Hire Purchase Accounts Hire Purchase n Hire Purchase

Hire Purchase Accounts

Hire Purchase n Hire Purchase (HP) is one of the payment methods of which the buyer use the goods without immediate full settlement of the price of the goods

With Hire Purchase Agreement n The HP selling price includes normal Cash Price PLUS HP Interest n The seller agreed that the buyer could hire the goods by payments of ‘deposit’ and ‘instalments’

Hire Purchase Price = Cash Price + Total Hire Purchase Interest OR = Deposit (Down payment) + Outstanding Balance (including HP interest paid by instalments

Calculation of Hire Purchase Interest Straight line method (b) Actuarial Method (c) Sum-of-digits Method (a)

Straight Line Method(Equal apportionment) • Interest is apportioned evenly over the number of installments agreed upon. HP Interest per instalment = Total HP Interest Number of total instalments

Example 1 n An asset is acquired on the following terms: n Cash price $9000 n Down payment $1000 n HP Price $12200 n Nominal rate of interest 10% n Four annual instalments $2800

Answer: Total HP interest = $12000 -$9000 =$3200 HP interest payable per annum = $3200/4 = $800 OR An alternative way to calculate hire purchase interest ($9000 -$1000)*10% = $800 Year 1 2 3 4 HP interest + Capital = $ $ 2000 800 Instalments $ 2800

B. Actuarial Method n Interest is charged on the outstanding balance of the cash price after the down payment is made. 1. Equal instalments 2. Unequal instalment

1 Equal instalment Equal instament = HP price – Down payment No. of instalment n Example n n n 2 An asset is acquired on the following terms: Cash price $9000 Down payment $1000 HP price $11096 Interest 10% on outstanding balance Four annual instalment $2524 (11096 -1000)/4

Year 1 2 3 4 HP interest 6276 $ (9000 -1000)*10% =800 (8000+800 -2524)*10%=628 (6276+628 -2524)*10%=438 (4380+438 -2524)*10%=230 4380 2096 Capital $ 1724 1896 2086 2294 8000 Instalments $ 2524 10096

Unequal instalment=Cash price-Down payment+Interest accrued No. of instalment (i. e. unpaid interest) n Example n n n 3 An asset is acquired on the following terms: Cash price $9000 Down payment $1000 HP price $11000 Interest 10% on outstanding balance Four annual instament $2000+interest

Year 1 2 3 4 HP interest 6000 $ (9000 -1000)*10% =800 (8000+800 -2800)*10%=600 (6000+600 -2600)*10%=400 (4000+400 -2400)*10%=200 4000 2000 Capital $ 2000 8000 Instalments $ 2800 2600 2400 2200 10000

C. Sum of Digits Method n The HP interest is apportioned according to the digit assigned (descending order) n Using this method, more interest is charged in the earlier periods, less interest is charged in the later periods.

When n = number of instalments Sum of digits = n(n+1) 2 HP interest per instalment = Total HP interest* Digit assigned in the instalment Sum-of-digits of total instalment

n Example 4 n A motor vehicle was purchased under a hire purchase agreement Cash price $10000 Hire Purchase $13600 Instalments 4 months Date of sale 1 October 1996 Calculate the interest under each of the three cases: (a) First instalment due at the end of month from the date of sale (b) First instalment due at the beginning of month following the date of sale (c) First instalment due at the date of sale. n n n n

Total HP interest =$13600 -$10000=$3600 Sum of digit= 4*(4+1)/2=10 Case (a) and (b) Interest paid 1 st instalment 2 nd instalment 3 rd instalment 4 th instalment $3600*4/10=$1440 $3600*3/10=$1080 $3600*2/10=$720 $3600*1/10=$360

Total HP interest =$13600 -$10000=$3600 Sum of digit= 3*(3+1)/2=6 Case ( C ) Interest paid 1 st instalment 2 nd instalment 3 rd instalment 4 th instalment $3600*3/6=$1800 $3600*2/6=$1200 $3600*1/6=$600 -

Concept Chart Hire Purchase Buyer Assets account Hire purchase creditors account Hire purchase interest suspense account Seller Hire purchase interest account Hire purchase sales Provision for unrealized profit Hire purchase debtors account

Purchaser’s Books

Acquisition of Assets on Hire Purchase • When an asset is acquired on hire purchase, there are 2 ways to account for this in the purchaser’s books. 1. Progress interest charge system 2. Interest Suspense Method • They differ mainly in the way they record hire purchase interest.

2 Method of HP Interest Treatment (i) Progress interest charge system (ii) Interest suspense method = 6 Version * 3 method of HP Interest Apportionment (i) Straight-line method (ii) Actuarial method (iii) Sum-of-digit method

Progress interest charge system n Interest is charged upon each instalment.

