5.1 Hire purchase and installment sale transaction

CFA

UNIT 5

Hire purchase

If you purchase a TV for cash, you pay, say, Rs.15,000. But if you wish to make the payment by installments of say, Rs.3,000 each, every year, you may be required to pay four installments, that is Rs.20,000 in all. The extra amount of Rs.3,000 is for interest. If you choose the latter mode of the payment, you should debit Rs.5,000 to interest and treat the TV as valued at Rs.15,000 (and not at Rs.20,000). In case payment is to be made by installments, there may be two kinds of arrangements. Each installment may be treated as a ‘hire’ the purchaser becoming the owner only if he pays all the instalments. In other words ,property does not pass to him even if one installment remains unpaid. The seller will have the right to take away the goods in case of default in respect of any installment. This is known as ‘Hire Purchase ‘system.

According to J.R. Batliboi, ‘‘Under the Hire Purchase System, goods are delivered to a person, so agrees to pay the owners by equal periodical instalments, such instalments to be treated as hire of those goods, until a certain fixed amount has been paid, when these goods become the property of the hirer.

Important Terms in Hire Purchases system

Hirer-Hirer is a person who buys or in this case who obtains the possession of the goods from the owner as per the Hire purchase Agreement.

Hirer Vendor-Hirer vendor or the owner is a person who lets or who has delivered or delivers the goods to hirer under an agreement. Hire vendor is the seller of the goods on the hire purchase system.

Cash Price-The cash price is the price of the goods which can be purchased by cash or the retail price, if not purchased under hire purchase system.

Hire Purchase Price-It is the total amount payable by the hirer under the hire purchase agreement, in the agreed number of installments for the purchase of goods. Hire purchase price is the total of cash price and interest.

Hire purchase price=Cash price + Interest

5. Interest-Interest is the amount which is payable in addition to the actual cash price of the goods. It is the amount paid by the buyer for the delayed and postponed payment.

6. Hire Installment-It is the amount payable periodically by the hirer or the buyer, installment may be an equal amount or different amounts which are based on the agreement.

7. Down Payment or initial amount-The amount is a lump-sum out of the total Hire purchase price, payable to the vendor in advance while the agreement is signed, which does not carry any interest on it.

Features of hire purchase system

Hire-purchase system is governed by Hire-purchase Act, 1972.

It is an agreement of hiring.

It is an agreement between hirer and hire-vendor.

Terms and conditions between the parties are entered and recorded in a document called hire-purchase agreement.

Cash price of goods is paid in instalment on agreed terms.

The title of goods passes on last payment.

The hire-vendor can take possession of goods if hirer is failed to pay instalment.

The hirer is not responsible for risk of loss of goods, till the ownership is transferred.

The hirer cannot mortgage, hire, sell or pledge the goods.

The hirer has not a right to terminate the agreement at any time before xproperty so passes.

Installment purchase system

It is a system where the buyer is given the ownership as well as the possession of the goods at the same time of signing the contract. The buyer has the facility to pay the price in installment.

According to J.B Batliboi, installment purchase system is a system under there is an agreement to purchase and pay by installment, the goods which become the property of the purchaser immediately when he receives the delivery of the same.

Features of installment purchase system

There is an agreement between the seller and the buyer

The buyer is required to pay the total price in installment

The buyer gets the possession and ownership of goods immediately on signing the agreement

As the purchaser is the owner of the goods, he can dispose of the goods in any manner he likes.

Calculation of interest

Interest: In either case (hire purchase or instalment) interest must be separated from the principal sum due. Since payments continue over two or more financial year’s interest must be calculated for each year separately. Usually information is available regarding cash price and the rate of interest. Calculation of interest then becomes easy. Just prepare the account of one of the parties on ordinary lines and charge interest on the balance due. Suppose on 1st January, 2000 A purchases from B machinery whose cash price is Rs.15,000; Rs.5,000 is to be paid down, that is on signing of the contract, and Rs.4,000 is to be paid at the end of each year for 3 years. Rate of interest is 10% p.a. If we prepare B’s account (on a memorandum basis) in A’s books, we shall know the interest for each year.

A’s Books

Dr.			B’s Account		Cr.
		Rs.			Rs.
2000			2000
Jan.1	To Cash	5,000	Jan.1	By Machinery A/c	15,000
Dec.31	To Cash	4,000	Dec.31	By Interest A/c	1,000
’’	To balance c/d	7,000		(10% on Rs.10,000)
		16,000			16,000
2001			2001
Dec.31	To Cash	4,000	Jan.1	By Balance b/d	7,000
	To Balance c/d	3,700	Dec.31	By Interest A/c
				(10% on Rs.7,000)	700
		7,700			7,700
2002			2002
Dec.31	To Cash	4,000	Jan.1	By Balance b/d	3,700
			Dec.31	By Interest A/c*	300
		4,000			4,000

* As it is the last year of installment, interest amount will be the difference between the Outstanding balance and the actual amount of installment. [Students should note that if you calculate interest for the last year as per the given percentage on the O/S amount (3700 x 10%=370), total amount payable becomes (3700+370=4070) which is greater than the installment paid. So there will be again Rs. 70 payable even after the last installment being paid.]

If the rate of interest is not given, the interest for each year will be in proportion to amount outstanding in each year. In the example given above, the total sum payable is Rs.17,000 out of which Rs.5,000 is paid immediately. This leaves Rs.12,000 as outstanding throughout the first year at the end of which Rs.4,000 is paid. In the second year Rs.8,000 is outstanding and in the third year Rs.4,000 is due. The total interest is Rs.2,000. i.e., Rs.17,000. minus Rs.15,000. The interest should be apportioned over the 3 years in the ratio of amounts outstanding, that Rs.12,000; Rs.8,000 and Rs.4,000 or in the ratio of 3 : 2 :1. The interest for the first year is Rs.1,000 : for the second year it is Rs.670 and for the third year it is Rs.333. Note that the amount cannot be the same as worked out when the rate of interest isgiven.

