Wondering, “What is hire purchase system?” Well, it’s a financial game-changer! A hire purchase system is a system in which the hirer (hire purchaser) buys goods from the seller (hire vendor), but he does not pay him in full; instead, he makes a lump sum payment known as a down payment. Let’s understand this system in detail in this article.
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What is Hire Purchase System?
A hire purchase system is one in which the seller (hire vendor) sells to the hirer (hire purchaser), but the hirer does not pay the seller the entire amount upfront. However, pay a one-time payment in full as a down payment; the hirer will pay the remaining balance through installments.
It is similar to an installment system, but the timing of the ownership transfer is the main difference between an installment system and a hire purchase system.
The hire purchase system is generally applied to goods that have a good resale value in the market. Hence, if the hire purchaser fails to pay any installment, the hire vendor has the right to repossess the asset and resell it on the market in order to recoup his costs and profit margin in such a case.
Terms Involved in the Hire Purchase System
Hirer: A “Hirer” in general terms means a person or the buyer of a good who obtains a good from the seller or the owner under the hire purchase system.
Hire Vendor: A “Hire Vendor” is a seller or owner of the goods who sells the goods to the hirer under a hire purchase system.
Cash Price: The total amount to be paid in cash for an outright purchase in cash.
Down payment: This is the amount that must be paid initially when a hire purchase agreement is signed by the hire purchaser.
Hire Purchase Price: The total amount that hire purchasers must pay to the hire vendor for the goods he has purchased under the hire purchase system is known as the “hire purchase price.”
Formulas
1. How to calculate the hire purchase price
- Cost Price XXX
- Add: Profit Margin XXX
- Add: Interest on Outstanding Balance XXX
- Hire Purchase Price (HPP) ——-
2. How to Calculate Cash Price Installments
Net Cash Price* Hire Purchase Installment /Hire Purchase Price (HPP)
Hire Purchase Agreement
The terms and conditions on which the purchaser and the seller mutually agree to let the products be hired are specified in the hire purchase agreement. The following clauses are included in Hire purchase agreement:
- The vendor or seller transfers possession of the goods in question to the hirer or hire purchaser on the condition that ownership will be transferred to the hirer when he pays the final installment.
- If the hirer is unable to make the remaining installment payments or decides that he doesn’t want the asset, he can terminate the agreement at any time. The hirer shall return the asset to the vendor upon termination of the agreement, and the installments made up to that time shall be deemed rent for the use of an asset.
Contents of Hire Purchase Agreement
A hire purchase agreement must include the following details, per Section 4 of the Hire Purchase Act, 1972:
- A description of the goods sold.
- The selling price for the good sold.
- The actual price for the good sold
- The commencement date and time of the agreement.
- The total amount due from the hirer, the number of installments, and the interest rate.
- The due date by which all installments must be settled.
- The person’s name to whom the installment is due.
Read also: TDS on Rent – Section 194I, IB, IC & 195 of Income Tax Act
Advantages of Hire Purchase System
The hire purchase system has the following advantages:
- When payments are made in simple installments, the hirer finds it much easier to purchase an asset.
- Upon completion of all installment payments, the hirer will be able to take ownership of the asset.
- The hirer can take the tax benefits for the interest payable by him on the hired goods.
- The hirer can claim the depreciation on the hired assets.
- The hire-purchase system benefits vendors as well because it increases their volume of sales.
Features of Hire Purchase System
The following are a few important features of the Hire Purchase System:
- Act: The Hire Purchase Act, 1972, regulates hire purchase systems.
- Parties: An agreement between the hirer and the hire vendor determines the hiring and use of an asset.
- Claim rights: If the hirer makes any default in the payment, the hire vendor can file a suit or make a claim only for the asset’s return, not for the balance due on the installment.
- Selling Rights: Until ownership is transferred to the hirer, the hirer has no right to sell or mortgage the hired asset.
- Loss bearer: Until ownership is transferred to the hirer, the hire vendor is still responsible for any losses incurred on the goods being hired.
Difference between Hire Purchase and Lease
A hire purchase is a written agreement between the hire vendor and the hire purchaser in which the hire vendor sells an asset in exchange for funds. The consideration takes a hire purchase price, which is often more than the product’s cash price, and includes the security deposit as well as monthly payments because interest charges are part of the hire buy pricing. For an agreed-upon period of time, the hirer makes periodic payments on the installment. The payment includes both financing charges (interest) and installment payments.
A lease is an agreement whereby one party pays regular payments to another party for the use of an asset for a predetermined amount of time. Accounting Standard 19, dealing with leases, is applicable to all entities with a few notable exceptions.
The basic differences between hire, purchase, and lease are listed below:
- The duration of a lease is longer as compared to a hire purchase.
- A down payment is a must for hire purchases, whereas it is not required for leases.
- In a hire purchase, the installment includes both the principal and interest, whereas the lessee only pays for the cost of using the good leased.
- AS-19 is the accounting standard for leasing, whereas hire purchasing does not have a separate accounting standard.
Conclusion
The hire purchase system is a credit purchase system in which the hirer purchases goods from the hire vendor on credit and pays in installments. Even if the hirer has possession of the goods as of the date of the agreement, ownership of the asset will not be transferred to the hirer until the final installment is paid; until this point, the hire vendor retains ownership of the asset. So “what is hire purchase system?” you can answer easily.
Frequently Asked Questions (FAQ)
The total amount due by the hirer under a hire purchase agreement to complete the purchase of the goods covered by the agreement, including the cash price, interest, finance charges, and a deposit or other initial payment, is referred to as the hire purchase price.
One method of financing the purchase of a new or used car is through hire purchase. With the loan secured against the car, you typically pay back the loan balance in monthly installments after making a deposit. This implies that until the last payment is made, you do not own the car.
Depending on the asset’s intended use, hire purchases fall into one of two types. The consumer and industrial hire purchase agreements are of these types.
Hire purchase is one type of borrowing. Unlike other forms of borrowing, you do not become the owner of the goods until the entire amount due has been paid. In an HP agreement, you rent a good and pay a predetermined sum over time in installments.
You hire a car, laptop, or television, for example, and make monthly payments of a certain sum. The item is not yours until the last payment is received. One kind of hire purchase is a personal contract plan (PCP).