Progress interest charge system: Dr Fixed assets Cr HP Creditor With cash price of assets (at the date of purchase) Dr HP Creditor Cr Bank With deposit and instalment paid Dr HP Interest Cr HP Creditor With hire purchase interest accrued for the current year (at the year end) Dr Profit and Loss (expense) Cr HP Interest With the amount of hire purchase interest transferred to current year’s profit and loss account Dr Profit and Loss Cr Provision for depreciation Annual depreciation charged on full cash price of the asset

Notes : • Cut off of the financial period should be aware in order to calculate the total hire purchase interest of the financial period to be reflected in the P/L account as an ‘expense’ item • Each financial year may include up to 12 monthly instalment, 4 quarterly instalment or 2 half-yearly instalment

Balance Sheet Presentation n For instance: after 1 st instalment Paid n Progress interest charge system: Balance Sheet ( Instalment for 1 st year) $ Current Liabilities X HP Creditor (Instalment for 2 nd year) Instalment for 2 nd year – Interest payable for 2 nd year Long term Liabilities X HP Creditor (Instalment for 3 rd year and so on) Outstanding HP creditor – HP creditor on current liabilities

n For instance: after 1 st instalment Paid n Interest Suspense Method: Balance Sheet ( Instalment for 1 st year) $ Current Liabilities X HP Creditor (Instalment for 2 nd year) Less HP interest suspense (X) Interest payable for 2 nd year X Outstanding HP creditor – Instalment for next year Long term Liabilities HP Creditor (Instalment for 3 rd year and so on) X Less HP interest suspense (X) Outstanding interest suspense – interest X Payable for 2 nd year

Example Refer to textbook P. 24

Example 6 n n n n n ABC Ltd. purchased a vehicle from Grace Ltd. on 1 Jan 1996 on HP agreement. The details were as follows Cash price $9000 Down payment $1000 HP Price $11096 Nominal rate of interest 10% on outstanding balance Four equal annual instalments First due 31 Dec 1996 Depreciation 10% on cost Using (a) the progress interest charge system and (b) interest suspense method, show transactions in books of ABC Ltd.

Answer (a): Total HP interest= HP price – Cash Price = 11096 – 9000 = 2096 Equal instalments = (11096 – 1000)/4 =2524

Hire purchase Creditor (Grace Ltd) 1/1/96 Bank-deposit 31/12 Bank-instalment 1, 000 2, 524 31/12 Balance c/d 6, 276 1/1/96 Vehicle 9, 000 31/12 HP Interest 800 (9000 -1000)*10% 9, 800 Hire Purchase Interest 31/12/96 HP Creditor 800 31/12/96 P/L 800

Balance Sheet as at 31 Dec (Extract) 96 Fixed Assets 9000 Vehicle Less Pro for Dep 900 8100 Current Liabilities HP Creditor 1896 2524 -628 Long Term Liabilities 4380 HP Creditor 6276 -1896

Hire purchase Creditor (Grace Ltd) 1/1/96 Bank-deposit 31/12 Bank-instalment 1, 000 2, 524 31/12 Balance c/d 6, 276 1/1/96 Vehicle 31/12 HP Interest 2, 524 31/12 Balance 4, 380 800 9, 800 31/12 Bank-instalment 9, 000 1/1/97 Balance b/d 31/12 HP Interest (6276*10%) 6, 276 628 6, 904 Hire Purchase Interest 31/12/97 HP Creditor 628 31/12/97 P/L 628

Balance Sheet as at 31 Dec (Extract) 96 Fixed Assets 9000 Vehicle Less Pro for Dep 900 8100 97 9000 1800 7200 Current Liabilities HP Creditor 1896 2086 2524 -438 Long Term Liabilities 2294 HP Creditor 4380 -2086

Hire purchase Creditor (Grace Ltd) 1/1/96 Bank-deposit 31/12 Bank-instalment 1, 000 2, 524 31/12 Balance c/d 6, 276 1/1/96 Vehicle 31/12 HP Interest 2, 524 31/12 Balance 4, 380 1/1/97 Balance b/d 31/12 Hp Interest 2, 524 2, 294 6, 276 628 6, 904 31/12 Bank-instalment 31/12 Balance 800 9, 800 31/12 Bank-instalment 9, 000 1/1/98 Balance b/d 31/12 HP interest(4380*10%) 4, 818 4, 380 438 4, 818 Hire Purchase Interest 31/12/98 HP Creditor 438 31/12/98 P/L 438

Balance Sheet as at 31 Dec (Extract) 96 Fixed Assets 9000 Vehicle Less Pro for Dep 900 8100 Current Liabilities HP Creditor 1896 Long Term Liabilities HP Creditor 4380 97 9000 1800 7200 98 9000 2700 6300 2086 2294 2524 -230 2294 -2294 -

