Hire Purchase SystemCalculation of Interest

Mahesh Chandra SharmaAssociate Professor

Department of CommerceShaheed Bhagat Singh Eve. College

(University of Delhi) India

Hire Purchase System - FeaturesUnder the hire purchase system goods are sold

on instalment basis.

Ownership of the goods is transferred when the last instalment is paid.

If the hire purchaser becomes defaulter, the hire vendor has the right to take away the goods and forfeit the instalments received as hire charges for the use of goods.

Important TermsFor details of the following terms, please see

my other presentation on slideshare.net (Hire Purchase System Default and Repossession.Hire Purchaser or HirerOwner or Hire VendorDeposit or Initial Payment or Down PaymentHire ChargesCost PriceCash PriceHire Purchase PriceHire Purchase Charges or Interest

Accounting for Hire Purchase Transactions

Accounting Methods

For Goods of Considerable

Value

Asset Full Value Method

Asset Accrual Method

For Goods of Small Value

Hire Purchase

Trading A/c Method

Stock and Debtors Method

Calculation of InterestFor recording hire purchase transactions for

goods of considerable value, calculation of interest is must.

In this presentation, various methods of calculation of interest have been presented in simple and understandable format.

Case 1: When Cash Price, down payment, instalments and rate of interest are givenExample:Cash Price = Rs. 37,230Down payment = Rs. 10,000Annual Instalments = 3 of Rs. 10,000 eachRate of Interest = 5% p.a.

Year Outstanding Cash Price

Interest

1 Total CPLess: DP

37,230(10,000)

Add: Interest27,230 1,362

27,230 = Rs. 1,362

Less: Instalment paid

28,592(10,000)

2.Add: Interest

18,592 930

18,592 = Rs. 930

Less: Instalment paid

19,522(10,000)

3.Add: Interest

9,522478

478 = 10,000 – 9522

Instalment paid 10,000

Case 2: When Cash Price, down payment and instalments are given but rate of interest not given.

Example:Cash Price = Rs. 55,840, Down payment = Rs.

15,000Annual Instalments = 3 of Rs. 15,000 eachSolution:HPP = 15,000 + (15,000 *3) = 60,000Total Interest = HPP – Cash Price

= 60,000 – 55840 = 4160This interest shall be distributed among three years in the ratio of outstanding instalments or Outstanding HPP.

Year

Outstanding HPP

Ratio Interest

1 60,000 – 15,000=45,000

3 4,160 = Rs. 2080

2. 45,000 – 15,000=30,000

2 4,160 = Rs. 1,387

3. 30,000 – 15,000=15,000

1 4,160 = 693

Total 6 4,160

Case 3: When down payment, instalments and rate of interest are given but Cash Price is not given

Example:Down payment = Rs. 10,000Annual Instalments = I yr. Rs. 13,000, II yr.

Rs. 12,000 and III yr. Rs. 11,000. Rate of Interest – 10% p.a.

Solution:In this question interest and principal component of each instalment shall be calculated starting from last year. Balance at the end of each year includes O/S Cash Price and Interest.

Year Outstanding HPP at end

Interest Cash Price paid

3 11,000 11,000 = Rs. 1,000

(11,000 – 1,000)10,000

2. 10,000 +12,000

22,000 = Rs. 2,000

(12,000 – 2,000)10,000

1. 10,000+10,000 +13,000

33,000 = Rs. 3,000

(13,000 – 3,00010,000

0 DP Nil 10,000Total Cash Price 40,000

Case 4: When Cash Price, down payment, instalments (excluding interest) and rate of interest are given.

Example:Cash Price = Rs. 50,000Down payment – Rs. 20,000 and balance payable

in 3 equal annual instalments plus interest.Rate of Interest – 9 % p.a.Solution:Annual Instalment = = 10,000 plus interestIn this question interest shall be calculated every year and shall be added to 10,000 to find total amount of instalment paid.

Year Outstanding Cash Price

Interest

1 Total CPLess: DP

50,000(20,000)

Add: Interest30,000 2,700

30,000 = Rs. 2,700

Less: Instalment paid (10,000 + 2,700)

32,700(12,700)

2.Add: Interest

20,000 1,800

20,000 = Rs. 1,800

Less: Instalment paid (10,000 + 1,800)

21,800(11,800)

3.Add: Interest

10,000 900

10,000 = Rs. 900

Less: Instalment paid (10,000 + 900)

10,900(10,900)

Case 5: Annuity Method when Instalments are equal When down payment, instalments and rate of interest are given. Cash Price not given.Example:Down payment = Rs. 15,000Annual Instalments = 3 of Rs. 15,000 eachRate of Interest – 5% pa.Solution:Total Cash Price = Down payment + (Annual Instalment Present Value of Re. 1 annuity for 3 yrs at 5% interest) = 15,000 + (15,000 X 2.723)= 15,000 + 40,845 = 55,845

Year Outstanding Cash Price

Interest

1 Total CPLess: DP

55,845(15,000)

Add: Interest40,845 2,042

4 = Rs. 2,042

Less: Instalment paid 42,887

(15,000)2.

Add: Interest27,887 1,394

27,887 = Rs. 1,394

Less: Instalment paid29,281

(15,000)3.

Add: Interest14,281

71915,000 – 14281 = Rs. 719

Less: Instalment paid15,000

(15,000) Total Interest = 4,155

Case 6: Annuity Method when Instalments are unequal When down payment, instalments and rate of interest are given. Cash Price not given.

Example:Down payment = Rs. 4,650Annual Instalments = I yr – Rs. 7,130, II yr – Rs. 9,020

and III yr – Rs. 4,200.Rate of Interest – 5% pa.

Solution

Total Cash Price = Down payment

+ Ist Instalment Present Value of annuity for 1 yr at 5% + 2nd Instalment Present Value of annuity for 2 yrs at 5% + 3rd Instalment Present Value of annuity for 3 yrs at 5%

= 7,000 + (8,900X 0.952) + (6,500 X 0.907 ) + (4,200 X 0.864)= 7,000 + 8,473 + 5,896 + 3629= 24,998

Year Outstanding Cash Price

Interest

1 Total CPLess: DP

24,998(7,000)

Add: Interest17,998

90017,998 = Rs. 900

Less: Instalment paid 18,898(8,900)

2.Add: Interest

9,998 500

9,998 = Rs. 500

Less: Instalment paid10,498(6,500)

3.Add: Interest

3,998 202

4,200 – 3,998 = Rs. 202

Less: Instalment paid4,200

(4,200) Total Interest = 1,602

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