To ascertain Cash Price, rate of interest and instalments being given. Sometimes the cash price is not given. Since the asset cannot be debited with more than the cash price, it must be ascertained. The process is to take the last year first and separate interest from principal out of the total sum due. In the example given above, Rs.4,000 is due at the end of 2002. The rate of interest is 10%. If in the beginning of 2001 Rs.100 was due, Rs.10 would be added making Rs.110 as due at the end of 2002. Thus, out of the sum due at the end of the year, one-eleventh is interest; rest is principal. We can proceed year by year likethis.

Thus: —

	Rs.
Amount due on 31-12-2001	4,000
Interest @ 1/11	364
Amount due on 1-1-2002 or 31-12-2001	3,636
Paid on 31-12-2001	4,000
Total amount due on 31-12-2001	7,636
Interest @ 1/11	694
Amount due on 1-1-96 or 31-12-2000	6,942
Paid on 31-12-2000	4,000
Total amount due on 31-12-2000	10,942
Interest @ 1/11	995
Amount due on 1-1-2000	9,947
Paid Cash down on 1-1-2000	5,000
Cash Price	14,947
The interest for three years is Rs.995, Rs.694 and Rs.364 respectively.

Key takeaways:

Employment purchase contracts are not considered an extension of credit.

Employment purchase contracts do not transfer ownership to the purchaser until all payments have been made.

Employment purchase contracts have usually proven to cost more in the long run than purchasing the item in full.

A down payment is a payment made as part of a large purchase in the early stages of financing.

The higher the down payment, the less interest you pay for the rest of the loan.

Lenders may require different amounts of down payment (from 3.5% to 50% in the US), depending on the borrower and purchase.

Accounting arrangement for hire purchase transaction

For such high value goods, two methods of records can be maintained.

First method - Capitalising only the portion of cash price paid or asset accrual method.

Second method - Capitalising the full cash price or credit purchase with interest method.

Asset accrual method

In this method cash price paid is alone capitalized. The asset account is debited with the amount of cash price paid in that instalment. This method as use that the title pages two the buyer only after the last instalment is paid. Unit then the seller is the owner. So as and when the instalment amount is paid the case price in the instalment is capitalized. In this method the goods are consider to the acquired only gradually when the cash price is paid each time.

First year (On delivery): Assets A/c Dr. To Vendor’s A/c	- With the amount of down payment
(a) When the down payment is made: Vendor’s A/c To Bank A/c	Do
(b) When instalment becomes due at the end of the year: Assets A/c Dr. Interest A/c Dr. To Vendor’s A/c	- With the amount of Principal - With the amount of Interest - With the amount of Instalment
(c) When the instalment is paid: Vendor’s A/c Dr. To Bank A/c	- With the amount of Instalment
(d) When depreciation is provided for: Depreciation A/c Dr. To Assets A/c	- With the amount of Depreciation
(e) For transferring Depreciation and Interest Account: Profit & Loss A/c Dr. To Interest A/c “ Depreciation A/c

In the subsequent years (b), (c), (d) and (e) with their respective amounts will appear in the books.

2. Credit purchase with interest

In this method the full case price is capitalised. The hire purchaser debits the Asset account A/c with full case price and credits the higher vendor A/c. this method assumes that the assets are consider to be acquired immediately when the position is taken. The purchaser enters into an agreement with the intention of fulfilling it.

Journal entry in the books of hire purchase

First year (On delivery): Assets A/c Dr. To Vendor’s A/c	- With the amount of Total Cash Price
(f) When the down payment is made: Vendor’s A/c To Bank A/c	- With the amount of Down Payment
(g) When interest becomes due at the end of the year: Interest A/c Dr. To Vendor’s A/c	- With the amount of Interest
(h) When the instalment (including interest) is paid: Vendor’s A/c Dr. To Bank A/c	- With the amount of Instalment
(i) When depreciation is provided for: Depreciation A/c Dr. To Assets A/c	- With the amount of Depreciation
(j) For transferring Depreciation and Interest Account: Profit & Loss A/c Dr. To Interest A/c “ Depreciation A/c

In the subsequent years (b), (c), (d) and (e) with their respective amounts will appear in the books.

Journal entry in the books of hire vendor

First Year: (a) On delivery Purchase A/c Dr. To Hire-Purchase Sales A/c	- With the amount of Total Cash Price
(b) When down payment is received: Bank A/c Dr. To Purchase A/c	- With the amount of down payment
(c) When interest becomes due at the end of the year: Purchaser A/c Dr. To Interest A/c	- With the amount of Interest
(d) When the instalment (including interest) is received: Bank A/c Dr. To Purchase A/c	- With the amount of Instalment
(e) For transferring interest account: Interest A/c Dr. To Profit & Loss A/c	- With the amount of Interest

In the subsequent years (c), (d) and (e) with their respective amounts will appear in the books.

Accounting records for goods of small values

Trading method - In this method, the hire purchase trading account is prepared in the book of vendor of asset in the form of hire purchase system.

Hire Purchase Trading Account

To Stock with customers on hire purchase price (opening)

To Goods sold on hire purchase account

To stock reserve on closing stock

By Hire purchase sales

- Cash received from customers

- Instalments due but received

By Stock Reserves

By Stock with customers at hire price at end

2. stock and debtor method

In this method, hire purchase stock, hire purchase debtor and hire purchase adjustment account are maintained. Following entries will pass in the books of vendor

a) When goods are sold on hire purchase

hire purchase stock account Dr. ( Hire purchase price)

stock account Cr. ( Actual cost of sale of goods )

hire purchase adjustment account Cr. ( difference between hire purchase price and actual cost )

b)When installments become due for payment

hire purchase debtors account Dr.

hire purchase stock account Cr.

c) When cash is received

Cash account Dr.

Hire purchase debtor account Cr.

d) Stock reserve account on opening stock

stock reserve account Dr.

hire purchase adjustment account Cr.

e) Stock reserve on closing stock

Hire purchase adjustment account Dr.