Hire purchase Creditor (Grace Ltd) 1/1/96 Bank-deposit 31/12 Bank-instalment 31/12 Balance c/d 1, 000 2, 524 6, 276 9, 800 1/1/96 Vehicle 31/12 HP Interest 2, 524 4, 380 6, 904 2, 524 1/1/97 Balance b/d 31/12 Hp Interest 6, 276 628 1/1/98 Balance b/d 6, 904 4, 380 31/12 Balance 2, 294 4, 818 31/12 HP interest(4380*10%) 31/12 Bank-instalment 2, 524 1/1/99 Balance b/d 31/12 HP interest(2294*10%) 2524 31/12 Bank-instalment 31/12 Balance 31/12 Bank-instalment 9, 000 800 9, 800 438 4, 818 2294 230 2524 Hire Purchase Interest 31/12/99 HP Creditor 230 31/12/99 P/L 230

Balance Sheet as at 31 Dec (Extract) 97 96 Fixed Assets 9000 Vehicle Less Pro for Dep 900 8100 9000 1800 7200 Current Liabilities HP Creditor 1896 Long Term Liabilities HP Creditor 4380 98 99 9000 2700 9000 3600 6300 5400 2086 2294 - -

Interest Suspense Method n Interest is recorded all together at the beginning of hire purchase agreement and charge proportionally to the profit and loss account every year.

Interest Suspense Method: Dr Fixed assets Dr HP Interest Suspense Cr HP Creditor With the cash price of assets With total hire purchase interest With the hire purchase price (at the date of purchase) Dr HP Creditor Cr Bank With deposit and installments paid Dr HP Interest Cr HP Interest Suspense With hire purchase interest accrued for the current year (at the year end) Dr Profit and Loss Cr HP Interest With the amount of hire purchase interest transferred to current year’s profit and loss account. Dr Profit and Loss Cr Provision for depreciation Annual depreciation charged based on full cash price of the asset.

Example n Refer to textbook P. 24

Example 6 n n n n n ABC Ltd. purchased a vehicle from Grace Ltd. on 1 Jan 1996 on HP agreement. The details were as follows Cash price $9000 Down payment $1000 HP Price $11096 Nominal rate of interest 10% on outstanding balance Four equal annual instalments First due 31 Dec 1996 Depreciation 10% on cost Using (a) the progress interest charge system and (b) interest suspense method, show transactions in books of ABC Ltd.

Answer (b): Total HP interest= HP price – Cash Price = 11096 – 9000 = 2096 Equal instalments = (11096 – 1000)/4 =2524

Hire purchase Creditor (Grace Ltd) 1/1/96 Bank-deposit 31/12 Bank-instalment 31/12 Balance c/d 1, 000 2, 524 7572 9, 800 1/1/96 Vehicle 1/1/96 HP Interest Suspense (11096 -9000) 9, 000 2096 9, 800 HP Interest Suspense 1/1/96 HP Creditor 31/12/96 HP Interest 2096 800 (9000 -1000)*10% 31/12/96 Bal c/d 1296 2096 Hire Purchase Interest 31/12/96 HP suspense 800 31/12/96 P/L 800

Balance Sheet as at 31 Dec (Extract) 96 Current Liabilities HP Creditor 2524 Less HP interest suspense 628 1896 (7572 -1296)*10% 7572 -2524 Long Term Liabilities 5048 HP Creditor Less HP interest suspense 668 1296 -628 4380

Hire purchase Creditor (Grace Ltd) 1/1/96 Bank-deposit 31/12 Bank-instalment 31/12 Balance c/d 1, 000 2, 524 7572 9, 800 1/1/96 Vehicle 1/1/96 HP Interest Suspense 2, 524 5048 6, 904 1/1/97 Balance b/d 9, 000 2096 9, 800 7572 6, 904

HP Interest Suspense 1/1/96 HP Creditor 2096 31/12/96 HP Interest 800 (9000 -1000)*10% 31/12/96 Bal c/d 2096 1/1/97 Bal b/d 1296 31/12/97 HP Interest (7572 -1296)*10% 31/12/97 Bal c/d 2096 1296 2096 628 668 2096 Hire Purchase Interest 31/12/97 HP Creditor 628 31/12/98 P/L 628

Balance Sheet as at 31 Dec (Extract) 96 97 Current Liabilities 2524 HP Creditor 2524 438 Less HP interest suspense 628 1896 2086 (5048 -668)*10% 5048 -2524 Long Term Liabilities 5048 HP Creditor Less HP interest suspense 668 4380 668 -438 2524 230 2294

Hire purchase Creditor (Grace Ltd) 1/1/96 Bank-deposit 31/12 Bank-instalment 31/12 Balance c/d 1, 000 2, 524 7572 9, 800 1/1/96 Vehicle 1/1/96 HP Interest Suspense 2, 524 5048 6, 904 2, 524 1/1/97 Balance b/d 7572 1/1/98 Balance b/d 6, 904 5048 2524 4, 818 9, 000 2096 9, 800 4, 818

HP Interest Suspense 1/1/96 HP Creditor 2096 31/12/96 HP Interest 800 (9000 -1000)*10% 31/12/96 Bal c/d 2096 1/1/97 Bal b/d 1296 31/12/97 HP Interest (7572 -1296)*10% 31/12/97 Bal c/d 2096 1/1/98 Bal b/d 668 31/12/98 HP Interest (5048 -668)*10% 31/12/98 Bal c/d 2096 1296 2096 628 668 2096 438 230 2096 Hire Purchase Interest 31/12/98 HP Creditor 438 31/12/98 P/L 438

