Hire purchase and instalment accounting

In short

Hire purchase (HP) is a financing arrangement in which the buyer (hirer) takes possession of an asset at once, pays a down payment and a series of instalments, and becomes the owner only on paying the last instalment; until then the transaction is a bailment coupled with an option to purchase. The instalment payment system looks similar but ownership passes immediately on delivery, so the seller cannot take the goods back — only sue for the unpaid price. Accounting has to split every instalment into principal (cash price) and interest (hire purchase charges), capitalise the asset at cash price and charge depreciation on it. The topic is a standing 12-16 mark question in B.Com financial accounting papers and in CA/CS/CMA Foundation and Inter, and it is applied daily in vehicle and equipment finance by NBFCs, in dealer accounting and in asset-leasing teams.

Explained

Meaning, parties and legal position in India

• Parties: the hire vendor (owner/seller or financier) and the hirer (user/buyer). The agreement fixes the cash price, down payment, number and amount of instalments, and the rate of HP charges.
• Legal nature: bailment of goods plus an option to buy. Ownership (title) passes only on payment of the last instalment and exercise of the option; possession and use pass on delivery.
• Governing law: the Hire Purchase Act, 1972 was enacted but never brought into force (and was later repealed), so HP is governed by the Indian Contract Act, 1872 (bailment, ss. 148-181), the Sale of Goods Act, 1930 and the terms of the agreement. For HP finance by NBFCs, RBI directions apply (the old "Asset Finance Company" category was merged into NBFC-ICC in the 2019 harmonisation).
• Key case: *K. L. Johar & Co. v. Dy. CTO* (SC) — an HP agreement contains an element of bailment and an element of sale; the sale fructifies only when the option is exercised. A hirer is not a "buyer in possession", so a sale by the hirer before the last instalment does not pass good title.
• Taxation: under the long-standing CBDT position (Circular No. 9 of 1943), in a genuine HP the hirer claims depreciation on the asset and deducts the HP charges as expense. Under GST, HP is a supply of goods (Schedule II, para 1(c) — property passes at a future date on full payment), taxed on the full value at delivery; the finance charge is part of that value, unlike interest on a plain loan. Tax positions change by notification — verify the current rule before quoting it.

Hire purchase versus instalment payment system versus lease

• In the instalment payment system (instalment sale/credit sale) the property in the goods passes on delivery; the buyer takes the risk of loss and can sell or pledge the goods; the seller's only remedy on default is a suit for the balance price.
• In HP the vendor can repossess; the hirer may terminate the agreement and return the goods (losing what he has paid, which is treated as hire); the hirer bears no risk of ownership.
• A lease gives only the right to use; an operating lease never transfers ownership, while a finance lease transfers substantially all risks and rewards — economically the same as HP.
• Accounting convergence: although the legal positions differ, the hirer's/buyer's books are kept the same way in both systems — asset at cash price, interest as revenue expense — because accounting follows substance over form. AS 19 (Leases) deals with finance and operating leases; under Ind AS 116 (effective from 1 April 2019) a lessee recognises a right-of-use asset and a lease liability for nearly all leases and splits payments into interest (effective interest method) and principal — the same arithmetic as the cash price method below.

Computation of interest — the three standard situations

1. Cash price and rate both given: interest for a period = outstanding cash price at the beginning × rate. Balance of the instalment reduces the principal. (Interest is *never* calculated on the down payment.)
2. Cash price given, rate not given: total interest = HP price − cash price; apportion it over the instalments in the ratio of amounts outstanding at the start of each period (for equal instalments this becomes n : (n−1) : … : 1, the sum-of-digits rule).
3. Rate given, cash price not given: discount the instalments to present value — either by the annuity table (cash price = down payment + instalment × PVAF) or by working backwards from the last instalment, dividing by (1 + r) each step.
4. Where instalments are paid at the beginning of each period (annuity due), use the annuity-due factor = PVAF × (1 + r).