Disclosure in balance sheet under actual cash price method

Stock reserve account Cr. At the end each accounting period, the relevant accounts appear in the Balance Sheet as shown below:

Disclosure In Balance Sheet Under Actual Cash Price Paid Method

Balance Sheet of Hire Purchaser			Balance Sheet of Hire Vendor
Liabilities	Rs.Assets	Rs.	Liabilities	Rs.Assets	Rs.
	Fixed Assets :
	Asset (at actual cash)			No disclosure is
	price paid)	xxx		Required
	Less : Depreciation till date	xxx
		xxx

Hire Purchase: Books of the Vendor

Books of the Vendor: The vendor follows no special method for recording sales on hire purchase, especially in case of sale of large items. He debits the purchaser with the cash price and credits him with the amount received. Every year the interest due is debited. We illustrate this below.

Illustration-1

Based on particulars given below calculate Interest under the hire purchase system

(a) X & Co.—purchaser Y & Co.-Seller Date of purchase—Jan. 1,1999

cash price—Rs.74,500.

Installments Rs.20,000 on signing of the agreement. Rest in three instalments of Rs.20,000 each. Rate of Interest—5%. Depreciation 10% on the diminishing Balance.

(b) All particulars as above except that the rate of interest is notgiven.

Solution :

(a) Calculation of Interest
		Rs.
Jan.1, 1999	Cash Price	74,500
	Less-Cash down	20,000
	Balance Due	54,500
	Interest @ 5% for 1999	2,725
Dec.31, 1999	Total	57,225
	Amount paid	20,000
Jan.1, 2000	Balance Due	37,225
	Interest for 2000 @ 5%	1,861
Dec.31, 2000	Total	39,086
	Amount paid	20,000
Jan.1,2001	Balance due 2001	19,086
	Interest for (balancing figure) 2001	914
Jan.1,2002	Amount paid	20,000

(b) Calculation of interest when the rate of interest is not given:

Hire Purchase Price				80,000
Cash Price				74,500
Total interest				5,500

Year	Amount Outstanding	Ratio	Interest	Rs.
1	60,000	3	3/6 x 5,500	2,750
2	40,000	2	2/6 x 5,500	1,833
3	20,000	1	1/6 x 5,500	917

Instalment	Amount due at the end of the year (after payment of Installment)	Instalment paid	Total amount due at the end of the Year (before payment of instalment)		Interest @ 1/21	Principal due in the beginning
	Rs.	Rs.		Rs.	Rs.	Rs.
3	Nil	20,000		20,000	952	19,408
2	19,048	20,000		39,048	1,859	37,189
1	37,189	20,000		57,189	2,723	54,466
					5,534

Cash Price: 54,466 + cash down, Rs.20,000 or Rs.74,466.

Illustration-2

Y & Co. sold machinery whose cash price is Rs.74,500. to X and Co., on hire purchase basis on 1st January, 2000. Payment was to be made as Rs.20,000 down and Rs.20,000 every year for three years. Rate of interest was 5%& Co. charged depreciation @ 10% p.a. on the diminishing balance. Give ledger accounts in the books of Y &Co.

Ledger of Y & Co.
Dr.			X & Co.		Cr.
		Rs.			Rs.
2000			2000
Jan.1	To Sales	74,500	Jan.1	By Cash	20,000
Dec.31	To Interest A/c		Dec.31	By Cash	20,000
	(5% on Rs.54,500)	2,725		By Balance c/d	37,225
		77,225			77,225
2001			2001
Jan.1	To Balance b/d	37,225	Dec.31	By Cash	20,000
Dec.31	To Interest A/c	1,861		By Balance c/d	19,086
		39,086			39,086
2002			2002
Jan.1	To Balance b/d	19,086	Dec.31	By Cash	20,000
Dec.31	To Interest A/c	914
		20,000			20,000

Dr.	Sales Account			Cr.
		2000
		Jan. 1	By X & Co.	Rs. 15,000.
Interest Account
Dr.				Cr.
2000		2000
Dec.31 to P & L A/c	2,725	Dec.31	By X & Co.	2,725
2001		2001
Dec.31 to P & L A/c	1,861	Dec.31	By X & Co.	1,861
2002		2002
Dec.31 to P & L A/c	914	Dec.31	By X & Co.	914

Hire Purchase: Books of Purchaser

Books of Purchaser—First Method. The purchaser can also follow the system adopted by the vendor and make entries like ordinary purchase of an asset. Only, he should credit the vendor with interest due every year and debit him with cash as and when paid. The above given example can be worked out in the following way (ledger accounts.) :—

Dr.		Machinery account			Cr.
		Rs.			Rs.
2000			2000
Jan.1	To Y & Co.	74,500	Dec.31	By Depreciation A/c	7,450
				By Balance c/d	67,050
		74,500			74,500
2001			2001
Jan.1	To Balance b/d	67,050	Dec.31	By Depreciation A/c	6,705
				By Balance c/d	60,345
		67,050			67,050
2002			2002
Jan.1	To Balance b/d	60,345	Dec.31	By Depreciation A/c	6,035
				By Balance c/d	54,310
		60,345			60,345
2003
Jan.1	To Balance b/d	54,310

Y & Co. A/c
2000		Rs.	2000		Rs.
Jan.31	To bank A/c	20,000	Jan.1	By Machinery A/c	74,500
Dec.31	To Bank A/c	20,000	Dec.31	By Interest A/c	2,725
’’	To Balance c/d	37,225
		77,225			77,225
2001			2001
Dec.31	To Bank A/c	20,000	Jan.1	By Balance b/d	37,225
’’	To balance c/d	19,086	Dec.31	By Interest A/c	1,861
		39,086			39,086
2002 Dec.31	To Bank A/c	20,000	2002 Jan.1	By Balance b/d	19,086
			Dec.31	By Interest A/c	914
		20,000			20,000

The student should prepare accounts relating to Interest and Depreciation.

Second Method. Under the second method, entries are passed only when payment is due or made. At this time, the vendor is credited with the amount due. Interest for the period is debited to interest Account and the balance (principal) is debited to the Asset Account. On payment, of course, the vendor is debited and Cash (or Bank) credited. The two entries are:

Debit Asset Account, Debit Interest Account, Credit (hire) Vendor

Debit (Hire)Vendor, Credit Cash or (Bank)

Depreciation has to be charged according to the cash price of theasset

We give below the journal entries and ledger accounts in the books of X & Co., the purchaser, in the example given above.

