Ch.6-Hire Purchase Finance

8/13/2019 Ch.6-Hire Purchase Finance

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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.

Documents

Ch.6-Hire Purchase Finance