Hire Purchase and Installment Payment System

What is installment payment system? Distinguish between hire purchase and installment payment system?

An installment system is just like a credit purchase and hire purchase system of selling and buying goods. Like hire purchase, in installment system an agreement is made between buyer and seller to purchase and sell of goods. The buyer makes certain down payment at the time of signing agreement and the balance is paying in installment over a period of time.

An installment system is a credit sale in which payments are made in installments over a period of time. In this system, the buyer gets the possession as well as ownership of the goods right at the time of signing the agreement. During the course of paying the installment, if the buyer makes default in paying the installment, the vendor cannot responses the goods. In that case, the vendor can sue the buyer for recovery of dues. Like in hire purchase even the paid installments also can not be forfeited in case of default in paying installment.
Thus, it can be said that installment system is a kind of credit sale where installments are entertained over the period and default in such payment cannot responses the goods and in that case, the vendor can only sue the buyer for the recovery of amount due.

Features Of Installment Purchase System

The following are the features of installment purchase system:

1. Installment purchase system is just like an outright credit sale of goods.
2. The buyer makes the payment in different installment over a period of time as agrees upon in the agreement.

3. Under installment purchase system, the buyer gets the immediate possession as well as the ownership of goods.

4. The seller can not responses the good if the buyer made default in the payment of installment but he/she can sue against the buyer for the recovery of amount due.

5. In case of default in the payment of installment, the total amount of installments already paid by the buyer can not be forfeited.

6. Under installment system, the buyer can sell or mortgage the goods even before clearing all the installments.

7. Risk of goods/assets are to be borne by the buyer just after signing the agreement.

8. The buyer of the goods under installment purchase system has no right to return the goods to the seller.

Advantages of Installments systems

1. The installment schemes enable the buyers to buy goods which are beyond their reach.

2.It also enables the business to find buyers for their products. A business cannot always look for cash parties for products that are expensive in nature.

3. It widens the market.

4. Middlemen are eliminated

5. It has helped the finance companies to develop their business. Now-a-days finance companies finance several articles widely under hire purchase and installment system.

6. Price is stabilized.

7. As convenience and luxury goods are sold under hire purchase and installment system, the standard of living of the people increases.

8. Sellers can increase their sales. Moreover, sales under the hire purchase and installment system are more profitable.

9. These days, most business houses come out with a number of offers, like free gifts, exclusively for hire-purchase customers.

Disadvantages Installment systems

1. Hire purchase and installment system tempt the buyers to buy goods which are beyond their means. So, it becomes extravagant.

2. The buyer pays a very high price fro the article under such schemes. This is because, he has to pay interest on the outstanding balance.

3. The need of the hour is savings. Schemes like hire-purchase make the people spendthrifts.

4. Price is higher than the cash price. Buyers under hire purchase system are charged interest. The rate of interest is often higher.

5. If buyers default in payment, goods sold under hire purchase system are repossessed by the hire vendor. The purchaser suffers a huge loss on repossessed goods.

6.Installment transactions are cumbersome. An agreement has to be entered into and guarantee is to be given. More legal formalities are to be gone through.

7. The rate of default under hire purchase and installment system is higher. It is because only people with inadequate means buy under this system.

8. A number of legal formalities will have to be fulfilled by the buyer. He may have to find a guarantor. The agreement must be prepared and signed by both the seller and the buyer and it must be witnessed. The document of title will vest with the vendor/financier till the dues are cleared by the hirer.

Difference between Hire Purchase and Installment Sale

The following are some of the difference between Hire Purchase and Installment Sale

1. There are 3 parties in Hire Purchase trade namely the seller, the financier and the buyer. There are only 2 parties involved in Installment sale namely the seller and buyer.

2. There are 3 agreements in a hire purchase, namely between the (a) seller and financier. (b) financier and buyer and (c) buyer and seller. But in Installment sale, there is only one agreement between the buyer and seller.