Journal of X & Co.

			Debit (Rs)	Credit (Rs)
2000
Jan.1	Machinery Account	Dr.	20,000
	To Y & Co.		20,000
	(Amount due to Y & Co. as down payment for purchase of machinery on hire purchase basis.)

Jan.1	Y & Co.	Dr.	20,000
	To Bank Account		20,000
	(Payment made to Y & Co. down)

Dec.31	Machinery Account	Dr.	17,275
	Interest Account	Dr.	2,725
	To Y & Co.		20,000
	(The amount due to Y & Co. under the hire purchase Contractfor interest (and debited as such) andthe balance treated as payment for machinery)

Dec.31	Y & Co.	Dr.	20,000
	To Bank A/c		20,000
	(Payment made to Y & Co.)

Dec.31	Depreciation Account	Dr.	7,450
	To Machinery Account		7,450
	(Depreciation for 1st year-10% on Rs.74,500)

Dec 31	Profit & Loss Account	Dr.	10,175
	To Interest Account		2,725
	To Depreciation Account		7,450
	(Being interest and depreciation transferred to P/L A/c)
2001
Dec.31	Machinery Account	Dr.	18,139
	Interest Account	Dr.	1,861
	To Y & Co.		20,000
	(Amount due to Y & Co. for interest the balance charged to Machinery A/c.)

Dec.31	Y & Co.	Dr.	20,000
	To Bank Account		20,000
	(Payment made to Y & Co.)

Dec. 31	Depreciation	Dr.	6,705
	To Machinery Account		6,705
	(Depreciation for the second year 10% on Rs.67,050; i.e. Rs.74,500 - Rs.7,450).

Dec 31	Profit & Loss Account	Dr.	8,566
	To Interest Account		1,861
	To Depreciation Account		6,705
	(Being interest and depreciation transferred to P/L A/c)
2002
Dec.31	Machinery Account	Dr.	19,086
	Interest Account	Dr.	914
	To Y & Co.		20,000
	(Amount due to Y & Co. in respect of interest and the principal sum.)

Dec.31	Y & Co.	Dr.	20,000
	To Bank Account		20,000
	(Payment made to Y & Co.)

Dec.31	Depreciation Account	Dr.	6,035
	To Machinery Account		6,035
	(Depreciation @ 10% of the diminishing balance charged for the third years).

Dec 31	Profit & Loss Account	Dr.	6,949
	To Interest Account		914
	To Depreciation Account		6,035
	(Being interest and depreciation transferred to P/L A/c)

Ledger Accounts
Dr.		Machinery Account			Cr.
2000		Rs.	2000		Rs.
Jan.1	To Y & Co.	20,000	Dec.31	By Depreciation	7,450
Dec.31	To Y & Co.		Dec.31	By Balance c/d	29,825
	(20,000—2,725)	17,275
		37,275			37,275
2001			2001
Jan.1	To balance b/d	29,825	Dec.31	By Depreciation A/c	6,705
Dec.31	To Y & Co.		Dec.31	By Balance c/d	41,259
	(20,000—1,861)	18,139
		47,964			47,964
2002			2002
Jan.1	To Balance b/d	41,259	Dec.31	By Depreciation A/c	6,035
Dec.31	To Y & Co.	19,086	Dec.31	By Balance c/d	54,310
		60,345			60,345
2003
Jan.1	To Balance b/d	54,310

Dr.		Interest Account			Cr.
2000		Rs.	2000		Rs.
Dec.31	To Y & Co.	2,725	Dec.31	By P & L A/c	2,725
2001			2001
Dec.31	To Y & Co.	1,861	Dec.31	By P & L A/c	1,861
2002			2002
Dec.31	To Y & Co.	914	Dec.31	By P & L A/c	914

Dr.			Y & Co.			Cr.
2000		Rs.		2000		Rs.
Jan.1	To Bank A/c	20,000	Jan.1	By Machinery A/c		20,000
Dec.31	To Bank A/c	20,000	Dec.31	By Sundries—
				Machinery	17,275
				Interest	2,725	20,000
		40,000			40,000
2001			2001
Dec.31	To Bank A/c	20,000	Dec.31	By Machinery A/c		18,139
				By Interest A/c	1,861
		20,000			20,000
2002			2002
Dec.31	To Bank A/c	20,000	Dec.31	By Machinery A/c		19,086
				By Interest A/c	914
		20,000			20,000

Depreciation Account

2000		Rs.	2000		Rs.
Dec.31	To Machinery A/c	7,450	Dec.31	By P & L A/c	7,450
2001		2001
Dec.31	To machinery A/c	6,705	Dec.31	By P & L A/c	6,705
2002		2002
Dec.31	To Machinery A/c	6,035	Dec.31	By P & L A/c	6,035

Solved example

Q1) Cash Price, Rate of Interest and Amount of Installments are given)

Om Ltd. purchased a machine on hire purchase basis from Kumar Machinery Co. Ltd. on

the following terms:

Cash price Rs. 80,000

Down payment at the time of signing the agreement on 1.1.2011 Rs. 21,622.

5 annual instalments of Rs. 15,400, the first to commence at the end of twelve months from the date of down payment.

Rate of interest is 10% p.a.

You are required to calculate the total interest and interest included in cash instalment.

