Hire Purchase is a kind of agreement where the buyer buying an expensive asset chooses an option to pay for the asset by paying some down payment at the time of purchase of an asset and clearing the remaining dues in regular installments including interest.
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An Inc. purchased a machine on hire purchase from Z Ltd on January 1, 2018, paying $ $80,000 immediately and agreeing to pay three annual installments of $80,000 each on December 31, every year. The cash price of the machine is $2,98,000, and the vendors charge interest @ 5% per annum. Calculate the following:
Based on the above discussions, advantages, disadvantages discussed and shared, it cannot be outrightly said that purchasing an asset on hire purchase, in cash, a loan, or lease is best. The mode of acquisition shall be decided by multiple factors based on each individual organization. But yes, it is a good option in case the entity wants to use the asset without processing 100% payment at once. However, it is a costlier method of acquisition rather than Cash Purchase as it will always include hiring charges/interest element.
This has been a guide to what is Hire Purchase Agreement and its meaning. Here we discuss the most common types of hire purchase agreement along with calculation examples & explanations. We also discuss the advantages and disadvantages. You can learn more about accounting from following articles
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He makes the part payment at the time of purchase and the balance is paid in easy installments periodically. The important ingredient of this system is that the buyer becomes the owner of the goods only after full and final payment of all the installments, till then he hires the goods and every installment is treated as hiring charges paid by him.
Hire Purchase System is a system under which money is paid for goods by means of periodical installments with the view of ultimate purchase. All money being paid in the mean time is regarded as payment of hire and the goods become the property of the buyers only when all the installments have been paid. - Carter
From the above mentioned definitions it is clear that the buyer takes the delivery of the article on the payment of first installment and becomes the owner only after paying the final instalment. Hire purchase type of business is usually carried in the case of durable consumer articles like sewing machines, televisions, desert coolers and refrigerators etc.
It has been observed that the sellers do not get the installments from the purchasers on time. They may choose wrong buyers which may put them in trouble. They have to waste time and incur extra expenditure for the recovery of the installments. This sometimes led to serious conflicts between the buyers and the sellers.
The system puts a great financial burden on the families which cannot afford to buy costly and luxurious items. Recent studies in western countries have revealed that thousands of happy homes and families have been broken by hire purchase buyings.
Hire purchase is an arrangement. It allows for the purchase of an expensive consumer good on credit. The buyer is then required to make a down payment on their purchase, with the balance of the amount due paid off with installment payments, plus interest. It is similar to an installment plan with one exception: the ownership of the item purchased does not fully transfer to the buyer until all payments are made.
A hire purchase arrangement is beneficial because it reduces the risk of the provider for the consumer goods involved. Because the ownership of the item does not officially transfer until all payments are made, this plan offers protection to the vendor for an unsecured item because it can be repossessed. If the buyer is unable to make payments, losses can be recouped by acquiring the item purchased and selling it again.
When using a hire purchase agreement, it becomes possible to afford better equipment or consumer goods than if the transaction was to buy the item outright. Although it requires payments from the buyer, which often can last for years, it gives them the ability to use the item right away. This is despite the lack of technical ownership. Buyers are still responsible for taxes and other costs associated with ownership as well, further reducing the risk to the vendor.
When purchasing large consumer goods, it is difficult for some businesses or households to come up with the necessary cash to purchase items outright. Hire purchase allows for the payments to be spread out over time to make the purchase affordable. Buyers can take confidence in the fact that they have fixed monthly payments which are guaranteed not to increase. Interest rates are locked in with a hire purchase at the time of the transaction.
If your country has a value-added tax or something similar that is assigned to transactions, then leasing an item will result in a tax charge being added onto the buyers monthly payments. This issue goes away when a hire purchase agreement is in force. There will still be a sales tax charge or other upfront taxes as part of the transaction. The advantage here is that vendors usually permit buyers to roll the cost of taxation into the overall agreement, reducing long-term add-on costs.
Buyers can choose which vendor they want to work with when there is a specific purchase that needs to be made. That allows them to find the best possible price on the items they require. Financing for the hire purchase may be offered by the vendor. Buyers can also secure their own financing arrangement with the hire purchase process, giving them even more flexibility in where they shop. That makes it easier to avoid borrowing or using corporate or personal savings to secure items that are required.
If a monthly payment seems too high, even with a down payment being provided, there are still options available to further lower the cost of the transaction. A balloon payment is the most popular method to reduce monthly payments. It will require the buyer to make a large one-time payment at the end of the hire purchase agreement to finalize ownership transfer. If that payment is not made, then ownership does not transfer and the right to repossess still exists.
For corporations or households with an excellent credit profile, a down payment may not be necessary as part of the hire purchase agreement. That means it is possible to take home the items needed without paying anything to secure the right to do so. The buyer would still be required to make the structured monthly payments to avoid repossession. Monthly payments with a zero-down option tend to be much higher as well, so it is usually better to put down some type of down payment if possible.
