Meaning of purchase Account
Operation of hire purchase Account
Hire purchase can be defined as a system under which property or goods is acquired,with payments made installmentally. The system of trading enables the consumer to enjoy the goods even though he has not finished paying for it.
Operation of hire purchase system
Under the hire purchase system,the goods are delivered to the hirer and he agrees to make periodical installmental payments of fixed amount,the hirer cannot sell the goods while the installmental payment is in operation.it,therefore,means that the hirer only possesses the goods and ownership remains with the seller until the full price of the article has been paid. If the hirer defaults,the seller can recover the goods while the hirer forfeits installments previously made.
Accounting records
For the purpose of convenience it is usual to divide hire purchase into large and small items.Large items are usually assets in the hands of the buyers while small items are generally those ones sold to the general public.
Different aspects of hire purchase
Treatment in the books of the buyer of large items.
Treatment in the books seller of large items.
Treatment in the books of seller of small items.
Treatment in the book of finance companies.
In the books of the buyer
The first step is to break down the total contract price into cash price and interest charge.
Open three accounts: asset account,hire vendor account and hire purchase interest suspense account(is also called interest suspense account).
Procedure is then as follows:
Credit hire purchase account with total amount of contract
Debit asset account with cash price of asset and debit hire purchase interest suspense account with total interest charge included in the contract.
Treatment in the balance sheet
These are alternative methods of presenting the information in the balance sheet.In the first method ,the asset is shown in the usual way but the account due to hire vendor has the balance on the interest suspense account deducted from it at the end of the first year.
Second method assumes that the buyer does not possess the asset but has simply an interest in the hire purchase of it. The value of his interest is shown as one figure and at the end of the second year it would appear in the balance sheet.
Apportionment of interest charge: as sales are credited with the cash price,the gross profit on the transaction is automatically taken to credit in the same year as that in which the sale is made. However,the interest charge must be apportioned over the period of the contract. They are two methods of apportionment
Methods of apportionment
Straightforward time basis
Method which allows for the reduction in the debt outstanding.
Suppliers of small items
Generally small items are items which the supplier considers that the gross profit on the article should be apportioned in the same way as interest,that is gross profit is not taken when the articles are sold but is taken bit by bit as the installments become due and payable.
Simple hire purchase trading account
Under this method the equivalent of sales in the normal account is the total of hire purchase sales during the period covered by the transaction.the sales under hire purchase consist of installments received and,if applicable,installments due but not yet received.the cost of these hire purchase sales is the cost element included in the installments.
Stock on hire purchase: Under the hire purchase contract sales are not legally effected until the final installment is paid the goods remain the property of the seller.Any figure of cost of price of installments not yet due in really stock belonging to the seller but actually out in possession of the person buying under hire purchase contract.
Calculation of the value of stock: The seller only owns bit of the stock out on hire purchase or more precisely,a proportion of it. The proportion is simply;
Amount outstanding/contract price x cost of article.
Opening stock of goods on hire purchase: Under normal circumstances,a large number of the installments received related to contract entered into or goods in earlier period
Procedure with goods repossessed: When goods are repossessed,a valuation must be placed on them, this valuation is equivalent to stock valuation,i.e.it is measured by the formula cost price x outstanding installment, then open a goods repossessed accounts
Debit value of goods repossessed
Credit proceeds of sales
If any goods are still held at end of accounting period carry balance down as stock in hand
Any difference on the account is the profit or loss on the transaction and it’s transferred to profit and loss account.
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