Hire Purchase and Leasing

Hire purchase (HP) or leasing is a type of asset finance that allows firms or individuals to possess and control an asset during an agreed term, while paying rent or instalments covering depreciation of the asset, and interest to cover capital cost.

Assets are defined as anything of monetary value that is owned by a firm or an individual. Assets listed on a firm’s balance sheet can include tangible items such as inventories, equipment and real estate, as well as intangible items such as property rights or goodwill.

Leases differ from term lending in that the lessee does not have ownership rights to the asset. At the end of the lease contract, the lessee usually has a choice of extending the lease, returning the asset, or introducing a buyer for the asset. Some leasers are entitled to a refund of 95% of the sale proceeds when they introduce a buyer. The refund amount will depend on the contract between the original leaser and lessee.

HP is a financing solution suitable for businesses wishing to purchase assets without paying the full value immediately. The customer pays an initial deposit, with the remainder of the balance and interest paid over a period of time. On completion, ownership of the asset transfers to the customer.

It is important to note that the accounting and tax treatment of leases varies according to the type of lease it is. For example, as a finance lease is accounted for as a loan funding the asset, the tax treatment follows the legal form of the transaction which is the hiring of an asset. More specifically, the treatment of capital allowances differs, and tax treatment should be taken into consideration when deciding how to finance an asset purchase.

Hire Purchasing

Hire Purchasing is an agreement, in which the hire vendor transfers an asset to the hire purchaser, for consideration. The consideration is in the form of Hire Purchase Price (HPP) which includes cash down payment and instalments. The hire purchase price is normally higher than the cash price of the article because interest charges are included in that price.  The instalment paid by the hirer at periodical intervals up to a specified period. The instalment is a sum of finance charges i.e. interest and the capital payment i.e. principal.

The recording of accounting transactions in the books of hire vendor and hire purchaser is different. The method of accounting used by the parties is as under:

In the books of hire vendor:

• Interest Suspense Method
• Sales Method

In the books of hire-purchaser:

• Interest Suspense Method
• Cash Price Method

Leasing

A contract in which one party (lessor) permits to use the asset for a specified period to another party (lessee) in exchange for periodic payments for a specified time is known as Leasing. Accounting standard–19 deals with leases which apply to all the enterprises, subject to certain exemption.

At regular intervals, the lessee pays a sum to the lessor which is known as Lease Rents, as a consideration for using the asset owned by the lessor. In addition to this, the lessor also gets a terminal payment known as Guaranteed Residual Value (GRV). The aggregate of the lease rent and guaranteed residual value is known as Minimum Lease Payments (MLP). If the Lessor receives, the amount more than the guaranteed residual value is known as Unguaranteed Residual Value. There are two ways of leasing the asset, which is as under:

• Operating Lease: The lease which covers only a small part of the useful life of the asset is Operating Lease. In this kind of lease, there is no transfer of risk and rewards.
• Finance Lease: A lease agreement to finance the use of the asset for the maximum part of its economic life is known as Finance Lease. All the risk and rewards incidental to the ownership is transferred to the lessee with the transfer of the asset.