Hire purchase and lease: Differences and implications for the business
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.
Under Hire Purchase transaction only the possession of the assets is transferred to the hirer. However, there is a condition of the transfer of ownership, i.e., hire-purchaser ought to pay all the instalments due on the asset transferred. By virtue of this, if the hire purchaser is unable to pay the outstanding instalments, then the hire vendor can repossess the asset without paying any compensation to the hirer.
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
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.
Differences between Hire Purchase and Leasing
- Transfer of ownership
In Hire purchase, the agreement is entered for the transfer of ownership after a fixed period. But in Leasing it is only in financial lease, the ownership will get transferred. While in operating lease, the ownership is not transferred.
- Agreement type
Hire purchase is a tripartite agreement involving the seller, finance company and the purchaser / hirer whereas Leasing is only a bipartite agreement, involving lessor and lessee.
- Depreciation Claim
Depreciation is claimed by the purchaser / hirer in a hire purchase. But in leasing, Depreciation is claimed by the lessor in the lease agreement.
- Buyers count
In hire purchase, the goods or property is sold once and there cannot be more than one buyer. But in operating lease, though the lessor can be one person, there can be a number of lessees.
- Period of Agreement
Period of HP agreement is longer as valuable goods or properties are purchased. But in Leasing, the period of lease will be of shorter duration as technological changes will affect the lessee.
- Relationship in agreement
The relationship between the seller and the buyer will be that of owner and hirer in a hire purchase. But the relationship in a lease agreement is that of lessor and lessee.
- Transfer of ownership
In Hire purchase ownership passes on to the buyer only on the last installment from the finance company. But in leasing, the Ownership will pass on when the lessor has acquired enough money from the lessee, which is equivalent to the value of the goods or equipment.
Hire Purchase agreement is more common with the consumer durable goods. But lease agreement is entered more among business concerns.
- Sales Tax
Sales tax is paid by the buyer on the total value of goods in a hire purchase. Sales tax depends on the actual value at the time of sale in leasing.
- Payment defaults
Any default in payment of installment enables the seller / finance company to seize the goods from the purchaser / hirer. On the termination of lease agreement if it is a operating lease, the equipment is taken back by the lessor. In the case of financial lease, the equipment can be sold for a particular value to the lessee.
- Interest rates
The interest rate charged on HP is on a flat rate which is distributed for the entire period of HP agreement and collected along with the principal amount on the equated monthly installment basis. In leasing, Interest does not form a major part of lease agreement, but the lease charges will include interest also as a part of it.
|Meaning||The deal in which one party can use the asset of the other party for the payment of equal monthly installments is known as Hire Purchasing.||Leasing is an agreement where one party buys the asset and allows the other party to use it by paying consideration over a specified period is known as Leasing.|
|Governing Accounting Standard||No Specific Accounting Standard||AS- 19|
|Down Payment||Required||Not Required|
|Installments||Principal plus interest||Cost of using the asset|
|Asset type||Car, trucks, lorries etc.||Land and Building, Property.|
|Ownership||Ownership of the asset is transferred to the hire purchaser on the payment of the last installment.||Transfer of ownership depends on the type of lease.|
|Repairs & Maintenance||Responsibility of hire purchaser.||Depends upon the type of lease|
|Consideration||Initial payment plus installment.||Lease Rentals|
|Duration||Short Term||Comparatively Long term|