Solution:

Calculation of interest

	Total (Rs.)	Interest in each instalment (1)	Cash price in each instalment (2)
Cash Price Less: Down Payment Balance due after down payment Interest/Cash Price of 1st instalment Less: Cash price of 1st instalment Balance due after 1st instalment Interest/cash price of 2nd instalment Less: Cash price of 2nd instalment Balance due after 2nd instalment Interest/Cash price of 3rd instalment Less: Cash price of 3rd instalment Balance due after 3rd instalment Interest/Cash price of 4th instalment Less: Cash price of 4th instalment Balance due after 4th instalment Interest/Cash price of 5th instalment Less: Cash price of 5th instalment Total	80,000 (21,622) 58,378 - (9,562) 48,816 - (10,518) 38,298 - (11,570) 26,728 - (12,728) 14,000 - (14,000) Nil	Nil Rs. 58,378 x10/100 = Rs. 5,838 Rs. 48,816 x 10/100 = Rs. 4,882 Rs. 38,298x10/100 = Rs. 3,830 Rs. 26,728 x10/100 = Rs. 2,672 Rs. 14,000 x10/100 =Rs. 1,400 Rs. 18,622	Rs. 21,622 Rs. 15,400 – Rs. 5,838 = Rs. 9,562 Rs. 15,400 - Rs. 4,882 = Rs. 10,518 Rs. 15,400 - Rs. 3,830 = Rs. 11,570 Rs. 15,400 - Rs. 2,672 = Rs. 12,728 Rs. 15400 – Rs. 1,400 = 14,000 Rs. 80,000

Total interest can also be calculated as follow:

(Down payment + instalments) – Cash Price = Rs. [21,622+(15400 x 5)] – Rs. 80,000 = Rs. 18,622

Q2)Cash Price and Amount of Installments are given; Rate of Interest is not given)

Happy Valley Florists Ltd. acquired a delivery van on hire purchase on 01.04.2011 from Ganesh Enterprises. The terms were as follows:

Particulars	Amount (Rs.)
Hire Purchase Price	180,000
Down Payment	30,000
1st installment payable after 1 year	50,000
2nd installment after 2 years	50,000
3rd installment after 3 years	30,000
4th installment after 4 years	20,000

Cash price of van Rs. 1,50,000. You are required to calculate Total Interest and Interest included in each instalment.

Solution: Calculation of total Interest and Interest included in each installment Hire Purchase Price (HPP) = Down Payment + instalments= 30,000 + 50,000 + 50,000 + 30,000 + 20,000 = 1,80,000

Total Interest = 1,80,000 – 1,50,000 = 30,000

Computation of IRR (considering two guessed rates of 6% and 12%)

Year	Cash Flow	DF @6%	PV	DF @12%	PV
0	30,000	1.00	30,000	1.00	30,000
1	50,000	0.94	47,000	0.89	44,500
2	50,000	0.89	44,500	0.80	40,000
3	30,000	0.84	25,200	0.71	21,300
4	20,000	0.79	15,800	0.64	12,800
		NPV	1,62,500	NPV	1,48,600

Interest rate implicit on lease is computed below by interpolation:

Interest rate implicit on lease= 6% + 1,62,500-1,50,000 x (12-6) = 11.39%

1,62,500-1,48,600

Thus, repayment schedule and interest would be as under:

Installment no.	Principal at beginning	Interest included in each installment	Gross amount	Installment	Principal at end
Cash down	1,50,000		1,50,000	30,000	1,20,000
1	1,20,000	13,668	1,33,668	50,000	83,668
2	83,668	9,530	93,198	50,000	43,198
3	43,198	4,920	48,118	30,000	18,118
4	18,118	2,064	20,182	20,000	182*
		30,182*
* the difference is on account of approximations.

On January 1, 2011 HP M/s acquired a Pick-up Van on hire purchase from FM M/s. The

terms of the contract were as follows:

(a) The cash price of the van was Rs. 1,00,000.

(b) Rs. 40,000 were to be paid on signing of the contract.

(d) Interest chargeable on the outstanding balance was 6% p.a.

(e) Depreciation at 10% p.a. is to be written-off using the straight-line method.

You are required to:

(a) Give Journal Entries and show the relevant accounts in the books of HP M/s from January 1, 2011 to December 31, 2013; and

(b) Show the relevant items in the Balance Sheet of the purchaser as on December 31, 2011 to 2013.

Solution:

Journal Entries in the books of HP M/s

Date	Particulars		Dr.	Cr.
2011			Rs.	Rs.
Jan. 31	Pick-up Van A/c To FM M/S A/c (Being the purchase of a pick-up van on hire purchase from FM M/s)	Dr.	1,00,000
				1,00,000
“	FM M/S A/c To Bank A/c (Being the amount paid on signing the H.P. contract)	Dr.	40,000
				40,000
Dec. 31	Interest A/c To FM M/s A/c (Being the interest payable @ 6% on Rs. 60,000)	Dr.	3,600
				3,600
“	FM M/s A/c (Rs. 20,000+Rs. 3,600) To Bank A/c (Being the payment of 1st instalment along with interest)	Dr.	23,600
				23,600
“	Depreciation A/c To Pick-up Van A/c (Being the depreciation charged @ 10% p.a. on Rs. 1,00,000)	Dr.	10,000
				10,000

“	Profit & Loss A/c To Depreciation A/c To Interest A/c (Being the depreciation and interest transferred to Profit and Loss Account)	Dr.	13,600
				10,000 3,600
2012 Dec. 31	Interest A/c To FM M/s A/c (Being the interest payable @ 6% on Rs. 40,000)	Dr.	2,400	2,400
“	FM M/s A/c (Rs. 20,000 + Rs. 2,400) To Bank A/c (Being the payment of 2nd instalment along with interest)	Dr.	22,400
				22,400
“	Depreciation A/c To Pick-up Van A/c (Being the depreciation charged @ 10% p.a.)	Dr.	10,000
				10,000
“	Profit & Loss A/c To Depreciation A/c To Interest A/c (Being the depreciation and interest charged to Profit and Loss Account)	Dr.	12,400
				10,000 2,400
2013 Dec. 31	Interest A/c To FM M/s A/c (Being the interest payable @ 6% on Rs. 20,000)	Dr.	1,200	1,200
“	FM M/s A/c (Rs. 20,000 + Rs. 1,200) To Bank A/c (Being the payment of final instalment along with interest)	Dr.	21,200
				21,200
“	Depreciation A/c To Pick-up Van A/c (Being the depreciation charged @ 10% p.a. on Rs. 1,00,000)	Dr.	10,000
				10,000
“	Profit & Loss A/c To Depreciation A/c To Interest A/c (Being the interest and depreciation charged to Profit and Loss Account)	Dr.	11,200
				10,000 1,200