Balance Sheet as at 31 Dec (Extract) 96 Current Liabilities HP Creditor 2524 Less HP interest suspense 628 1896 Long Term Liabilities 5048 HP Creditor Less HP interest suspense 668 4380 97 98 2524 438 2086 2524 230 2294 (2524 -230)*10% 2524 -2524 230 2294 230 -230 -

Hire purchase Creditor (Grace Ltd) 1/1/96 Bank-deposit 31/12 Bank-instalment 31/12 Balance c/d 31/12 Bank-instalment 1, 000 2, 524 7572 9, 800 1/1/96 Vehicle 1/1/96 HP Interest Suspense 9, 000 2096 2, 524 5048 6, 904 2, 524 1/1/97 Balance b/d 7572 1/1/98 Balance b/d 6, 904 5048 9, 800 2524 4, 818 2, 524 1/1/99 Balance b/d 2524

HP Interest Suspense 1/1/96 HP Creditor 2096 31/12/96 HP Interest 800 (9000 -1000)*10% 31/12/96 Bal c/d 2096 1/1/97 Bal b/d 1296 31/12/97 HP Interest (7572 -1296)*10% 31/12/97 Bal c/d 2096 1/1/98 Bal b/d 668 31/12/98 HP Interest (5048 -668)*10% 31/12/98 Bal c/d 1/1/99 Bal b/d 2096 230 31/12/98 HP Interest 1296 2096 628 668 2096 438 230 2096 230 (5048 -668)*10% Hire Purchase Interest 31/12/99 HP Creditor 230 31/12/99 P/L 230

Balance Sheet as at 31 Dec (Extract) 96 Current Liabilities HP Creditor 2524 Less HP interest suspense 628 1896 Long Term Liabilities 5048 HP Creditor Less HP interest suspense 668 4380 97 98 99 2524 438 2086 2524 230 2294 - - - 2524 230 2294

B. Termination of a Hire Purchase Agreement The buyer can terminate the hire purchase agreement earlier by paying balance earlier than the last installment date. n However, the buyer may also be forced to terminate the agreement earlier if the asset is scrapped due to its use. n Upon the termination of a hire purchase agreement, a number of entries should be made in the books. n The accounting treatments differ, depending on which method is used to record hire purchase interest. n

1. Progress interest charge system Summary of procedures Dr HP creditor Cr Bank With the last payment to the HP creditor Dr HP interest Cr HP creditor With the HP interest and penalty charges for early termination of the hire purchase contract Dr Disposal Cr Asset With the cost of the asset Dr Provision for depreciation Transferring related depreciation provision to the disposal account Cr Disposal Dr Bank Cr Disposal With the insurance claim for the disposal (if any) Dr Profit and Loss Cr Disposal With the loss on the disposal (Reverse the entries for a profit on disposal)

Example 7

Example 7 Cash Price n Prov for dep n $5000 $3200 ( A full year dep is charged in the year of purchase, but none in the year of disposal) n n n HP creditor on 1 Jan 1996 $1800 Instalments $250(monthly) Interest $50 The car was involved in an accident in May 1996 resulting in a total write off, and the sum of $1000 was received from the insurnance company. All instalments up to and including 31 May were paid. A payment of $930 was made on 30 June 1996 in full settlement

HP Creditor 1996 $ 1996 May 31 Bank –instalment 1250 Jan 1 Bal b/f Dec 31 HP interest ($250*5) ($50*6) June 30 Bank-settlement 930 Dec 31 HP interest -penalty 2180 $ 1800 300 80 2180 HP interest 1996 Dec 31 HP Creditor (300+80) $ 380 1996 Dec 31 P/L $ 380

Disposal of Vehicle 1996 $ 1996 Jun 30 Vehicle 5000 Jun 30 Dep Jun 30 Bank - insurance Dec 31 P/L - loss 5000 Dep - Vehicle 1996 Jun 30 Disposal $ 1996 3200 Jan 1 B/f $ 3200 1000 800 5000 $ 3200 Vehicle 1996 Jan b/f $ 5000 1996 Jun 30 Disposal $ 5000

2. Interest suspense method Summary of procedures Dr HP Creditor Cr Bank With the last payment to the HP creditor Dr HP interest Cr HP interest suspense Dr HP Creditor Cr Disposal Dr Disposal Cr HP Interest suspense Dr Disposal Cr Asset With the HP interest for the current year Dr Prov. for Depn. Cr Disposal Dr Bank Cr Disposal Dr Profit and Loss Cr Disposal Transferring the related depreciation provision to the disposal account With any outstanding balance in the HP creditor account With any outstanding balance in the HP interest suspense account With the cost of the asset With the insurance claim for the disposal (if any) With the loss on the disposal (Reverse the entries for a profit on disposal)

