Although hire purchase system could ultimately result in sale of goods, the sale in normal sense and sale under hire purchase system are not the same. The following are the differences between sale and hire purchase.
Credit Sale Hire Purchase
1. A ‘sale’ is governed by the sale of Goods Act, 1930.
1. Hire purchase is governed by the Hire Purchase Act, 1972.
2. In case of sale, the ownership of the goods is transferred to the buyer immediately.
2. In case of Hire purchase, the ownership of goods is transferred to buyer on payment of all installments.
3. In case of sale, the buyer makes payment in lumpsum. (if the lumpsum payment is made immediately on transfer of ownership and possession of goods, it is called Cash Sale and if the payment is made on a specified future date, it is called credit sale.
3. In case of hire purchase, the payment is made in installments.
4. The buyer pays only for the price of goods.
4. The hire purchaser pays for the price of goods and also some amount of interest.
5. On non-payment of the consideration the seller cannot take back the goods, but can only take legal action on buyer.
5. On non-payment of any installment, the seller can re-possess the goods.
6. Once a sale has taken place, neither the seller, nor the buyer can terminate the contract (unless it is for genuine reason like damage of goods etc.)
6. Either the buyer or the seller can terminate the contract at any point of time, until the payments of last installment.
7. When the buyer becomes insolvent, the seller has to undertake the risk of loss.
7. When the hire purchaser becomes insolvent, the seller can reposes the goods, and hence need not undertake the risk of loss.
8. A sale is subject to levy of Value Added tax at the time of contract of sale.
8. In this case, the Value Added tax will be leviable at the time of ownership (i.e. on payment of last installment).
178 s 3.3 Apportionment of interest on Hire Purchase Transactions
There are several methods available by which interest charged on a credit sale may be apportioned over the period of the payment. These include:
The straight-line method the total interest charge is spread equally over the accounting periods.
The reducing balance method interest charged to an accounting period is calculated by basing it on the amounts outstanding.
Sum of the digits method interest charged to an accounting period is calculated by basing it on the number of outstanding periods in relation to the total period of credit:
Year Outstanding Proportion of interest
1 5 5/15
2 4 4/15
3 3 3/15
4 2 2/15
5 1 1/15
in proportion to cash received interest charged to an accounting period is calculated by basing it on the amount of cash received relative to the total price. This method is sometimes easier to apply by first taking credit for all the interest and then transferring that proportion out to a suspense account relative to the amount not yet received.
actuarial method this method will be described in case-study about typical hire purchase contract.
Illustration 1
The following example illustrates the different results that may be obtained from some of the above methods.
Basic Data:
Cash price of goods: N9,600 Number of installments: 3 years
Amount of each installment: N4,000 per annum
Without consideration of time-value, combine the three installments together as its hire purchase price and then:
Amount of interest: N4,000×3 - N9,600= N2,400 1 Straight line
Year Interest N
1 800
2 800
3 800
N 2,400 2 Sum of the digits
Year Outstanding Interest N
1 3 3/6
N2,400 1,2002 2 2/6
N2,400 8003 1 1/6
N2,400 400N 2,400 3 In proportion to cash received
Year Received Cash Interest N
179 s
1 N 4,000
2 N 4,000
000 , 12
000 ,
4
N2,400,8003 N 4,000
000 , 12
000 ,
4
N2,400,800 Illustration 2Ijeshatedo Limited acquired a car on 1 January 2003 under a two-year hire purchase agreement. An initial deposit of N160,000 and four half-yearly installments of N160,000 commencing on 1 July 2003 are required. The cash price is N754,400 and the company’s year ends every 30 September.
Calculate the hire purchase interest Solution
N160,000 + (N160,00 x 4) - N754,400 = N45,600 Illustration 3
White sold a machine to Green on hire purchase basis. You are given the following information:
Cash price N2,800,000
Initial Deposit N1,000,000
A yearly installment of N750,000 payable on 31 December for 4 years, was agreed. The company makes up its accounts to 31 December.
(a) Calculate the hire purchase price.
(b) Calculate the hire purchase interest attributable to each year using straight line method.
1 N1,000,000 + (N750,000 X 4 yrs) = N4m 2 N4,000,000 – 2,800,000 = N300,000 4
Illustration 4
Calculate the hire purchase interest attributable to each year using straight line
Using the sum-of-the-year digit in hire-purchase agreement, calculate the finance charge in the income statement in the third year if the total finance charge for five years is N72,000.
3/15 x 72,000 = N14,400 3.4 Disclosure requirements
Income Statement
The hire purchase interest due is charged to income statement and it is treated as part of the Financial charges.
Depreciation for the year on the fixed asset is also charged to the profit & Loss Account.
Statement of Financial Position
The cost of the fixed assets acquired on hire purchase is disclosed as ‘fixed assets’ in the balance sheet. The relevant accumulated depreciation charged is also shown to determine the net book value of the asset.
180 s Similarly liabilities outstanding on the asset which is due to the vendor is also
disclosed as ‘current liabilities’ or creditors failing due within one year or falling due after one year, as the case may be.
Illustration 5
On 1 January 20x1 Homenda Ltd sold a machine, costing N15,000, to Bus Transportation Ltd under a hire purchase agreement requesting a deposit of N5,000 and three equal instalments of N6,000 per annum payable at the end of each year. Interest in the contract is at 9.7% per annum and cash price isN20,000.
Cash price 20,000 Cost 15,000 Profit 5,000
Hire purchase price (5,000+(3×6,000) 23,000 Cash price 20,000
Interest 3,000
3.5 Methods of Accounting for The Hire Purchase