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HIRE-PURCHASE FINANCE
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Hire purchase - Definitions
1. An agreement under which goods are let on
hire and under which the hirer has an option to
purchase them in accordance with the terms of
the agreement.
2. Hire purchase is a peculiar kind of transaction
in which the goods are let on hire with the
option to the hirer to purchase them.
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Hire Purchase Finance -
MeaningPayment of Periodic installments.
Immediate possession of goods by the buyer.
Ownership of goods with vendor until full and
final payment.
Vendors right to repossess the goods in case
of default by buyer.Treatment of installment as a hire charge till
the payment of last installment.
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Hire purchase vs. Installment
payment Installment saleis a contract of sale in which
the ownership is transferred to the buyer but the
price is pad in specified installments over a
definite period.
In Hire purchasecontract the possession is
delivered to the hirer at the time of entering into
the contract but the ownership is transferred to
the hirer on payment of the last installment.
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Lease financing Vs Hire
purchase Financing
Lease Financing
Ownership lies with
vendor(lessor)
Lessor(vendor) is
entitled to claim
depreciation tax
shield
HP Financing
Ownership
transferred to thehirer on the payment
of last installment.
The hirer is entitled
to claim depreciationtax shield
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Lease Financing Capitalization of the
asset is done in the
books of the leasing
co.
Leasing used as a
source of financing for
high cost assets likeships, machinery,
airplanes etc
HP Financing
Capitalization of the
asset is done in the
books of the hirer.
HP use as a source of
finance for low cost
assets as automobiles,
office equipments etc.
Cont
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Process of Hire Purchase
The Dealer contracts with finance co. for financing his hirepurchase deals.
The customer selects the goods for HP, and dealerarranges for the complete set of documents.
Down payment by customer on completion of proposal
form. Dealer sends documents to finance co. with request to
purchase the goods, and accept the HP transaction.
The finance co. signs the agreement and sends copyalong with EMI details to dealer.
Dealer delivers the goods to the customer, propertypasses on to the finance co..
Hirer pays EMIs, and on last payment , the ownershippasses on to him, with loan completion certificate by thefinance co.
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LEGAL FRAMEWORK
There is no legislation dealing with hire-
purchase transaction in India.
The hire-purchase act was passed in 1972.
The provision of the act are not inconsistent withthe general law and can be followed as a
guideline particularly where no provision exist in
general laws which, in the absence of any
specific law, govern the hire-purchase
transaction.
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SALE OF GOODS ACT
In a contract of hire-purchase, the elementof sale is inherent as the hirer always hasthe option to purchase the movable asset
by making regular payment of hire chargesand the property in the goods passes tohim on payment of the last installment.
It is in this context, and to that extent, thatthe provisions of the sales of goods act tohire-purchase contracts.
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CONTRACT OF SALES OF
GOODS
A contract of sales of goods is a contract
whereby the seller transfer or agrees to
transfer the property in goods to the buyer
for a price
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ESSENTIAL INGREDIENTS OF A
SALE
1. Two parties- buyer and seller
2. Goods
3. Money consideration- price4. Transfer of ownership
5. Essentials of valid contract under ICA
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DOCUMENT OF TITLE TO
GOODS A DOCUMENT OF TITLE TO GOODS is one which
entitles and enables its rightful holder to deal with thegoods represented by it, as if he were the owner.
It is used in the ordinary course of business as proof ofownership, possession or control of goods
e.g. cash memo,
bill of lading,
dock warrant,
warehouse keepers
wharfingers certificate
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PRICE
The price means the money consideration fortransfer of property in goods from the seller tothe buyer.
EARNEST MONEY or security deposit: In certain contract the buyer pays an amount in
advance as earnest money deposit or as a securitydeposit, for the due performance on his part of thecontract.
EM is liable to be forfeited if the buyer fails to performhis part and the contract goes off.
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TRANSFER OF PROPERTY IN
GOODS The property in goods is said to be transferred from the
seller to the buyer when the latter acquires theproprietary rights over the goods and the obligationslinked thereto. The transfer of property in goods is the
essence of a contract of sale.
RULES FOR TRANSFER OF PROPERTY Specific goods in deliverable state
Specific goods to be put in a deliverable state
Specific goods to be weighed or measured
Goods sent to the approval
unascertain goods
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DELIVERY OF GOODS
Delivery of goods: Delivery means voluntary transfer of possessionof goods from one person to another. Delivery may be actual
symbolic
constructive.
Delivery is said to be actualwhen the goods are handed overphysically.
A symbolicdelivery takes place where the goods are bulky andincapable of actual delivery
A constructivedelivery is a delivery by attornment which takesplace when the person in possession of the goods acknowledgesthat he holds the goods on behalf and at the disposal of the otherperson.
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RULES OF DELIVERY
PART DELIVERY A delivery of the part of the goods, in progress of the delivery of the
whole, amounts to delivery of the whole.
BUYER TO APPLY FOR DELIVERY Unless there is a contract to the contrary, the seller is not bound to
deliver the goods until the buyer applies for delivery.