Ledgers in the books of HP M/s

Pick-up Van Account

Date	Particulars	Rs.	Date	Particulars	Rs.
1.1.2011	To FM M/s A/c	1,00,000	31.12.2011	By Depreciation A/c	10,000
			31.12.2011	By Balance c/d	90,000
		1,00,000			1,00,000
1.1.2012	To Balance b/d	90,000	31.12.2012	By Depreciation A/c	10,000
			31.12.2012	By Balance c/d	80,000
		90,000			90,000
1.1.2013	To Balance b/d	80,000	31.12.2013	By Depreciation A/c	10,000
			31.12.2013	By Balance c/d	70,000
		80,000			80,000

FM M/s Account

Date	Particulars	Rs.	Date	Particulars	Rs.
1.1.2011	To Bank A/c	40,000	1.1.2011	By Pick-up Van A/c	1,00,000
31.12.2011	To Bank A/c	23,600	31.12.2011	By Interest c/d	3,600
31.12.2011	To Balance c/d	40,000
		1,03,600			1,03,600
31.12.2012	To Bank A/c	22,400	1.1.2012	By Balance b/d	40,000
31.12.2012	To Balance c/d	20,000	31.12.2012	By Interest A/c	2,400
		42,400			42,400
31.12.2013	To Bank A/c	21,200	1.1.2013	By Balance b/d	20,000
			31.12.2013	By Interest A/c	1,200
		21,200			21,200

Depreciation Account

Date	Particulars	Rs.	Date	Particulars	Rs.
31.12.2011	To Pick-up Van A/c	10,000	31.12.2011	By Profit & Loss A/c	10,000
31.12.2012	To Pick-up Van A/c	10,000	31.12.2012	By Profit & Loss A/c	10,000
31.12.2013	To Pick-up Van A/c	10,000	31.12.2013	By Profit & Loss A/c	10,000

Interest Account

Date	Particulars	Rs.	Date	Particulars	Rs.
31.12.2011	To FM M/s A/c	3,600	31.12.2011	By Profit & Loss A/c	3,600
31.12.2012	To FM M/s A/c	2,400	31.12.2012	By Profit & Loss A/c	2,400
31.12.2013	To FM M/s A/c	1,200	31.12.2013	By Profit & Loss A/c	1,200

Balance Sheet of HP M/s as at 31st December, 2011

Liabilities	Rs.	Assets	Rs.
FM M/s	40,000	Pick-up Van	90,000

Balance Sheet of HP M/s as at 31st December, 2012

Liabilities	Rs.	Assets	Rs.
FM M/s	20,000	Pick-up Van	80,000

Balance Sheet of HP M/s as at 31st December, 2013

Liabilities	Rs.	Assets	Rs.
		Pick-up Van	70,000

Q3) 1st January, 2000 Mr. A purchases from Mr. B machinery whose cash price is Rs. 15,000; Rs. 5,000 is to be paid down, that is on signing of the contract, and Rs. 4,000 is to be paid at the end of each year for 3 years. Rate of interest is 10% p.a. Prepare B’s account in the books of Mr. A

Solution:

A’s Books

Dr.			B’s Account		Cr.
		Rs.			Rs.
2000			2000
Jan.1	To Cash	5,000	Jan.1	By Machinery A/c	15,000
Dec.31	To Cash	4,000	Dec.31	By Interest A/c	1,000
’’	To balance c/d	7,000		(10% on Rs. 10,000)
		16,000			16,000
2001			2001
Dec.31	To Cash	4,000	Jan.1	By Balance b/d	7,000
	To Balance c/d	3,700	Dec.31	By Interest A/c
				(10% on Rs. 7,000)	700
		7,700			7,700
2002			2002
Dec.31	To Cash	4,000	Jan.1	By Balance b/d	3,700
			Dec.31	By Interest A/c*	300
		4,000			4,000

Q4) Based on particulars given below calculate Interest under the hire purchase system

X & Co.—purchaser Y & Co.-Seller Date of purchase—Jan. 1,1999, Cash price—Rs. 74,500.

Installments Rs. 20,000 on signing of the agreement. Rest in three instalments of Rs. 20,000 each. Rate of Interest—5%. Depreciation 10% on the diminishing Balance.

Solution:

Calculation of Interest
		Rs.
Jan.1, 1999	Cash Price	74,500
	Less-Cash down	20,000
	Balance Due	54,500
	Interest @ 5% for 1999	2,725
Dec.31, 1999	Total	57,225
	Amount paid	20,000
Jan.1, 2000	Balance Due	37,225
	Interest for 2000 @ 5%	1,861
Dec.31, 2000	Total	39,086
	Amount paid	20,000
Jan.1,2001	Balance due 2001	19,086
	Interest for (balancing figure) 2001	914
Jan.1,2002	Amount paid	20,000

Q5) Based on particulars given below calculate Interest under the hire purchase system

X & Co.—purchaser Y & Co.-Seller Date of purchase—Jan. 1,1999, Cash price—Rs. 74,500.

Installments Rs. 20,000 on signing of the agreement. Rest in three instalments of Rs. 20,000 each. Depreciation 10% on the diminishing Balance.

Solution:

Calculation of interest when the rate of interest is not given:

Hire Purchase Price				80,000
Cash Price				74,500
Total interest				5,500

Year	Amount Outstanding	Ratio	Interest	Rs.
1	60,000	3	3/6 x 5,500	2,750
2	40,000	2	2/6 x 5,500	1,833
3	20,000	1	1/6 x 5,500	917

5.2 Valuation of inventory? (AS-2) Insurance claims

AS – 2 Valuation of inventories

Purpose: - The purpose of this standard is to formulate the method of computation of cost of stock, determine the value of closing stock to be shown in the Balance Sheet.

Definition

I. Definition of the Inventory includes the following:

A. Held for sale in the normal course of business i.e finished goods

B. Goods which are in the production process i.e work in progress

C. Raw materials which are consumed during production process or rendering of services (including consumable stores item)

II. Net Realisable Value (NRV):

“Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale”

Valuation of Inventories

Inventories should be valued at lower of cost and net realizable value. Following are the steps for valuation of inventories:

Determine the cost of inventories

Determine the net realizable value of inventories

On Comparison between the cost and net realizable value, the lower of the two is considered as the value of inventory. A comparison can be made the item by item or by the group of items.

