purchase agreement.
Hire Vendor: He is a seller in a hire purchase agreement.
Cash Price: It is the amount to be paid for outright purchase in cash.
Down Payment: It is the initial payment payable by the hire purchaser at the time of entering
into a hire purchase agreement.
Hire Purchase Price: It is the total amount payable by the hire purchases to the hire vendor of
goods are purchased under the hire purchase system.
4. Advantages of Hire Purchase System:
(1) Convenience in Payment:
The buyer is greatly benefited as he has to make the payment in installments. This system is
greatly advantageous to the people having limited income.
(2) Increased Volume Of Sales:
This system attracts more customers as the payment is to be made in easy installments. This
leads to increased volume of sales.
(3) Increased Profits:
Large volume of sales ensures increased profits to the seller.
(4) Encourages Savings:
It encourages thrift among the buyers who are forced to save some portion of their income for
the payment of the installments. This inculcates the habit to save among the people.
(5) Helpful For Small Traders:
This system is a blessing for the small manufacturers and traders. They can purchase
machinery and other equipment on installment basis and in turn sell to the buyer charging full
price.
5. Disadvantages of Hire Purchase System:
(1) Higher Price:
A buyer has to pay a higher price for the article purchased which includes cost plus interest.
The rate of interest is quite high.
(2) Artificial Demand:
Hire purchase systems create artificial demand for the product. The buyer is tempted to
purchase the products, even if he does not need or afford to buy the product.
(3) Heavy Risk:
The seller runs a heavy risk under such a system, though he has the right to take back the
articles from the defaulting customers. The second hand goods fetch little price.
(4) Difficulties in Recovery of Installments:
It has been observed that the sellers do not get the installments from the purchasers on time.
They may choose wrong buyers which may put them in trouble. They have to waste time and
incur extra expenditure for the recovery of the installments. This sometimes led to serious
conflicts between the buyers and the sellers.
(5) Break Up Of Families:
The system puts a great financial burden on the families which cannot afford to buy costly
and luxurious items. Recent studies in western countries have revealed that thousands of
happy homes and families have been broken by hire purchase buying’s.
6. Hire Purchase and Installment Sales | Difference
Hire Purchase Sale:
1. Ownership in the goods is transferred only after the payment of the last installment.
2. The remittance is made by the buyer through installments.
3. On default, the goods will be seized by the seller.
4. If the buyer sells the goods before making the last installment, the new buyer does not get a
better title than the purchaser under credit purchase.
5. The buyer has no right to dispose of the goods.
Installment sale:
1. Ownership is transferred at the moment of purchase.
2. Payment of price is generally made in installments or according to agreement.
7. X Transport Ltd. purchased from Delhi Motors 3 trucks costing Rs 5,00,000 each on
the hire purchase system. Payment was to be made Rs 3,00,000 down and the
remainder in 3 equal instalments together with interest @ 18% p.a. X Transport Ltd.
wrote off depreciation @ 20% on the diminishing balances. It paid the instalment due
at the end of the first year but could not pay the next.
Delhi Motors agreed to leave one truck with the purchaser, adjusting the value of the other 2
trucks against the amount due. The trucks were valued on the basis of 30% depreciation
annually on diminishing balances. Prepare the necessary ledger accounts in the books of X
Transport Ltd. for 2 years. Also show journal entries for all the transactions taking place on
the date of default.
The figure of Rs 2,94,000 includes the loss of Rs 1,44,000 due to interest, entry for which has
not been passed in Delhi Motors Account under the second method. Under the first method
also, the total loss is Rs 2,94,000; Rs 1,50,000 appearing in Trucks Account and Rs 1,44,000
appearing by way of interest in Delhi Motors Account.

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A hire purchase (HP), also known as an installment plan, is an arrangement whereby a

2. Characteristics of Hire Purchase System

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