Most hire purchase agreements allow the buyer to pay off the contract early if they have the money to do so. Some agreements may require monthly payments to continue for 12-24 months to ensure the transaction is profitable for the vendor. This option is a good way to reduce the long-term cost of the hire purchase transaction when it can be accomplished.
Using the example of purchasing a car here, vendors will often put mileage stipulations or conditions on the agreement that must be met. If these conditions are not met, then additional charges become the responsibility of the buyer at the end of the lease. A hire purchase contract removes these restrictions, allowing buyers to use the vehicle as their own until it becomes their own when they make the last payment on it.
There are several laws in place which prevent vendors from being able to repossess certain items, even if the buyer falls behind on payments or refuses to make them. In Washington State, for example, it is not permitted for creditors to move another car to reach your car if you qualify for repossession. Creditors are not permitted to have a vehicle towed from your garage. They are even forbidden from repossession if you resist them taking the vehicle.
To get the best hire purchase arrangement, buyers must have a strong credit profile. If they do not have a strong profile, vendors may decide not to work with the business or household attempting to make a purchase. Those with subpar credit scores will find that if they are approved, the interest rates will be higher than if they had good credit. Over the lifetime of a hire purchase agreement, a higher interest rate can result in thousands of extra dollars being spent on the item.
Even with a solid down payment on the transaction, the interest rates on a hire purchase agreement will cause the final cost of the item to be higher than if it were purchased outright. Over the life of a 5-year agreement, for example, the final cost of a $21,000 vehicle might exceed $30,000 when all the payments are added together. Some buyers may qualify for low- or no-cost financing to reduce this issue, though for the average agreement, this disadvantage stands true.
A hire purchase agreement is usually reported to the major credit reporting bureaus, even if it is a B2B transaction. If the buyer fails to make a single payment, this fact will be reported. The impact of the missed payment can then affect the buyers ability to make another hire purchase in the future. If a repossession occurs, this issue could stay on the credit report for the business or individual for up to 7-10 years in some jurisdictions. For that reason, it is imperative for buyers to be proactive about their hire purchase agreements if they are unable to make a payment on time.
Compared to a leasing agreement or an outright purchase, there are fewer discounts usually offered to buyers who pursue a hire purchase agreement. That is because there are more risks associated with that type of transaction. With a lease, consumers are paying for the depreciation of the item. With an outright purchase, there is zero risk to the vendor, allowing for the possibility of more discounts.
The advantages and disadvantages of hire purchase contracts create a win/win for all parties involved. Buyers get the chance to use, and eventually own, equipment they might not be able to purchase outright immediately. Vendors benefit by being able to sell more items while retaining technical ownership over them to reduce their risk. All elements of a transaction should be closely examined before signing anything to ensure the best possible results can be achieved.
An Agreement made at . this . day of . 2000, between M/s. ABC & Sons, a partnership carrying on the business of SALE AND HIRE OF CONSUMER GOODS at . (hereinafter called the Owner) of the ONE PART and X son of Y resident of . (hereinafter called the Hirer) of the OTHER PART.
2. The owner shall deliver the Washing machine at his own expense at the house of the hirer at . .. on the said . day of and the owner or his servants shall install the said Washing machine in one of the bath room of the said house in accordance with the directions of the hirer.
3. The hirer shall during the continuance of hiring pay to the owner at his address for the time being and without previous demand by way of rent for the hire of the said Washing machine, the monthly sum of Rs.., payable in advance, the first payment to be made on the execution of these presents and each subsequent payment on the . day of every succeeding month.
4. The hirer during the continuance of the hiring will not sell, assign, mortgage, pledge, underlet, lend or otherwise deal with the said Washing machine but will keep the said Washing machine in his own possession and will not remove the said Washing machine from the place where the said Washing machine is installed without the consent of the owner in writing and will protect the said Washing machine against distress, execution or seizure and indemnity the owner against all losses, costs, charges, damages and expenses incurred by him by reason or in respect thereof.
5. The hirer during the continuance of the hiring will at his own expense keep the said Washing machine in good and substantial repair and condition (reasonable wear and tear excepted) and will permit the owner or his agents or servants at all reasonable times to have access to the said Washing machine and to inspect the state and condition thereof.
6. The hirer may determine the hiring at any time by .. days notice in writing to the owner at his address for the time being and by returning the said Washing machine to the owner and shall thereupon pay to the owner all money then payable to him under this agreement.
7. If the hirer shall make default in punctual payment of any monthly rent or shall fail to observe or perform or shall commit any breach of any stipulation or condition binding upon him hereunder, then the owner may without notice determine the hiring and way retake possession of the said Washing machine and for that purpose, the owner, his servants or agents may enter upon any premises upon or in which the said Washing machine may be believed to be installed.