Topic 2 hire_purchase

BKAF3063 A141 1

Accounting for Hire Purchase

Topic

2

BKAF3063 A141 2

Chapter Outline

☞ Procedures and rules under Hire Purchase Act 1967. Definition hire purchaser rights seller’s right

☞ Accounting by purchaser/hirer: recognition of interest expense repossession

☞ Accounting by seller/owner: recognition of interest revenue and gross profit repossession

☞ Disclosure requirements.

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Learning Outcomes:

By the end of this chapter, students should be able to:

Explain the nature of hire purchase

Journalize the entry using gross method

Explain the treatment for hire purchase in different situations

Explain the disclosure requirements

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Definition

Hire Purchase Act 1967:

“Hire purchase agreement” includes a letting of goods with an

option to purchase and an agreement for the purchase of goods by

instalments.

Legal view:

Hire Purchase is a system of acquiring goods on credit whereby

The seller of the goods is regarded as the dealer, the purchaser is

regarded as the hirer and the finance company as the owner.

www.lawyerment.com.my

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5

Hire-Purchase Act 1967

☺ Hirer:

- The person who takes goods from the owner under a

hire-purchase agreement.

☺ Owner:

- a person who lets a goods to a hirer under a hire-purchase

agreement.

☺ Hire purchase price:

- the total sum payable by the hirer under a hire-purchase

agreement in order to complete the purchase of goods.

☺ Minimum deposit:

- no minimum deposit prescribed, it should not less than

one-tenth (10%) of the cash price of the goods.

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☺ Details must be stated in agreement:

1) specify a date on which the hiring shall be deemed to have

commenced.

2) specify the number of instalments to be paid under the

agreement by the hirer.

3) specify the amount of each of instalments and the person whom

and the place at which the payments of these instalments are

to be made.

4) specify the time for the payment of each of those instalments.

5) contain a description of the goods sufficient to identity them.

6) specify the address where the goods under the hire purchase

agreement are.

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☺ Among others, it must also set out in tabular form:

1) cash price

2) freight or delivery charges if any

3) vehicle registration fees

4) insurance

5) terms charges or interests

6) the annual percentage rate for terms charges

7) the balance originally payable under the agreement

8) the total amount payable.

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Only the following goods can be bought on hire purchase in

Malaysia :

1) all consumer goods

2) motor vehicles namely

3) invalid carriages

4) motor cycles

5) motor cars including taxi cabs and hire cars

6) goods vehicles where the maximum permissible laden weight

does not exceed 2,540 kilograms

7) buses, including stage buses

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Hire-Purchase Vs Credit Sales

Hire-purchases Credit sales

Ownership of the

asset Not transferred Transferred

Return of goods Returnable Not returnable

Repossession of

goods Yes No

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Accounting for

Hire-Purchase in

the book of Hirer

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HP in the Book of Hirer

Substance over form.

Hire-purchase price = Cash price + interest

or

= Deposit + instalments amount

Depreciation: cost over useful life of the asset.

Method of recording:

1. Net Method

2. Gross Method

Cost of asset = cash price

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Hirer : Interest

Interest rate: should not be more than 10% per annum.

Total interest = hire-purchase price - cash price

Matching principle applied: interest need to be amortised.

Method of amortization:

1) Actuarial / effective interest / residual balance

2) Sum-of-the-years digit

3) Straight line

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Hirer : Interest

Illustration 1:

On 1 July 2013, Abric Berhad purchased a machine under

hire-purchase agreement with Banker Berhad. The company

paid deposit of RM1,000 and further instalments of RM902

per month for 5 months starting from 31 July 2013. The cash

price of the machine is RM5,400. Interest rate charged is 6%

per year. The current effective interest rate is 0.83% per

month.

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Hirer : Interest

Solution to Illustration 1:

HP price = cash deposit + instalments

= 1,000 + (902 x 5)

= RM5,510

Interest = HP price – Cash price

= 5,510 – 5,400

= RM110

Interest amortization?