3. Hire purchase is an agreement to hire and later to buy. Installment is an agreement to buy.

4. In hire purchase, the ownership transfers from the seller to the financier and then to the buyer on the payment of the last installment. In Installment sale, The ownership transfers on the first installment from the seller to buyer.

5. In hire purchase, when there is a default in payment, the financier will take back the goods from the buyer. In installment sale, if there is a default of payment, the seller cannot take back the goods, but can only sue the buyer.

6. In Hire purchase, any damage to the goods will only lead to claiming of insurance by the financier from the insurance company since the ownership has not been transferred. In installment sale, any damage to the goods will be claimed by the buyer from the insurance company.

7. Buyer cannot sell the goods to any third party until he pays the last installment to the financier in hire purchase. In case of installment sale, the buyer can sell to any third party as he is the owner of the goods.

8. The interest rate in hire purchase will be on a flat rate basis and is included in the installment and recovered as equated monthly installment (EMI).

Example: Car finance by Sundaram Finance. The interest rate in installment sale is on a declining basis as every installment paid will reduce the principal amount and hence the total interest payable is lesser than H.P scheme. Example: Bank finance for purchase of consumer goods.

 What is Hire Purchase system? Distinguish between hire purchase and installment payment system?

Purchase and sale of goods under a hire purchase system is different from cash sale and credit sale. In case of cash sale, the buyer pays the lump sum to the seller and immediately ownership is passed along with the goods. While in credit sale the payment is made in future. In these both cases the ownership and possession of goods pass on the buyer. However, hire purchase system is a special system of purchase and sale.

In hire purchase system, the buyer acquires the property by promising to pay necessary installment payment of monthly, quarterly, half yearly or any other period. The period of payment has to be fixed while, signing the hire sell agreement. Though, the buyer acquires the asset under hire purchase system after signing the agreement, the title of ownership remains with vendor until the buyer squares up his/her entire liability. When the buyer pays the final installment and any other obligation according to hire purchase agreement, only then the title of ownership of the goods would be transferred to hirer. If the hirer makes default in the payment of any installment, the hire vendor has the right to re-possess the goods. When the vendor re-possesses the goods due to the default of payment of installment, in this case the amount already paid so far by the hirer will be forfeited.

The hire purchase price of goods is normally higher than the cash down price of article because it includes interest as well as cash price. Under hire purchase system, the vendor is responsible to repair the goods which are in the possession of buyer provided that the buyer takes the utmost proper care of the goods acquired. The risk is also borne by the vendor until the payment of last installment. The buyer has the right to return the goods to the vendor, if they are not according to the terms and condition of hire purchase agreement.

Under hire purchase system, the purchaser gets the possession of the goods without paying the full price for them.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.

If the purchaser makes default in the payment of an installment, the seller can take back the possession of the goods. Some of the important definitions of hire purchase system are given here:“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“The hire-purchase is a form of trade in which credit is granted to the customer on the security of a lien on the goods.” —J. Stephenson

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.

Advantages of Hire Purchase System:

(1) Convenience in Payment:

The buyer is greatly benefited as he has to make the payment in installments. This system is greatly advantageous to the people having limited income.

(2) Increased Volume Of Sales:

This system attracts more customers as the payment is to be made in easy installments. This leads to increased volume of sales.

(3) Increased Profits:

Large volume of sales ensures increased profits to the seller.

(4) Encourages Savings:

It encourages thrift among the buyers who are forced to save some portion of their income for the payment of the installments. This inculcates the habit to save among the people.

(5) Helpful For Small Traders:

This system is a blessing for the small manufacturers and traders. They can purchase machinery and other equipment on installment basis and in turn sell to the buyer charging full price.

(6) Earning Of Interest:

The seller gets the installment which includes original price and interest. The interest is calculated in advance and added in total installments to be paid by the buyer.

(7) Lesser Risk:

From the point of view of seller this system is greatly beneficial as he knows that if the buyer fails to pay one installment, he can get the article back.