SELLERS DUTY TO DELIVERY The seller is duty bound to deliver the goods in accordance with the
terms of the contract or as and when applied for by the buyer.
PLACE OF DELIVERY
TIME OF DELIVERY
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Hire-purchase Agreement
A hire-purchase agreement is in
many ways similar to a lease
agreement, in so far as the terms andconditions are concerned. The
important clauses in a hire-purchase
agreement are:
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Contd
1. Nature of Agreement:
Stating the nature, term and
commencement of the agreement.
2. Delivery of Equipment :The place and time of delivery and
the hirers liability to bear delivery charges.
3. Location :The place where the equipment shall
be kept during the period of hire.
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Contd4.Inspection:
That the hirer has examined the equipment and is satisfied
with it.
5. Hire-Charges:
To be paid by the hirer, the schedule, the rate of
interest/penalty for delayed payment/default.
6.Repairs :
The hirer to obtain at his cost, insurance on the equipment
and to hand over the insurance policies to the owner.
7.Alteration :
The hirer not to make any alterations, and so on to the
equipment , without prior consent of the owner.
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Contd
8. Termination :
The events or acts of hirer that would constitute a
default eligible to terminate the agreement.
9. Risk:
Of loss and damage to be borne by the hirer.
10. Registration and fees :
The hirer to comply with the relevant laws,obtain registration and bear all requisite fees.
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Taxation Aspects on Hire-Purchase
Agreement
Income tax
Sales tax
Interest tax
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INCOME TAX
Hire-purchase,as a financing alternative,
offers tax benefits both to the hire-
vendor(hire-purchase finance company)
and the hire-purchaser (user of theasset).
1) Assessment of Hire-purchaser (hirer)
2) Assessment of Owner (Hire-vendor)
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Tax planning in Hire-purchase
It can be used as a tax planning device
in two ways:
1) Net income can be inflated at the rear
end of the transaction and thereby defer
tax liability
2) To use hire-purchase as a bridge b/w the
lessor and the lessee.
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Sales-Tax Aspects
Hire-purchase is demand to be sale
Its payable by the owner even if
transaction does not fructify into a sale
No refund of sales tax
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Interest Rate
Companies have to pay interest-tax under
the Interest-tax Act,1974
Total amount of interest earned- bad debts
in the previous year @ 2%
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Accounting And Reporting
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What entry is made on purchase of an asset
on hire purchase ?
Asset on hire purchase a/c
to hire purchase vendor a/c(with the cash price of assets)
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What entry is made on payment of an asset
purchased on hire purchase ?
Hire vendor a/c
to bank
Interest on hire purchaseto hire vendor a/c
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What entry is made about depreciation of
an asset purchased on hire purchase ?
Depreciation on asset a/c
to asset account
&
P & l a/c
to depreciation
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What entry is made in the books of vendor
on hire purchase sale ?
Hire purchaser a/cto hire purchase sale a/c
(with the cash price of goods)
When Payment is received
Bank a /c
to hire purchaser a/c
FOR INTEREST
Hire purchaser
To interest on hire purchase sale a/c
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FINANCIAL EVALUATION
The framework of financialevaluation of a hire-purchase both
the hirers as well the financecompanys view point.
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1. HIRE-PURCHASER (From the Point
of View of the Hirer)
The lessor is entitled to claim depreciationand other deductions associated with theownership of the equipment includinginterest on the amount borrowed topurchase the asset, while the lesseeenjoys full deduction of lease rentals.
The evaluation of hire-purchasetransaction from the hirers angle,therefore, has to be done in relation toleasing alternative.
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Decision-criterion
The decision-criterion from the point of
view of a hirer is the cost of hire-purchase vis--vis the cost of leasing.
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A) Cost of hire-purchase:
Down payment
(+) service charges
(+) P.v of hire purchase paymentsdiscounted by cost of debt
(-) P.v of depreciation tax shield discounted
by cost of capital
(-) P.v of net salvage value discount by cost
of capital
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B) Cost of leasing
Lease management fee
(+) P.v of lease payments discounted by Kd.
(-) P.v of tax shield on lease payments andlease mgmt. fees discounted by Kc.
(+) P.v of interest tax shield on hire
purchase discounted by Kc.
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2. HIRE-VENDOR (From the View
point of Finance Company)
Decision criterion is based on a
comparison of the net present values of
the two alternative
1)Hire purchase plan
2)Lease financing
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Net present value of hire purchase
plan
The NPV(HPP) consist of
Present value of hire-purchase installment
(+):Documentation service fee(+):Present value of tax shield on initial
direct cost
(-):Loan amount(-):initial cost
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(-):Present value of interest tax on finance
income(interest)
(-): Present value of interest tax on finance
income(interest) meted for interest tex
(-): Present value of interest tax on
documentation and service fee
N t t l f l
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Net present value of lease
planThe NPV(LP) consist of
Present value of lease rentals
(+):Lease agreement fee(+):Present value of tax shield on intial direct
costs and depreciation
(+):Present value of net salvage value
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(-):Initial investment
(-):Initial direct costs
(-):Present value of tax liability on lease
rentals and lease management fee
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THANK YOU.
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