Example 8

Example 8 Cash Price $5000 n Prov for dep $3200 ( A full year dep is charged in the year of purchase, but none in the year of disposal) n HP creditor on 1 Jan 1996 $2250 n Instalments $250(monthly) n Interest $50 n HP interest suspense $450 n The car was involved in an accident in May 1996 resulting in a total write off, and the sum of $1000 was received from the insurnance company. n All instalments up to and including 31 May were paid. n A payment of $930 was made on 30 June 1996 in full settlement n

HP Creditor 1996 $ 1996 May 31 Bank –instalment 1250 Jan 1 ($250*5) June 30 Bank-settlement 930 Jun 30 Disposal 70 2250 1996 Dec 31 HP Creditor 1996 Jan 1 Bal/f Bal b/f HP interest $ 1996 Dec 31 P/L 300 $ 2250 $ 300 HP interest suspense $ 1996 $ Jun 30 HP interest(60*5) 300 450 Jun 30 Disposal 150 450

Disposal of Vehicle 1996 $ 1996 Jun 30 Vehicle 5000 Jun 30 Dep Jun 30 HP interest Jun 30 Bank Suspense 150 - insurance Jun 30 HP Creditor Dec 31 P/L - loss 5000 Dep - $ 3200 1000 70 880 5000 Include the penalty charge $80 Vehicle For early termination of HP 1996 Jun 30 Disposal $ 1996 3200 Jan 1 B/f $ 3200 1996 Jan b/f Vehicle $ 1996 5000 Jun 30 Disposal $ 5000

Seller’s Book

2 Method of HP Interest Treatment (i) Profit Suspense Method (ii) HP Interest Suspense Method = 4 Version * 3 method of HP Interest Apportionment (i) Straight-line method (ii) Actuarial method (iii) Sum-of-digit method

Hire Purchase Profit n HP profit= HP price – Cash selling Price n Gross profit=Cash price-Cost of good sold n Total Profit=HP profit+Gross profit

Interest Suspense Method n The characteristics of the interest suspense method are: 1. 2. 3. 4. 5. The hire purchase sale is recorded at the cash price Profit is recognized immediately in the year of sale. The gross profit and interest income are accounted for separately. Interest income is allocated over the period of the hire purchase agreement on a suitable basis. Only the amount of hire purchase interest receivable in the current period is taken into account.

Summary of procedures Dr HP debtors Dr HP Sales With the cash selling price of the sale. Dr HP debtor Cr HP interest suspense With the total HP interest Dr Bank Cr HP debtors With the deposit and installments received Dr HP interest suspense Cr HP interest / P&L(income) With the hire purchase interest receivable for the current period Dr HP Sales Cr HP Trading Transfer the HP sales to HP trading account

Example 9

Example 9 n n n A company selling on HP has the following details: The interest is accrued evenly throughout the period of HP agreement The gross profit on the sales is recognized in the year of sales Sales volume 2 units Date of sale 1 Jan 1996 Cash price $1200 HP price $2000 Cost $1000 Down payment NIL Instalments $250*8 quarterly First due 31 Mar 1996

HP Debtors 1996 $ 1996 Jan 1 HP Sales Dec 31 Bank-instalment ($1200*2) 2400 ($250*4*2) Jan 1 Interest suspense 1600 Dec 31 Bal c/d 4000 (2000 -1200)*2 Cash price HP Sales 1996 $ 1996 Dec 31 HP Trading 2400 Jan 1 HP Debtors HP interest suspense 1996 $ 1996 Dec 31 HP interest Jan 1 HP Debtors received (2000 -1200)*4/8*2 800 Dec 31 Bal c/d 800 1600 HP interest received 1996 $ 1996 Dec 31 P/L 800 Jan 1 HP int suspense $ 2000 4000 $ 2400 $ 1600 $ 800

Trading and profit and loss account for the year ended (Extract) 96 $ Sales (cash price) 2400 Less: cost of goods sold 2000 400 HP Gross profit Add: HP interest received 800 Balance Sheet as at 31 Dec (Extract) 96 $ Current Assets 2000 HP Debtors 800 Less Interest suspense 1200

1996 Jan 1 HP Sales ($1200*2) HP Debtors $ 1996 Dec 31 Bank-instalment 2400 ($250*4*2) Jan 1 Interest suspense 1600 Dec 31 Bal c/d (2000 -1200)*2 4000 1997 Jan 1 Bal b/d $ 2000 4000 1997 2000 Dec 31 Bank- instalment 2000

HP interest suspense 1996 $ 1996 Jan 1 HP Debtors Dec 31 HP interest received (2000 -1200)*4/8*2 800 Dec 31 Bal c/d 800 1600 1997 Dec 31 HP interest 800 Jan 1 Bal b/d received (2000 -1200)*4/8*2 $ 1600 800 Interest received 1996 Dec 31 P/L $ 800 1996 $ Dec 31 HP interest suspense 800

Trading and profit and loss account for the year ended (Extract) 96 97 $ $ Sales (cash price) 2400 Less: cost of goods sold 2000 400 HP Gross profit Add: HP interest received 800 Balance Sheet as at 31 Dec (Extract) 96 $ Current Assets 2000 HP Debtors 800 Less Interest suspense 1200 97 $ -

B. Profit suspense method n The profit suspense method has the following characteristics: 1. The hire purchase sale is recorded at the hire purchase price. 2. The profit is recognized in proportion of the amount collected. 3. The gross profit and the interest income are not accounted for separately.