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Hirer : Interest

1. Effective interest method:

instalment Interest (0.83%)

Principle Balance

1,000 4,400

1 902 36.52 865.48 3,534.52

2 902 29.34 872.66 2,661.86

3 902 22.09 897.91 1,781.95

4 902 14.79 887.21 894.74

5 902 7.26 894.74 0

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Hirer : Interest

Illustration 2:

On 1 July 2013, Jobfast Berhad. purchased a delivery van

under hire-purchase agreement with Banker Berhad. The

company paid deposit of RM20,000 and further instalments of

RM5,200 per month for 6 months starting from 31 July 2013.

The cash price of the delivery van is RM50,000. Interest rate

charged is 8% per year.

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Hirer : Interest


HP price = cash deposit + instalments

= 20,000 + (5,200 x 6)

= RM51,200

Interest = HP price – Cash price

= 51,200 – 50,000

= RM1,200

Interest amortization?

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Hirer : Interest

2. Sum-of-the-years digit:

Amortization of interest:

Number for specific instalments x total interest

Total number of instalments

n(n+1) = 6(6+1) = 21

2 2

Inst. Calculation Interest (RM)

1 (6/21) x 1,200 343

2 (5/21) x 1,200 286

3 (4/21) x 1,200 229

4 (3/21) x 1,200 171

5 (2/21) x 1,200 114

6 (1/21) x 1,200 57

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Hirer : Interest

2. Straight-line:

Amortization of interest = 1,200 / 6 = RM200 per month

Total interest .

Total number of instalments

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Hirer : Net Method

Dr. Asset (cash price) 50,000

Cr. Account payable 50,000

(To record amount payable to seller – cash price)

Dr. Account payable 20,000

Cr. Cash 20,000

(To record payment of deposit)

Dr. Interest expense 343

Cr. Account payable 343

(To record interest expense)

Refer to Illustration 2: using sum-of-the-years method


Cr. Cash 5,200

(To record payment of instalment)

1 July 2013

31 July 2013

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Hirer : Gross Method

Dr. Asset (cash price) 50,000

Deferred interest 1,200

Cr. Account payable 51,200

(To record amount payable to seller – hp price)


Cr. Cash 20,000

(To record payment of deposit)

Dr. Interest expense 343

Cr. Deferred interest 343

(To record interest expense)

Refer to Illustration 2: using sum-of-the-years method


Cr. Cash 5,200

(To record payment of instalment)

1 July 2013

31 July 2013

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HP in the Book of Hirer

Situations:

1. HP complete as per contract.

2. Hirer fails to pay instalment

defaults & repossession

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Hirer:Default and Repossession

S16 - Owner has a right to repossess asset if:

S16(1): hirer fails to pay 2 instalments

consecutively or fail to pay last instalment.

Notice should be given to hirer to notify about the

repossession (Schedule 4). Owner has the right to

repossess asset after 21 days of notification.

S16(2): owner feel suspicious that asset will

be transferred to another place other than

place which stated in contract .

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S16A- If asset is returned within 21 days of

notification, the hirer would not bear any cost related

to the repossession, storage and other cost.

S16(3): Alternatives given to hirer:

a) renew the contract; or

b)settle contract before maturity date; or

c) let owner to repossess goods.

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a) renew the contract:

Payment to be made:

instalment in arrears

(+) interest in arrears

(+) storage/custody/repair cost

(+) repossession cost

(+) redelivery cost

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b) settle contract before maturity date:

Payment to be made:

Hire-purchase price xx

(-) (deposit + instalment paid) xx

(-) statutory rebate xx

(+) storage/custody/repair cost xx

(+) repossession cost xx

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☞ Illustration 3:

On 1 January 2013, Shellix Berhad. purchased a drilling machinery under a

hire-purchase agreement with Fortune Berhad. The cash price of the

machinery is RM70,000 with estimated useful life of 10 years. The company

paid deposit of RM20,000 and further instalments of RM4,375 per month for

12 months starting from 31 January 20013. Interest rate charged is 5% per

year.

On 15 September 2013, Shellix Berhad received a notice to repossess by the

Fortune Berhad due to its failure to pay the last two instalments (July &

August). 21 days later, the company decided to make a payment to settle the

contract. The storage and repossession costs to be borne were RM200 and

RM350 respectively.