Books of the hirer

• Cash price method (asset accrual at full cash price) — the standard method
  1. On delivery: *Asset A/c Dr (cash price)* — *To Hire Vendor A/c*
  2. Down payment: *Hire Vendor A/c Dr* — *To Bank A/c*
  3. Interest for the year: *Interest A/c Dr* — *To Hire Vendor A/c*
  4. Instalment paid: *Hire Vendor A/c Dr* — *To Bank A/c*
  5. Depreciation: *Depreciation A/c Dr* — *To Asset A/c* (on full cash price, by SLM or WDV, as per AS 10 / Schedule II of the Companies Act, 2013)
  6. Transfer interest and depreciation to Profit and Loss A/c.
• Interest suspense method: on delivery, *Asset A/c Dr (cash price)* and *HP Interest Suspense A/c Dr (total interest)* — *To Hire Vendor A/c (HP price)*. Each year, *Interest A/c Dr — To HP Interest Suspense A/c*. In the balance sheet, the unexpired suspense is deducted from the vendor's balance. Profit is identical to method 1; only presentation differs.
• Asset accrual method (partial cash price method): the asset is recorded only to the extent of the cash price actually paid each year, and depreciation is charged on that growing amount. Rarely used; it understates the asset and is not acceptable under accrual/substance principles.
• Balance sheet: asset at cash price less accumulated depreciation under non-current assets; vendor's unpaid balance split into current and non-current liabilities.

Books of the hire vendor

• Sales method (for goods of large value, few customers): *Hire Purchaser A/c Dr (cash price) — To HP Sales A/c*; interest credited to Interest A/c as it accrues; cash received debited to Bank. Closing balance of the hirer's account = unpaid principal.
• Interest suspense method: debtor is raised at full HP price with the unearned interest parked in HP Interest Suspense A/c and released to revenue year by year.
• Hire purchase trading account (debtors method) for goods of small value sold to many hirers: one account absorbs opening HP stock and instalments due, goods sold on HP at HP price, cash collected, goods repossessed and closing balances, and throws up the HP profit.
• Stock and debtors system: separate accounts — *Shop Stock A/c*, *HP Stock A/c* (goods with hirers at HP price), *HP Debtors A/c* (instalments due), *Goods Sold on HP A/c*, *HP Adjustment A/c* (where loading is adjusted and profit emerges), and a Stock Reserve for the loading contained in closing HP stock (unrealised profit).
• Loading = HP price − cost. If loading is x% on cost, it is x/(100 + x) of the HP price; if it is y% on HP price, it is y/(100 − y) of cost.

Default, repossession and termination

• Complete repossession: the vendor takes back all the goods in full satisfaction. Hirer: close the asset account and the vendor account; the difference is profit or loss on repossession. Vendor: debit *Goods Repossessed A/c* with the agreed/estimated value, credit the hire purchaser; add reconditioning costs; profit or loss arises on resale.
• Partial repossession: only some units are taken back, usually at an agreed value computed at a higher depreciation rate than the hirer uses. The hirer keeps the remaining units at his own book value, and the shortfall is a loss on repossession; the vendor and hirer accounts continue for the balance.
• Value of repossessed goods is agreed in the contract, or estimated; it is *not* the hirer's book value, which is why a profit or loss arises.
• On termination by the hirer, amounts already paid are forfeited as hire charges, and the asset leaves the hirer's books at book value against the liability extinguished.

Advantages and limitations

• For the hirer: immediate use without full payment; spreads cash outflow; depreciation and interest are deductible; useful for small firms with no access to term loans.
• For the vendor: higher effective return; security retained through ownership; wider market.
• Limitations: total cost is higher than the cash price (HP charges are typically a flat rate, so the effective rate is nearly double the quoted flat rate); risk of repossession and loss of all instalments paid; the hirer cannot sell or mortgage the asset; heavy documentation and stamp duty; for the vendor, collection costs, default risk and the cost of repossessed second-hand goods.

Key points

• Hire purchase - possession now, ownership on the last instalment; bailment plus an option to purchase.
• Instalment system - ownership passes on delivery; no repossession, only a suit for price.
• Cash price - price if bought outright; the amount capitalised as the asset.
• Hire purchase price - down payment + all instalments; always more than the cash price.
• HP charges (interest) - HP price − cash price; a revenue expense of the hirer, revenue income of the vendor.
• Down payment - initial cash; carries no interest and reduces the principal at once.
• Interest rule - charge on the outstanding cash price at the start of the period, never on the HP price.
• Depreciation rule - always on the full cash price, by the hirer's usual method; it is independent of the instalments.
• Sum-of-digits / ratio of outstanding balances - used to split interest when the rate is not given.
• Annuity method - cash price = down payment + instalment × PVAF when the rate is given but the cash price is not.
• Interest suspense method - unearned interest shown separately and released each year; same profit, different presentation.
• Stock reserve - loading on goods with hirers at the year end; removes unrealised profit.
• Goods repossessed - recorded by the vendor at agreed/estimated value, not at the hirer's book value.
• Partial repossession - vendor values the returned units at a higher depreciation rate; hirer books the difference as loss.
• Flat versus effective rate - a flat rate quoted on the original amount understates the true cost roughly by half.
• Ind AS 116 / AS 19 - HP is a finance arrangement in substance: right-of-use asset plus liability, interest on the reducing balance.
• GST - HP is a supply of goods at delivery on the full value (Schedule II para 1(c)); rules change by notification.