Summary of procedures: Dr HP Debtors Dr HP Sales With the hire purchase price. Dr Bank Cr HP Debtors With the deposit and instalments received Dr HP Sales Cr HP Trading Transfer the HP Sales to HP Trading a/c Dr HP Trading Cr Provision for Unrealized profit With the increase in the provision for unrealized profit. *Transfer the unearned total profit ( unearned HP profit & unearned GP) Dr Provision for Unrealized profit Cr HP trading With the decrease in the provision for unrealized profit. * Transfer the unearned total profit (unearned HP profit & unearned GP)

Provision for unrealized profit = Total Profit * instalments not yet received HP price = (HP price – Cost) * Instalments not yet received HP price

Example 10

Example 10 n n n n n A company selling on HP has the following details: The gross profit on the sales is recognized on the basis of the cash received Sales volume 2 units Date of sale 1 Jan 1996 Cash price $1200 HP price $2000 Cost $1000 Down payment NIL Instalments $250*8 quarterly First due 31 Mar 1996

Required: Account prepared according to the following assumptions: (a) All instalments were received for the years ended 31 Dec 1996 and 1997 (b) All instalments were received for the years ended 31 Dec 1996 and 1997, except one in arrears as at 31 Dec 1996 which was received in 1997

(a) HP Price 1996 Jan 1 HP Sales ($2000*2) HP Debtors $ 1996 Dec 31 Bank-instalment 4000 ($250*4*2) Dec 31 Bal c/d 4000 Provision for unrealized profit 1996 $ 1996 Dec 31 Bal c/d 1000 Dec 31 HP Trading ($4000 -2000)*2000/4000 $ 2000 4000 $ 1000

Trading and profit and loss account for the year ended (Extract) 96 $ $ Sales (HP price) 4000 Less: cost of goods sold 2000 Less: Provision for unrealised 1000 profit 1000 Gross profit Balance Sheet as at 31 Dec (Extract) 96 Current Assets 2000 HP Debtors Less Provision for unreaslised 1000 profit 1000

(a) HP Price 1996 Jan 1 HP Sales ($2000*2) 1997 HP Debtors $ 1996 Dec 31 Bank-instalment 4000 ($250*4*2) Dec 31 Bal c/d 4000 1997 $ 2000 4000 Jan 1 Bal b/d 2000 Dec 31 Bank- instalment 2000 Provision for unrealized profit 1996 $ 1000 Dec 31 Bal c/d 1000 Dec 31 HP Trading ($4000 -2000)*2000/4000 1997 $ 1997 Dec 31 HP Trading 1000 Dec 31 Bal b/d Dec 31 Bal c/d 0 ($4000 -2000)*0/4000 1000 $ 1000

Trading and profit and loss account for the year ended (Extract) 96 97 $ $ Sales (HP price) 4000 Add: Decrease in prov. for unrealized 1000 profit 2000 Less: cost of goods sold Less: Increase Provision for 1000 unrealized profit 1000 Gross profit Balance Sheet as at 31 Dec (Extract) 96 $ Current Assets 2000 HP Debtors Less Provision for unrealized 1000 profit 1000 97 $ -

(b) HP Price 1996 Jan 1 HP Sales ($2000*2) HP Debtors $ 1996 Dec 31 Bank-instalment 4000 ($250*4*2 -250) Dec 31 Bal c/d 4000 Provision for unrealized profit 1996 $ 1996 Dec 31 Bal c/d 1125 Dec 31 HP Trading ($4000 -2000)*2250/4000 $ 1750 2250 4000 $ 1125

Trading and profit and loss account for the year ended (Extract) 96 $ $ Sales (HP price) 4000 Less: cost of goods sold 2000 Less: Provision for unrealized 1125 profit 875 Gross profit Balance Sheet as at 31 Dec (Extract) 96 Current Assets 2250 HP Debtors Less Provision for unrealized 1125 profit 1125

(b) HP Price 1996 Jan 1 HP Sales ($2000*2) 1997 HP Debtors $ 1996 Dec 31 Bank-instalment 4000 ($250*4*2 -250) Dec 31 Bal c/d 4000 1997 $ 1750 2250 4000 Jan 1 Bal b/d 2250 Dec 31 Bank- instalment 2250 Provision for unrealized profit 1996 $ 1125 Dec 31 Bal c/d 1125 Dec 31 HP Trading ($4000 -2000)*2250/4000 1997 $ 1997 Dec 31 HP Trading 1125 Dec 31 Bal b/d Dec 31 Bal c/d 0 ($4000 -2000)*0/4000 1125 $ 1125

