A hire purchase agreement is a method of spreading the cost of capital items over a number of years. The purchaser enters into an contract with a finance company who initially fund the purchase.
The buyer usually pays a deposit and spreads the remainder of the cost into monthly repayments over the course of the agreement. The monthly repayments will include interest at a pre-agreed rate. Legally, the asset remains the property of the finance company until the final payment is made. The final payment is normally higher than the monthly repayments. This is often referred to as a 'balloon payment'.
To account for the hire purchase you will need to make the following entries in your company's books:
- When the asset is initially purchased:
Debit the assets code with the net amount of the purchase
Debit the full amount of input VAT (assuming you are not partially exempt)
Credit a hire purchase creditor on the balance sheet with the full amount
The VAT is reclaimable in the relevant VAT period.
- Monthly payments will decrease the liability but will also contain an element of interest which must be added to the liability. The entries are as follows:
Debit the hire purchase interest code on the profit and loss account
Debit the liability with the amount of the repayment less the aforementioned interest
Credit the bank with the gross repayment.
Over the course of the agreement, the balance sheet creditor will therefore diminish.
- The asset will need to be depreciated as a normal asset each year
For tax purposes, the interest in the profit and loss is allowable, the depreciation will be added back, but the van will qualify for capital allowances- potentially 100% relief in the year of purchase if you have not used all of your Annual Investment Allowance.
By Jo Nockels
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