A. Cost of Inventories

The cost of inventories includes the following

ii) Purchase cost

iii) Conversion cost

iv) Other costs which are incurred in bringing the inventories to their present location and condition.

B. Cost of Purchase

While determining the purchase cost, the following should be considered:

i) Purchase cost of the inventory includes duties and taxes (except those which are subsequently recoverable from the taxing authorities)

ii) Freight inwards

iii) Other expenditure which is directly attributable to the purchase

iv) Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase

C. Cost of Conversion

Cost of conversion includes all cost incurred during the production process to complete the raw materials into finished goods.

Cost of conversion also includes a systematic allocation of fixed and variable overheads incurred by the enterprise during the production process.

Following are the categories of conversion cost:

i) Direct Cost - All the cost directly related to the unit of production such as direct labor

ii) Fixed Overhead Cost- Fixed overheads are those indirect costs which are incurred by the enterprise irrespective of production volume. These are the cost that remains relatively constant regardless of the volume of production, such as depreciation, building maintenance cost, administration cost etc.

iii) Variable Overhead Cost- Variable overheads are those indirect costs of production that vary directly with the volume of production. These are the cost that will be incurred based on the actual production volume such as packing materials and indirect labor.

D. Other Cost

All the other cost which are incurred in bringing the inventories to the current location and condition. For (eg) design cost which is incurred for the specific customer order.

Cost of Purchase: - Cost of purchase includes Purchase Price, Duties and Taxes, Freight Inward and other expenditure directly attributable to the acquisition. Less Duties and Taxes recoverable by enterprises from taxing authorities, Trade Discount, Rebate, Duty drawback.

Disclosure in Financial Statement: - The financial statement should disclose the following:

a) Accounting policy adopted in measuring inventories.

b) Cost formula used.

c) Classification of inventories i.e. finished goods, work in progress, raw materials etc.

Insurance claim

Insurance claim for loss of stock and loss of profit

Steps to claim of loss

Step 1: Create Trading Account (i.e. Account related to previous year)

Trading Account

for the year ended____

Dr. Cr.

Particulars	Amount	Particulars	Amount
To opening stock To Purchase To Wages To Carriage Inwards To Gross Profit (balancing figure)	xxx xxx xxx xxx xxx	By Sales By closing stock	xxx xxx
	xxxx	By Sales By closing stock	xxxx

Create Memorandum Trading Account (i.e. Account related to current year till the date of fire)

Memorandum Trading Account

for the year ended____

Dr. Cr.

Particulars	Amount	Particulars	Amount
To opening stock To Purchase To Gross Profit (@__% on sales)	xxx xxx xxx	By Sales By closing stock (Stock on the date of fire) (Balancing figure	xxx xxx
	xxxx		xxxx

Step 3: Prepare the following working notes:

Gross Profit Rate = Gross Profit / Sales × 100

Calculate Gross Profit Rate:

2. Prepare statement of claim

Amount (Rs.)

Estimated Stock on the date of fire = xxx

Less: Stock saved/ salvaged = xxx

Value of Stock destroyed by fire = xxxx

3. Calculate Average Clause: (if policy amount is given)

Value of Policy × Value of stock destroyed by fire

Value of stock on the date of fire

Claim for loss of profit

Calculate short sales

The short sales are calculated as under

Particulars Rs.

Estimated sales during the period of indemnity xxx

Add: Increase in price (if any) xxx

Less: Actual sales during the period of indemnity xxx

Short Sales xxxx

Indemnity period = Period during which sales are expected to be affected due to fire, this period is mentioned in policy. The usual period is one year.

2. Calculate Gross Profit Rate:

Gross Profit Rate = Net profit + Insured standing charges × 100

Annual Sales

Standing charges = These are the expenses required to be incurred irrespective of the fact whether the business activities are suspended or not. They includes wages & salary, rent, rates, taxes, insurance, directors fees, auditors fees, interest on loan, etc

3. Calculate Loss of Profit:

Loss of Profit = Short Sales × Gross Profit Rate

4. Calculate increase in cost of working (Working Expenses):

= Net profit + Insured standing charges × increased working expenses

Net profit + All standing charges

5. Average Clause:

If the amount of the policy is less than the Gross Profit in the standard sales, the amount of claim is reduced in the ratio of amount of policy to Gross Profit in standard sales.

6. Insurance Claim:

Insurance claim = Amount of policy x Amount of claim

Gross Profit in standard sales

Key takeaways –

When a fire occurs, it destroys a number of assets such as building, machinery, furniture, stock, etc. T

The books of account maintain accounts of all the assets except (usually) stock-in-trade.

The value of stock on hand on the date of fire, therefore, has to be estimated.

This is done by ascertaining the cost of goods sold (sales minus the gross profit at the usual rate) and then deducting it from the total of opening stock, purchases, wages and other manufacturing expenses.

Example

A fire occurred in the business premises of Rajesh Traders on 15th October, 2010. from the following particulars, ascertain the loss of stock and prepare a claim for insurance.

Stock on 1-1-2009 Rs.15,300

Purchases from 1-1-2009 to 31-12-2009 Rs.61,000

Sales from 1-1-2009 to 31-12-2009 Rs.90,000

Stock on 31-12-2009 Rs.13,500

Purchases from 1-1-2010 to 14-10-2010 Rs.73,500

Sales from 1-1-2010 to 14-10-2010 Rs.75,000

The stock were always valued at 90% of cost. The stock saved was worth Rs.9,000. The amount of the policy was Rs.31,500, there was an average clause in the policy.

Solution

trading account
particulars	amount	particulars	amount
To opening stock	17,000	By sales	90,000
To purchase	61,000	By closing stock	15,000
To Gross profit	27,000
	1,05,000		1,05,000

Memorandum Trading Account

for the year ended 15-10-2010

Dr. Cr.