Trading and profit and loss account for the year ended (Extract) 96 97 $ $ Sales (HP price) 4000 Add: Decrease in prov. for unreasised 1125 profit 2000 Less: cost of goods sold Less: Increase. Provision for 1125 unrealised profit 875 Gross profit Balance Sheet as at 31 Dec (Extract) 96 $ Current Assets 2250 HP Debtors Less Provision for unreaslised 1125 profit 1125 97 $ -

C. A combination of the 2 methods n. The combination of 2 methods has the following characteristics: 1. The hire purchase sale is recorded at the cash price. 2. The profit is recognized in proportion of the amount collected. 3. The gross profit and the interest income are accounted for separately. 4. Interest income is allocated over the period of the hire purchase agreement on a suitable basis

Summary of procedures Dr HP debtors Dr HP Sales With the cash price. Dr Bank Cr HP debtor With the deposit received Dr Bank Cr HP debtors Cr Interest receivable With the installments received. With the capital part of the installments. With the interest receivable for the current period Dr HP trading Cr Provision for Unrealized profit With the increase in the provision for unrealized profit. (Reverse the entries for a decrease in the provision for unrealized profit)

Provision for unrealised profit = (Cash price – Cost ) * Instalments not yet received Cash Price

Example 11

Example 11 n n n A company selling on HP has the following details: The interest is accrued evenly throughout the period of HP agreement The gross profit on the sales is recognized in the accounts on the basis of the amounts received Sales volume 2 units Date of sale 1 Jan 1996 Cash price $1200 HP price $2000 Cost $1000 Down payment NIL Instalments $250*8 quarterly First due 31 Mar 1996

Interest per instalment = ($2000 -1200) 8 = $100 Instalment = $250 = Capital $150 + Interest + $100

Cash. Price 1996 Jan 1 HP Sales ($1200*2) HP Debtors $ 1996 Dec 31 Bank-instalment 2400 ($250 -100)*4*2 Dec 31 Bal c/d 4000 HP Interest Receivable 1996 Dec 31 P/L $ 800 $ 1200 4000 1996 $ Dec 31 Bank ($100*4*2) 800 Provision for unrealized profit 1996 $ 1996 Dec 31 Bal c/d 200 Dec 31 HP Trading ($2400 -2000)*1200/2400 $ 200

Trading and profit and loss account for the year ended (Extract) 96 $ $ Sales (cash price) 2400 Less: cost of goods sold 2000 Less: Provision for unrealised 200 profit 200 HP profit Add: Interest received 800 Balance Sheet as at 31 Dec (Extract) 96 Current Assets HP Debtors 1200

Cash. Price 1996 Jan 1 HP Sales ($1200*2) 1997 Jan 1 Bal b/d HP Debtors $ 1996 Dec 31 Bank-instalment 2400 ($250 -100)*4*2 Dec 31 Bal c/d 1200 4000 1200 1997 $ Dec 31 Bank- instalment 1200 HP Interest Receivable 1997 Dec 31 P/L $ 800 1997 $ Dec 31 Bank ($100*4*2) 800

Provision for unrealized profit 1996 $ 1996 Dec 31 Bal c/d 200 Dec 31 HP Trading ($2400 -2000)*1200/2400 1997 $ 1997 Dec 31 Bal b/d Dec 31 HP Trading 200 Dec 31 Bal c/d 0 ($2400 -2000)*0/2400 200 $ 200

Trading and profit and loss account for the year ended (Extract) 96 97 $ $ Sales (cash price) 2400 Add: Decrease in prov. for unreasised 200 profit Less: cost of goods sold Less: Increase. Provision for unrealised profit Gross profit Add: Interest Received 2000 200 800 Balance Sheet as at 31 Dec (Extract) 96 $ Current Assets 1200 HP Debtors 200 800 97 $ -

Repossession

Repossession n It may be happen that hire purchase debtors cannot make all of the payments required under the agreement. n Once the hire purchase debtor stops paying the instalments, the seller can take away the goods. This is called repossession.

Dr Repossession Cr HP Creditor With the outstanding balance for the particular HP debtors Interest suspense method Dr HP interest suspense Cr Repossession With the HP interest not yet received Profit suspense method Dr Provision for unrealized profit Cr Repossession With the outstanding provision transferred The combined method Dr Repossession Cr interest Receivable Dr Trading Cr Repossession Dr Bank Cr Repossession Dr Profit and loss Cr Repossession With the amount of accrued HP interest With the value of the repossessed item which is taken back into stock With the insurance claim or any sale proceeds for the repossessed item. With the loss on the repossession (Reverse the entries for a profit on repossession)

The value of the repossessed item Cost = HP price * Outstanding balance of the particular HP debtor ( repossessed items)

