Hire Purchase

HIRE PURCHASE

According to the Hire Purchase Act of 1972, the term hire purchase is defined as, 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, and includes an agreement under which a. Possession of goods is delivered by the owner thereof to a person on the condition that such person pays the agreed amount in periodic payments b. The property of the goods is to pass to such a person on the payment of the last of such installment c. Such a person has a right to terminate the agreement any time before the companies are controlled by the Hire Purchase Act, 1972. A Hire purchase transaction has two elements, Bailment which is governed by the Indian Contract Act, 1872 and Sale under the Sale of Goods Act, 1930.

1 Hire Purchase Agreement

A Hire Purchase Agreement is an agreement between the seller and the buyer, where the ownership of goods does not pass to the buyer until he pays the last installment. There are two parties to the hire purchase agreement. The hire vendor, who is the seller and other, is the hire purchaser, the buyer. The purchaser has to make a down payment of 20 to 25% of the cost and the remaining amount has to be paid in equal monthly installments. In the case of a Deposit linked plan, the hire purchaser has to invest a fixed amount as fixed deposits in the finance company which is returned together with interest after the payment of the last installment.

Parties to the Hire Purchase Contract:

There are two parties in a hire purchase contract 1. The intending seller 2. The intending

purchaser or the hirer.

Tripartite agreement 1. Seller 2. Financier 3. Hirer/Purchaser

Difference between Hire Purchase and Leasing:

Characteristics    

Ownership:

Leasing: With the finance company, the lessor

Hire purchasing: It is transferred to the hirer on the payment of the last installment

Depreciation:

Leasing: Lessor, and not the lessee is         entitled to claim depreciation tax      shield

Hire purchasing: The hirer is entitled to claim depreciation tax shield

Capitalization     

Leasing: Done in the books of lessor

Hire purchasing: Done in the books of hirer

Payments

Leasing: The entire lease payments are eligible for tax computation in the books of lessee

Hire purchasing: Only the hire interest is eligible for tax computation in the books of hirer

Magnitude

Leasing: Used as a source of finance, usually for acquiring high cost assets such as machinery, ships etc

Hire purchasing: Used as a source of finance, usually for acquiring low cost assets such as automobiles, office equipments etc

Maintenance of asset

Leasing: Lessee in case of financial, Upkeep is the responsibility of the lessor in the case of operating lease

Hire purchasing: It is the hirer‘s responsibility to ensure the maintenance of the asset bought

Nature of asset   

Leasing: Asset- as a fixed asset of the lessor

Hire purchasing:  Shows the asset either as a stock in trade or as receivables

Down payment

Leasing: No down payment required

Hire purchasing: It is required

Financial Evaluation:

It is an evaluation by the hirer of the desirability for lease and hire purchase. The hirer makes decision based on the Present Value of Net Cash Outflow. The decision is considered favorable when the PV of Net Cash Outflow under Hire Purchase is less than the PV of Net cash Outflow under leasing. Following are the steps involved.

Step 1 Calculate annual interest amount

Step 2 Find the principal amount outstanding at the beginning of the each year = Total outstanding principal –principal paid in the previous year.

Step 3 Find principal paid in the previous year = Annual installment amount –Annual Interest

Step 4 Find Annual ITS = Annual Interest x Tax rate

Step 5 Find Annual Depreciation

Step 6 Find Annual DTS = Annual depreciation x Tax rate

Step 7 Find Total TS = Step 4 + Step 6

Step 8 Find Annual installment amount = Total HP amount + (HP amount x flat rate of interest) / No. of HP years

Step 9 Find PV of salvage value of assets = SV x PVF

Step 10 Find Net Cash Outflow of HP = Step 8 –Step 7

HIRE PURCHASE LEASING

1. It is a tripartite agreement, involving the seller, finance company and the purchaser/hirer

2. Depreciation is claimed by the purchaser/hirer

3. The agreement is entered for the transfer of ownership after a fixed period. 1. It is a bipartite agreement involving lessor and lessee. 2. Depreciation is claimed by the lessor in the lease agreement. 3. In finance lease the ownership will get transferred. While in operating lease, the ownership is not transferred.

Step 11 Find PV of net cash outflow of HP at the appropriate discount rate.

Step 12 Find Total PV net cash outflow of HP = Step 11 –Step 9.

Step 13 Find Tax shield on annual ease rentals = Annual Lease rental x Tax rate.

Step 14 Find Net cash outflow of Leasing = Annual lease rental –Step 13.

Step 15 Find Total PV of net cash outflow of Leasing at the approp. Discount rate = Net cash outflow of Leasing x PVAF.

Step 16 Make a decision: HP is desirable if total PV of net cash flow of HP is Less than that of leasing.