• August 11th, 2011
  • Posted by athanne

Hire Purchase

In Kenya, the law relating to hire purchase is contained in the hire purchase act (CAP57).The Act defines hire purchase agreement as an agreement for the bailment of goods under which the bailee may buy the goods or under which the property in the goods will pass to the bailee after fulfillment of certain conditions. Business Training in Kenya has more articles.

Under the provisions of Section 6 of the hire purchase Act before a hire purchase agreement is entered into a statement of the cash price must be furnished by the owner to the hirer otherwise any contract and any agreement or security based on it will not be enforceable. The agreement which is required to be registered must be signed by the hirer. It must contain a notice relating to the hirer’s right and statements of hire purchase and cash price, the amount of installments and the dates of payment.

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Under the hire purchase system the buyer agrees to pay for the commodity in installments on signing the agreement, the buyer can then take possession of the commodity but the ownership of the commodity remains with the seller until the buyer pays all the installments. In case the buyer fails to pay any installments the seller has a right to take back the commodity and the buyer will have no claim over the installments he has already paid. The amount paid will be treated as hire charges for the article. The difference between the hire purchase price and cash price is called the hire purchase interest. The first payment is called a down payment or deposit. Monthly fixed payments are called monthly installments.

Accounting treatment for hire purchase transactions

The normal accounting policy is to treat hire purchase transactions as the actual purchase or sales because the intention of the buyer is to pay the full amount of the good though in installments. The hire purchase transactions may be recorded be recorded in the buyer’s books and the seller’s or vender’s books.

Hire purchase transactions in the buyer’s books

Accounts to be maintained

Asset account

Hire purchase company account

Hire interest suspense account

 Hire PurchaseAccounting entries in respect of goods purchased on hire purchase basis

Assets purchased on hire purchase terms

Dr Asset account (cash price)

Dr Hire purchase interest suspense account (with total Hire Purchase charges)

Cr Hire Purchase Company account (total amount paid under Hire Purchase agreement)

In case of down payments and installments paid to the hire purchase company

Dr hire purchase Company

Cr cash or bank account

In a case where the hire purchase interest is written off at the end of the year

Dr Profit and loss account

Cr hire purchase interest suspense account

Balance sheet presentation

The balance on the hire purchase company less the balance on the hire purchase interest suspense account will be shown as the current liability in the balance sheet.

The asset account will be maintained at the cash price and the depreciation will be charged in the normal manner. The disposal of the asset will be treated in the normal manner.

In case of early repayment to the hire purchase company

Amount paid in early termination

Dr Hire purchase company account

Cr bank account

Balance remaining in the hire purchase company (interest waived)

Dr Hire purchase company account

Cr hire purchase interest suspense account

Balance remaining in the hire purchase interest suspense account

Dr Profit and loss account

Cr hire purchase interest suspense account

Methods of writing off hire purchase interest

Straight line method: Here the hire purchase interest is written off on a straight line basis over the period of the hire purchase agreement. The method is also known as the equal installments method.

Sum of digits methods (Rule of 78): It is an arithmetical method of apportioning interest in approximate proportions of the outstanding amount at any time. It is done by numbering the installments giving the highest digit to the installment and the lowest digit to the last installment. Then apportion to each accounting period a portion of the hire purchase interest for each installment paid in the period.

Actuarial method

The hire purchase interest which is to be written off is computed on a reducing balance basis.

Hire purchase transactions in the books of the seller

Hire purchase transaction is an income to the books of the seller.

Methods of accounting for hire purchase sales

Sales system

Stock system

Sales system

It is where the gross profit and the interest earned are calculated separately. The accounts required in the books of the seller include the sales account, hire purchase interest suspense account, the debtor’s account and the profit and loss account. The amount due from the debtors account will be taken as current assets. The profit and loss account will be credited with gross profit on sales, profit on repossession and hire purchase interest in the current year.

Stock system

This accounting system is used where the trader intends to apportion the whole profit to successive periods in proportion to cash received. The accounts required include hire purchase trading account, hire purchase debtor’s account




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