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Payment to be made:

Hire-purchase price 72,500

(-) deposit + instalment paid 46,250

(-) statutory rebate 192

(+) storage/custody/repair cost 200

(+) repossession cost 350

26,608

20,000 + (4,375 x6)

3(3+1) / 2 x 2,500

12(12+1) / 2

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☞ Solution to Illustration 3:

Journal entries:


Interest expense 481

Loss on hp settlement 550

Cr. Cash 26,608

Deferred interest expense 673

(6+5+4+3+2+1)/78 x 2,500

(6+5+4)/78 x 2,500

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c) let owner to repossess goods:

if: Repossess good’s value

+ total paidTotal net payable>

hirer can claim the excess,

vice versa, hirer must pay

original unpaid balance

(hp price)

() statutory rebate

1. reasonable best price, or

2. price to pay by a new hirer by cash

minus: - repossession cost

- storage cost

- sales cost/written-off goods

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Illustration 4:

Using the same information in Illustration 3:

On 10 September 2013, Shellix Berhad received a notice to

repossess by Fortune Berhad due to its failure to pay the last two

instalments (July & August). The machinery was then taken

back by the owner on 1 October 2013 and incurred the following

cost: Storage RM200, reselling RM500, and repossession cost of

RM350. The price of the machinery at the repossession date was

RM30,000.

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Journal entries?

Repossess good’s value + total paid

= [30,000 – (200 + 500 + 350)] + (4,375 x 6)

= RM55,200

Total net payable = (4,375 x 12) - 192

= 52,308

3(3+1) / 2 x 2,500

12(12+1) / 2

Total claimable = 55,200 – 52,308

= 2,892

Amount receivable from owner

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Hirer: Default and Repossession

Journal entries on the date of repossession:

1 Oct 2013 Dr. Interest expense 481

Cr. Deferred interest 481

[(6+5+4)/78 x 2,500]

Dr. Depreciation expense 5,250

Cr. Accumulated depreciation 5,250

(70,000 x 10% x 9/12)

Dr. Cash 2,892

Account payable 26,250

Accumulated depreciation 5,250

Loss on repossession 35,800

Cr. Deferred interest expense 192

Machinery 70,000

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Accounting for

Hire-Purchase in

the book of

Owner (Seller)

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HP in the Book of Owner

Use sales method:

Account receivables

Revenue: - Gross profit (Cash price – COGS)

- Interest revenue (Hp price – Cash price)

Inventory method:

No receivables to be recorded – only when no

payment received for expired instalment.

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HP in the Book of Owner

Interest revenue: to defer and contra with AR.

Gross profit:

Immediate recognition

based on collection

Journal entries on the agreement date:

Dr. Accounts receivable xxx

Cr. Sales revenue xxx

Deferred interest revenue xxx

HP price

Cash price

HP price – Cash price

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Owner:Recognition of Gross Profit

Recognition based on collection:

Gross Profit Realized

= Gross profit x (collection – interest recognized)

Cash price

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☞ Illustration 5:

On 1 May 2013, Hijau Berhad sold a risographic machine to

Merah Berhad on hire purchase. The cost and cash price of

the machine is RM7,000 and RM9,500 respectively. The

interest rate used is 10% per year. The agreement requires a

cash deposit of RM1,000 and 11 monthly instalments of

RM780 starting from 31 May 2013 and final instalment of

RM770.

Hijau Berhad closes its account on 31 December each year.

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Journal entries?

HP price = (780 x 11) + 770 + 1,000

= RM10,350

Total interest = 10,350 – 9,500

= RM850

GP = 9,500 – 7,000

= RM2,500

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Journal entries: Immediate recognition

1 May 2013

31 May –

30 Nov 2013

Dr. Accounts receivable 10,350

Cr. Sales revenue 9,500

Deferred interest revenue 850

Dr. COGS 7,000

Cr. Inventory 7,000

Dr. Cash 1,000

Cr. Accounts receivable 1,000

Dr. Cash 780

Cr. Accounts receivable 780

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Journal entries:

31 Dec 2013

Dr. Deferred interest revenue 741

Cr. Interest revenue 741

(12+11+10+9+8+7+6+5)/78 x 850

Dr. Income summary 7,000

Cr. COGS 7,000

Dr. Cash 780


May - Dec

Dr. Sales revenue 9,500

Cr. Income summary 9,500

Dr. Interest revenue 741

Cr. Income summary 741

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Hijau BerhadIncome Statement

