What is a Hire Purchase Agreement?
A Hire Purchase (HP) is a financing method businesses use to buy assets such as machinery, vehicles, or equipment. In an HP agreement, the buyer takes immediate possession of the asset but pays it off in instalments over an agreed period.
Importantly, ownership of the asset does not transfer until all payments (including interest) are completed. This differentiates hire purchase from leasing, where ownership typically remains with the lessor (the provider) rather than the lessee (the user).
Key Components of Hire Purchase:
- Initial Deposit: Upfront payment reducing the financed amount.
- Instalment Payments: Regular payments covering principal and interest.
- Interest Charges: Additional cost spread over the repayment period.
- Ownership Transfer: Occurs only after the final instalment payment.
Accounting Treatment of Hire Purchase Agreements
Accurate accounting involves clearly recognising the asset, GST, liability, and unexpired interest.
Example: A business purchases machinery under an HP agreement with:
- Asset Price: $50,000 + GST ($5,000) = Total $55,000
- Deposit Paid: $10,000
- Total Interest: $5,000 over the loan period
- Total HP Agreement: $60,000 ($55,000 + $5,000 interest)
- Term: 50 monthly payments of $1,000 each
Initial Journal Entry:
Account | Debit ($) | Credit ($) |
Machinery (Asset) | 50,000 |
|
GST Paid (Asset) | 5,000 |
|
Unexpired Interest (Liability) | 5,000 |
|
Hire Purchase Liability |
| 60,000 |
Explanation:
- The asset is recorded at the purchase cost, excluding interest.
- GST is separately recorded and can be claimed upfront (see GST section).
- The total interest payable (unexpired interest) is recorded as a liability.
- The Hire Purchase Liability equals the total payments due under the agreement.
Recording the Deposit:
| Account | Debit ($) | Credit ($) |
| Hire Purchase Liability | 10,000 | |
| Bank | 10,000 |
Explanation:
- Deposit payment reduces the liability.
Ongoing Monthly HP Payments
Each monthly payment reduces your liability and unexpired interest progressively.
Interest and Principal Breakdown Example:
Assume interest is evenly distributed (straight-line method):
- Total Interest: $5,000 ÷ 50 months = $100 interest per month.
- Monthly Payment: $1,000
- Interest Portion: $100
- Principal Portion: $900
Monthly Journal Entries:
Recording Interest:
| Account | Debit ($) | Credit ($) |
| Interest Expense | 100 | |
| Unexpired Interest | 100 |
Recording Payment:
| Account | Debit ($) | Credit ($) |
| Hire Purchase Liability | 1,000 | |
| Bank | 1,000 |
Explanation:
- Interest expense gradually reduces the unexpired interest balance.
- Regular payments steadily reduce the HP liability.
Reconciling Hire Purchase Balances
Regular checks ensure accuracy:
- Verify the HP liability matches the repayment schedule.
- Confirm remaining unexpired interest aligns with amortization schedules.
Early Payouts of Hire Purchase Agreements
Sometimes businesses may pay off the HP loan early (sale of asset, refinancing, etc.). When this occurs, adjustments are necessary to reflect actual interest paid.
Example of Early Settlement:
- Original Total HP Agreement: $60,000 (Asset + Interest)
- Interest initially recorded: $5,000
- Actual interest paid due to early payout: $4,500
- Adjustment needed: $500 reduction in interest expense
Adjustment Entry:
| Account | Debit ($) | Credit ($) |
| Unexpired Interest | 500 | |
| Interest Expense | 500 |
Explanation:
- Adjust the interest to reflect the actual amount paid.
GST Considerations for Hire Purchases
The Australian Taxation Office (ATO) guidelines state clearly:
“For hire purchase agreements entered on or after 1 July 2012, all components of the transaction are subject to GST including upfront purchase price, interest charges, and associated fees.”
Key GST Rules (from 1 July 2012 onwards):
- GST is fully claimable upfront (for non-cash accounting methods) when the first payment is made or upon receipt of a tax invoice, whichever comes first.
- Interest charges and fees under HP agreements also include GST.
- GST credits cannot be claimed if the supplier isn’t GST-registered or if the purchase is GST-free/input-taxed.
GST Claim Example:
- Machinery purchased for $55,000 (including $5,000 GST):
- The business claims the full $5,000 GST credit immediately in the next BAS period.
Interest portion payments going forward also contain GST and must be recorded accordingly.
Fundamental Lessons and Facts Summary:
- Hire Purchase allows asset acquisition without immediate full payment.
- Assets and liabilities are clearly recognized separately.
- Payments split between interest (expense) and principal (liability reduction).
- GST treatment depends on the date and terms of the HP agreement (post-2012 includes GST on all components).
Verification with ATO Guidelines
This guide’s information has been cross-checked against the Australian Taxation Office (ATO) to ensure accuracy. According to the ATO:
- Ownership passes to the purchaser only at the final payment.
- GST on hire purchase is claimable upfront (under accrual/non-cash methods).
- All payments (including interest and fees) in HP contracts after July 1, 2012, attract GST.
ATO Reference:
- Australian Taxation Office – Hire Purchase Agreements
Practical Tips for Accurate Record-Keeping:
- Always maintain a clear repayment schedule, tracking both interest and principal repayments.
- Keep all invoices and agreements organised, ensuring GST is accounted for correctly.
- Regularly reconcile the Hire Purchase Liability account.
Conclusion
Understanding hire purchase agreements is crucial for businesses acquiring assets with financing. Proper accounting includes accurate recognition of assets, liabilities, and interest expenses. GST rules must be carefully observed to ensure compliance. By following these guidelines, businesses ensure precise financial management and maintain compliance with taxation laws.
Please Note:
This guide has been carefully compiled and cross-checked. However, always consult the most recent guidelines from the ATO or a tax professional when applying these principles to specific cases or scenarios.