Particulars	Amount	Particulars	Amount
To opening stock To Purchase To Gross Profit (75,000 × 30 / 100)	15,000 73,500 22,500	By Sales By closing stock (Stock on the date of fire)	75,000 36,000
	1,11,000		1,11,000

Working Notes:

(1) Calculation of Stock:

Stock is always valued at 90% of cost

(A) Opening Stock = Rs.15,300 – (90%)

=15,300× 10/90

= 1,700 – (10%)

= 15,300 + 1,700 = 17,000

Opening Stock = Rs.17,000

(b) Closing Stock – Rs.13,500 – (90%)

13,500 ×10/90

= 1,500

13,500 + 1,500 = 15,000

Closing Stock = Rs.15,000.

(2) Calculation of Gross Profit Rate:

(Take the values of previous year i.e. Trading Account)

Gross Profit Rate = Gross Profit / Sales x 100

27,000/90,000 × 100

= 30%

Gross Profit Rate = 30%

(3) Statement of Claim:

Estimated stock on the date of fire = 36,000

Less: Stock saved = 9,000

Value of stock destroyed by fire = Rs.27,000

(4) Calculation of Average Clause:

(As there is policy value given so we have to calculate average clause)

Average Clause =

Value of Policy × Value of stock destroyed by fire

Value of stock on the date of fire

31,500/ 36,000 × 27,000

= 23,625

Average Clause = Rs.23,625

example 2

A fire occurred on 15th December, 2011 in the premises of D Co. Ltd. From the following figures, calculate the amount of claim to be lodged with the insurance company for loss of stock:

Rs.

Stock at cost as on 1st April, 2010 2,00,000

Stock at cost as on 1st April, 2012 3,00,000

Purchase for the year ended 31st March, 2011 4,00,000

Purchase from 1st April, 2011 to 15th December, 2011 8,80,000

Sales for the year ended 31st March, 2011 6,00,000

Sales from 1st April, 2011 to 15th December, 2011 10,50,000

During the accounting year 2011-2012, cost of purchase rose by 10% above the previous year’s levels while selling prices went up by 5%

The value of stock salvaged was Rs. 20,000

Solution:

Trading Account for the year ended 31st March, 2011

Dr. Cr.

To Stock as on 1st April, 2010 To Purchase To Gross Profit (balancing Figure)	Rs 2,00,000 4,00,000 3,00,000	By Sales By Stock as on 31st March, 2011	Rs 6,00,000 3,00,000
	9,00,000		9,00,000

Rate of gross profit = 3,00,000 / 6,00,000 × 100 = 50%

Memorandum Trading Account

for the period from 1st April, 2011 to 15th December, 2011

Dr. Cr.

Particulars	Actuals	At last year’s rates	Particulars	Actual	At last year’s rates
To Stock as on 1st April, 2011 To Purchase To Gross Profit (at last year’s rates = Rs. 10,00,000 × 50/100) (Actual, balancing figure)	Rs 3,00,000 8,80,000 5,30,000	Rs 3,00,000 8,00,000 5,00,000	By Sales By Stock on 15th Dec. 2011 (At last year’s rates -balancing figure) (Actual -on FIFO basis Rs.6,00,000 × 110 × 100)	Rs 10,50,000 6,60,000	Rs 10,00,000 6,00,000
	17,10,000	16,00,000		17,10,000	16,00,000

Rs.

Value of closing Stock on 31st December, 2011 at current rates 6,60,000

Less: Value of goods salvaged 20,000

Amount of the claim to be lodged 6,40,000

Example 3

On 15th June

2015, the premises and stock of a firm was destroyed by fire but the accounting records were saved from which the following particulars are available:

Stock on 1.1.2014 73,500

Stock on 31.12.2014 81,900

Purchases for the year 2014 3,98,000

Sales for the year 2014 4,87,000

Purchases from 1.1.2015 to 15.6.2015 1,62,000

Sales from 1.1.2015 to 15.6.2015 2,31,200

The stock salvaged was 5,300. Show the amount of claim.

Solution:

Step 1: Preparation of Last Year Trading Account

trading account for the year ending 31st dec 2014
particulars	amount	particulars	amount
To opening stock	73,500	By sales	487,000
To purchase	398,000	By closing stock	81,900
To Gross profit	97,400
	568,900		568,900

Step 2: Calculation of Rate of Gross Profit on Sales

Rate of G/P = Net Sales/Gross Profit × 100 = 4,87,000/97,400 × 100 = 20%

Step 3: Preparation of Memorandum Trading Account

Memorandum trading account
particulars	amount	particulars	amount
To opening stock	81,900	By sales	231,200
To purchase	162,000	By closing stock	58,940
To Gross profit	46,240
	290,140		290,140

Step 4: Calculation of Actual Amount of Loss

particulars	amount
Stock on the date of fire	58940
less: salvaged stock	5300
Actual amount of loss	53640

Step 5: Calculation of Amount of Claim

The problem does not provide any information about the policy amount. Hence, the amount of claim will be the same as actual amount of loss.

The amount of claim = 53,640.

Example 4

A fire broke out in the warehouse of Merchantile Traders Ltd. on 30th Sep., 15. The company desires to file a claim with the insurance company for loss of stock. From the following information prepare a statement showing the amount of claim. The last account of company were prepared on 31.12.14.

Stock on 31.12.14 1,20,000

Sundry debtors on 31.12.14 3,20,000

Sundry debtors on 30.9.15 2,40,000

Cash received from debtors 11,52,000

Purchases from 1.1.15 to 30.9.15 10,00,000

Rate of Gross Profit on sales 25%

Solution

Total debtors account
particulars	amount	particulars	amount
To opening balance b/d	320,000	By cash received	1,152,000
To credit sales	1,072,000	By closing balance c/d	240,000

	1,392,000		1,392,000

Memorandum trading account
particulars	amount	particulars	amount
To opening stock	120,000	By sales	1,072,000
To purchase	1,000,000	By closing stock	316,000
To Gross profit	268,000
	1,388,000		1,388,000
Statement of claim
particulars	amount
Closing stock	316000
less: salvaged	-
Amount of claim	316000

References

Corporate accounting by BS Raman

Corporate accounting by Dr. S.M. Shukla, Dr. K.L. Gupta

Corporate accounting by V RAJASEKARAN and R LALITA

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