(a) Using interest suspense method

Example 12 (a) n n n A company selling on HP has the following details: The interest is accrued evenly throughout the period of HP agreement The gross profit on the sales is recognized in the year of sales Sales volume 2 units Date of sale 1 Jan 1996 Cash price $1200 HP price $2000 Cost $1000 Down payment NIL Instalments $250*8 quarterly First due 31 Mar 1996 All the instalments were received on the due dates, except that payments on one of the items have been default since 31 Mar 1997. The repossessed item has been taken back into stock

HP Debtors 1997 $ Jan 1 Bal b/d 2000 Mar 31 Repossession 1000 Dec 31 Bank- instalment 1000 2000 HP interest suspense 1997 $ 800 Mar 31 Repossession 400 Jan 1 Bal b/d Dec 31 HP interest 400 received Value of 800 (2000 -1200)*4/8*1 Repossessed items Repossession 1997 $ Mar 31 HP Debtors 1000 Mar 31 HP int. suspense 400 ($800 -$400) Dec 31 HP Trading 500 ($1000*1000/2000) Dec 31 P/L-loss on repossession 1000

(b) Using profit suspense method

Example 12(b) n n n A company selling on HP has the following details: The gross profit on the sales is recognized on the basis of the cash received Sales volume 2 units Date of sale 1 Jan 1996 Cash price $1200 HP price $2000 Cost $1000 Down payment NIL Instalments $250*8 quarterly First due 31 Mar 1996 All instalments were received on the due dates, except that payments on one of the items have been in default since 31 Mar 1997. The repossessed item has been taken back into stock.

1997 Jan 1 Bal b/d HP Debtors $ 1997 2000 Mar 31 Repossession Dec 31 Bank- instalment 2000 Provision for unrealised profit 1997 $ 1997 Mar 31 Repossession 500 Jan 1 Bal b/d Dec 31 HP Trading 500 Dec 31 Bal c/d (2000 -1000)*0/2000 1997 Mar 31 HP Debtors 0 $ 1000 2000 $ 1000 Value of Repossessed items 800 Repossession $ 1997 $ 1000 Mar 31 Prov. for unrealised 500 profit (2000 -1000)*1000/2000 Dec 31 HP Trading 500 ($1000*1000/2000) 1000

(c) Using the combined method

Example 12(c) n A company selling on HP has the following details: n The interest is accrued evenly throughout the period of HP agreement n The gross profit on the sales is recognized in the accounts on the basis of the amounts received n Sales volume 2 units n Date of sale 1 Jan 1996 n Cash price $1200 n HP price $2000 n Cost $1000 n Down payment NIL n Instalments $250*8 quarterly n First due 31 Mar 1996

n 1. 2. All the instalments were received on the due dates, except that payments on one of the item has been in default since 31 Mar 1997 The seller repossessed the goods on the same date (31 Mar 1997)as that the HP debtor defaulted on the payment The seller repossessed the goods on 31 June 1997, after the HP debtor defaulted on the payment

(1) 1997 Jan 1 Bal b/d 1997 Dec 31 P/L HP Debtors $ 1997 1200 Mar 31 Repossession Dec 31 Bank- instalment ($250 -100)*4 1200 Interest receivable $ 1997 400 Dec 31 Bank ($100*4) Value of Repossessed items $ 600 1200 $ 400 Repossession 1997 $ Mar 31 HP Debtors 600 Dec 31 HP Trading 500 $1200 -(250 -100)*4 ($1000*1000/1200) Dec 31 P/L-loss on repossession 100 600

(2) 1997 Jan 1 Bal b/d 1997 Dec 31 P/L HP Debtors $ 1997 $ 1200 June 30 Repossession 600 Dec 31 Bank- instalment 600 ($250 -100)*4 1200 Interest receivable $ 1997 $ June 30 Repossession 200 600 ($100*2) Dec 31 Bank ($100*4) 400 Value of 600 Repossessed items Repossession 1997 $ June 30 HP Debtors 600 Dec 31 HP Trading 500 $1200 -(250 -100)*4 ($1000*1000/1200) June 30 Interest 200 Dec 31 P/L-loss on repossession 300 receivable 600

Hire Purchase Trading and Profit and loss account

Interest suspense method and the combined method Hire Purchase Trading Purchase Add Repossession Less closing stock Cost of Goods sold Gross profit $ x x x x Sales – cash price $ x x

Profit and Loss (Extract) Loss on Repossession $ x HP profit HP interest Profit on Repossession $ x x x

Profit suspense method Hire Purchase Trading Purchase Add Repossession Less closing stock Cost of Goods sold Provision for Unrealized profit Gross profit $ x x x x Sales – HP price $ x x

Profit and Loss (Extract) Loss on Repossession $ x HP profit Profit on Repossession $ x x

ABC Ltd. Purchased a vehicle from Grace ltd. On Jan 1996 on hire purchase agreement. The details were as follows: Cash price $9, 000 HP price $11, 096 Down payment $1, 000 Instalment 4 equal annual instalments First due Interest 31 December 1996 10% on outstanding balance Depreciation 10% on cost Using (a) the progress interest charge system and (b) interest suspense method