Disadvantages of Hire Purchase System:

(1) Higher Price:

A buyer has to pay higher price for the article purchased which includes cost plus interest. The rate of interest is quite high.

(2) Artificial Demand:

Hire purchase system creates artificial demand for the product. The buyer is tempted to purchase the products, even if he does not need or afford to buy the product.

(3) Heavy Risk:

The seller runs a heavy risk under such system, though he has the right to take back the articles from the defaulting customers. The second hand goods fetch little price.

(4) Difficulties in Recovery of Installments:

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.

(5) Break Up Of Families:

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 buying’s.

Difference between Hire Purchase and Installment Sale

The following are some of the difference between Hire Purchase and Installment Sale

1. There are 3 parties in Hire Purchase trade namely the seller, the financier and the buyer. There are only 2 parties involved in Installment sale namely the seller and buyer.

2. There are 3 agreements in a hire purchase, namely between the (a) seller and financier. (b) financier and buyer and (c) buyer and seller. But in Installment sale, there is only one agreement between the buyer and seller.

3. Hire purchase is an agreement to hire and later to buy. Installment is an agreement to buy.

4. In hire purchase, the ownership transfers from the seller to the financier and then to the buyer on the payment of the last installment. In Installment sale, The ownership transfers on the first installment from the seller to buyer.

5. In hire purchase, when there is a default in payment, the financier will take back the goods from the buyer. In installment sale, if there is a default of payment, the seller cannot take back the goods, but can only sue the buyer.

6. In Hire purchase, any damage to the goods will only lead to claiming of insurance by the financier from the insurance company since the ownership has not been transferred. In installment sale, any damage to the goods will be claimed by the buyer from the insurance company.

7. Buyer cannot sell the goods to any third party until he pays the last installment to the financier in hire purchase. In case of installment sale, the buyer can sell to any third party as he is the owner of the goods.

8. The interest rate in hire purchase will be on a flat rate basis and is included in the installment and recovered as equated monthly installment (EMI).

Example: Car finance by Sundaram Finance. The interest rate in installment sale is on a declining basis as every installment paid will reduce the principal amount and hence the total interest payable is lesser than H.P scheme. Example: Bank finance for purchase of consumer goods.

Journal Entries In The Books Of HirePurchaser

There are two methods of recording hire purchase transactions in the books of the hire purchaser:

i. When the asset is recorded in full cash price-:full cash price method

ii. When the asset is recorded at cash price actually paid in each installment-: Actual cash price method.

1. For the purchase of asset:

First Method

Asset A/C (full cash price)...........Dr.

To vendor A/C

Second Method

No entry

2. For the payment made for 'down payment'

First Method

Vendor A/C.............Dr.

To bank A/C

Second Method

Asset A/C............Dr.

To Bank A/C

3. For installment due

First Method

Interest A/C............Dr.

To vendor A/C

Second Method

Asset A/C (part of cash value)............Dr.

To Interest A/C

4. For the payment of installment (both method)

Vendor A/C............Dr.

To Bank A/C

5. For charging depreciation( on the basis of cash value) (both methods)

Depreciation A/C...................Dr.

To Asset A/C

6. For transfer of interest and depreciation(both methods)

Profit and loss A/C............Dr.

To depreciation A/C

To interest A/C

Note: entries 3,4,5 and 6 will be repeated year after year until the final installment is paid.

Journal Entries In The Books Of Vendor

1. For selling goods on hire purchase

Hire purchase A/C...........Dr.(full cash price)

To sales/hire purchase sales A/C

2. For receiving down payment

Cash/bank A/C.................Dr.

To hire purchaser A/C

3. For installment due

Hire purchaser A/C............Dr.

To Interest A/C

4. For receiving the installment

Cash/bank A/C .............Dr.

To hire purchaser A/C

5. For transferring interest

Interest A/C............Dr.

To profit and loss A/C.

Note: * Depreciation will not charge by hire vendor.

* Entries 3, 4 and 5 will be repeated year after year until the first installment is paid.