For the year ended 31 Dec 2013 (partial)

Sales revenue 9,500Less: COGS 7,000Gross profit 2,500

Other income:Interest revenue 741

Hijau BerhadBalance Sheet

31 Dec 2013 (partial)

Current Assets: Account receivable 3,110Less: Deferred interest revenue 109

3,001

10,350 - 1,000 - (780x8)

850 - 741

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Journal entries: Recognition based on collection

1 May 2013

31 May –

30 Nov 2013

Dr. Accounts receivable 10,350

Cr. Sales revenue 9,500

Deferred interest revenue 850

Dr. COGS 7,000

Cr. Inventory 7,000

Dr. Cash 1,000


Dr. Cash 780


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31 Dec 2013



Dr. Deferred Gross Profit 7,000

Cr. COGS 7,000

Dr. Cash 780


Dr. Sales revenue 9,500

Cr. Deferred Gross Profit 9,500

Dr. Interest revenue 741


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31 Dec 2013

Dr. Deferred Gross Profit 1, 710

Cr. Gross Profit realized 1,710

Dr. Gross Profit realized 1,710

Cr. Income summary 1,710

2,500 x 6,499

9,500

[1,000 + (780 x 8)] - 741

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Hijau BerhadIncome Statement

For the year ended 31 Dec 2013 (partial)

Gross profit realized 1,710

Other income:Interest revenue 741

Hijau BerhadBalance Sheet

31 Dec 2013 (partial)

Current Assets: Account receivable 3,110Less: Deferred interest revenue 109

Deferred GP 7902,211

2,500 – 1,710

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Owner:Repossession

Journalize the closing entries for:

Accounts Receivable

Deferred interest

Deferred GP

Transfer to Repossession account.

Recognize gain or loss from repossession.

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Owner:Repossession

☞ Illustration 6:

Refer to Illustration 5.

Assume Hijau Berhad has repossessed the asset on 1 April

2014 due to failure of Merah Berhad to settle the arrears

since January 2014. Merah Berhad also failed to return the

assets after 21 days receiving notice of repossession. The best

value of the asset at the date of the repossession is RM7,800.

Hijau Berhad charged Merah Berhad for repossession charge

of RM360, storage RM150 and repair of RM230. The selling

cost of the machine is expected to be RM600.

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Owner:Repossession


Journal entries?

Repossess good’s value

= 7,800 – (360 + 150 + 230 + 600)

= RM6,460

Total net receivable = 10,350 - 11

= RM10,339

Total claimable (hirer) = (6,460 + 7,240) – 10,339

= RM3,361

Total payment = 1,000 + (780 x 8)

= RM7,240

1(1+1) / 2 x 850

12(12+1) / 2

Amount to be paid to hirer

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Owner:Repossession


1 April 2014



(Record statutory rebate April 2014)

Dr. Repossession account 3,099


(Close accounts receivable)



(Recognize interest rev. for Jan, Feb & March 2014)

(4+3+2) / 78 x 850

Dr. Inventory 7,200

Cr. Repossession account 7,200

(Record the repossess asset)

7,800 - 600

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Owner: Repossession


1 April 2014 Dr. Repossession account 740

Cr. Cash 740

(Record the repossession, storage & repair expenses)


Cr. Cash 3,361

(Record payment claimable by hirer)

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Owner: Repossession

Journal entries: Based on collection

1 April 2014



(Record statutory rebate April 2014)



(Close accounts receivable)



(Recognize interest rev. for Jan, Feb & March 2014)

Dr. Inventory 7,200

Cr. Repossession account 7,200

(Record the repossess asset)

7,800 - 600

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Owner: Repossession


1 April 2014 Dr. Repossession account 740

Cr. Cash 740

(Record the repossession, storage & repair expenses)


Cr. Cash 3,361

(Record payment claimable by hirer)

Dr. Deferred GP 790

Cr. Repossession account 790

(Close Deferred GP account)

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Owner: Repossession


1 April 2014Dr. Repossession account 790


(Record gain on repossession)

BKAF3063 A141 55

End of Topic 2

Reference:

Hire Purchase Act 1967

Topic 2 hire_purchase

Education

Transcript of Topic 2 hire_purchase