Formulas and examples

Example 1 — Cash price and rate given (full schedule, hirer's books). Machine, cash price ₹4,00,000, bought 1 April 2024. Down payment ₹1,00,000; balance in 3 annual instalments of ₹1,00,000 principal plus interest at 10% p.a. on the outstanding balance. Depreciation 20% p.a. WDV.

• HP price = 1,00,000 + (1,30,000 + 1,20,000 + 1,10,000) = ₹4,60,000; total interest = 4,60,000 − 4,00,000 = ₹60,000 (= 30,000 + 20,000 + 10,000 ✓).
• Depreciation: Yr 1 ₹80,000 (WDV 3,20,000); Yr 2 ₹64,000 (WDV 2,56,000); Yr 3 ₹51,200 (WDV ₹2,04,800).
• Charge to Profit and Loss: Yr 1 ₹1,10,000; Yr 2 ₹84,000; Yr 3 ₹61,200.
• Entries, year 1: *Machinery A/c Dr 4,00,000 — To Vendor 4,00,000*; *Vendor Dr 1,00,000 — To Bank 1,00,000*; *Interest Dr 30,000 — To Vendor 30,000*; *Vendor Dr 1,30,000 — To Bank 1,30,000*; *Depreciation Dr 80,000 — To Machinery 80,000*.
• Under the interest suspense method the opening entry would instead be *Machinery Dr 4,00,000* and *HP Interest Suspense Dr 60,000 — To Vendor 4,60,000*, with ₹30,000 / ₹20,000 / ₹10,000 released to Interest A/c each year.

Example 2 — Rate given, cash price not given (working backwards). Down payment ₹1,00,000 and three annual instalments of ₹1,33,100 each; interest 10% p.a.

• Before 3rd instalment: 1,33,100 ÷ 1.10 = ₹1,21,000.
• Before 2nd: (1,21,000 + 1,33,100) ÷ 1.10 = 2,54,100 ÷ 1.10 = ₹2,31,000.
• Before 1st: (2,31,000 + 1,33,100) ÷ 1.10 = 3,64,100 ÷ 1.10 = ₹3,31,000.
• Cash price = 1,00,000 + 3,31,000 = ₹4,31,000. HP price = 1,00,000 + 3,99,300 = ₹4,99,300; total interest = ₹68,300 (33,100 + 23,100 + 12,100 ✓).
• Same answer by annuity: PVAF(10%, 3) = 2.48685 → 1,33,100 × 2.48685 ≈ ₹3,31,000.

Example 3 — Rate not given (ratio of outstanding balances). Cash price ₹60,000; down payment ₹15,000; three equal annual instalments of ₹18,000.

• HP price = 15,000 + 54,000 = ₹69,000 → total interest = 69,000 − 60,000 = ₹9,000.
• Outstanding at the start of years 1, 2, 3 = 54,000 : 36,000 : 18,000 = 3 : 2 : 1.
• Interest = ₹4,500, ₹3,000, ₹1,500; principal repaid = 13,500 + 15,000 + 16,500 = ₹45,000 = 60,000 − 15,000 ✓.

Example 4 — Repossession. (a) *Complete:* taking Example 1, the hirer defaults immediately after the second instalment (start of year 3, before any year-3 interest or depreciation) and the vendor repossesses in full settlement. Asset book value = ₹2,56,000; vendor's balance = ₹1,00,000. Entry: *Hire Vendor A/c Dr 1,00,000; Loss on Repossession A/c Dr 1,56,000 — To Machinery A/c 2,56,000.* (b) *Partial:* two machines, cash price ₹1,00,000 each, hirer depreciates 10% SLM. After two years each stands at ₹80,000. The vendor repossesses one, valuing it at 20% p.a. WDV: 1,00,000 → 80,000 → ₹64,000. Entry: *Hire Vendor Dr 64,000; Loss on Repossession Dr 16,000 — To Machinery 80,000.* The retained machine stays at ₹80,000.

Example 5 — Hire Purchase Trading Account (vendor, loading 50% on cost). Goods sold on HP during 2025-26 at HP price ₹3,00,000 (cost ₹2,00,000); cash collected ₹2,20,000; instalments due but unpaid ₹20,000; goods with hirers (instalments not yet due) at HP price ₹60,000. No opening balances.

Check: loading is 1/3 of HP price (50% on cost) → total loading ₹1,00,000; unrealised portion in closing stock = 60,000 × 1/3 = ₹20,000; realised profit = ₹80,000 ✓.

Where it is used

• Vehicle and equipment finance: NBFCs such as Sundaram Finance, Shriram Finance, Cholamandalam, Mahindra Finance and Tata Motors Finance fund trucks, tractors, cars and construction equipment on HP terms.
• Consumer durables and retail credit: no-cost and low-EMI schemes by Bajaj Finserv and retail chains — accounting splits each EMI into principal and finance charge exactly as above.
• SME capital assets: printing presses, CNC machines, generators and medical equipment bought on HP; the finance charge is a profit and loss item, depreciation a Schedule II item.
• Dealer and manufacturer accounting: HP trading accounts, stock-and-debtors records and stock reserves in dealerships selling goods of small value to many hirers.
• Job roles: accounts executive and finance manager roles in NBFCs and dealerships, credit and collections (repossession accounting), statutory audit of HP debtors and unearned interest, and Ind AS 116 lease-accounting teams.
• Exams and selection tests: B.Com and M.Com financial accounting papers, CA/CS/CMA Foundation and Inter, bank PO and SBI/IBPS specialist accounting sections, and accounting rounds at Big Four and captive finance firms.

Interview questions

• Q: How does hire purchase differ from an instalment sale? A: In hire purchase ownership passes only with the last instalment and the vendor can repossess; in an instalment sale ownership passes on delivery and the seller can only sue for the balance price.
• Q: At what value does the hirer capitalise the asset, and why? A: At the cash price, because the excess paid is a finance charge for deferred payment, not part of the asset's cost — substance over form.
• Q: On what amount is depreciation charged? A: On the full cash price from the date of delivery, by the hirer's normal method; it has nothing to do with how much of the price has been paid.
• Q: Is interest calculated on the down payment? A: No. Interest accrues only on the cash price still outstanding at the beginning of each period.
• Q: How do you find the cash price when only the rate and the instalments are given? A: Discount the instalments to present value using the annuity factor, or work backwards from the last instalment dividing by (1 + r) each step, then add the down payment.
• Q: What is the interest suspense method and does it change profit? A: The debtor/creditor is raised at the full hire purchase price with unearned interest in a suspense account released year by year; profit is identical, only the presentation changes.
• Q: What is loading and why is a stock reserve created? A: Loading is the difference between hire purchase price and cost; the part of it inside goods still with hirers is unrealised, so a stock reserve removes it from the year's profit.
• Q: How is partial repossession accounted for in the hirer's books? A: The returned units leave at the hirer's book value, the vendor's account is debited with the agreed value (usually computed at a higher depreciation rate), and the difference is a loss on repossession.
• Q: A flat rate of 8% on a 3-year hire purchase — what is the real cost? A: Far higher, roughly 2n/(n+1) times the flat rate — about 12% effective — because the principal keeps reducing while the flat rate is charged on the original amount.
• Q: Who claims depreciation for income tax in a hire purchase? A: The hirer, along with a deduction for the hire purchase charges, following the long-standing CBDT position for genuine hire purchase agreements.
• Q: How does Ind AS 116 treat such an arrangement? A: As a lease in substance — the user recognises a right-of-use asset and a lease liability and splits payments into interest on the reducing liability and principal, which is arithmetically the cash price method.
• Q: If the hirer sells the asset before the last instalment, does the buyer get title? A: No — the hirer is only a bailee with an option to purchase and cannot pass a better title than he has.

Common mistakes

• Capitalising the asset at the hire purchase price instead of the cash price, which inflates both the asset and depreciation.
• Charging depreciation only on the amount paid so far, or on the instalments actually discharged.
• Computing interest on the hire purchase price, on the down payment, or on the original balance every year instead of the reducing balance.
• Using the sum-of-digits ratio even when the interest rate is given, or discounting when the cash price is already stated.
• Valuing repossessed goods at the hirer's book value, so no profit or loss on repossession appears — and forgetting that the vendor usually applies a higher depreciation rate.
• Omitting the stock reserve on closing hire purchase stock, which takes unrealised loading into profit.
• Forgetting the last instalment's interest check: the sum of the yearly interest figures must equal hire purchase price minus cash price, and the final outstanding balance must be exactly nil.

Related topics

Depreciation · Journal, ledger and trial balance · Final accounts · Branch and departmental accounts · Company accounts and Ind AS basics · Key Ind AS standards explained