Posted in Finance, Accounting and Economics Terms, Total Reads: 1984
Definition: Hire Purchase
Hire Purchase (HP), also known as closed end leasing, is a contract in which a buyer buys goods by making payment in installments over time. Under this contract, the buyer is leasing the good and doesn’t obtain full ownership until the full amount of the contract is paid.
This tactic is used by businesses to better dress their earnings metrics, as the debt and the asset don’t appear on the balance sheet unless the entire amount is paid. It is a mode to finance the price of the goods to be sold on a future date.
Possession: Ownership transferred on payment of entire amount of the contract
Treatment: Doesn’t appear on balance sheet until full payment is made
Example: A company XYZ purchases an equipment from another company at a down payment of 10% and the rest 90% of the money is paid in installments. This is different from the Installment sale method, where the ownership is transferred right away after the payment of first installment is made.
Advantages of hire-purchasing:
• A buyer who cannot afford to make a one-time payment on expensive goods like cars, houses etc. can still afford to buy the good i.e the need to pay immediate cash is eliminated
• Businesses use hire-purchasing to improve the appearance of their earning metrics. In this system, the debt which is used to purchase the asset, and the asset are kept off the balance sheet, which results in higher operational and return-on-asset figures
• This system results in the growth of the economy since more people possess expensive goods now, which means the socio-economic gap is reducing
• Easy possession of goods and hence relief to the buyer
Disadvantages of hire-purchasing:
• There are buyers who default in the payments
• Sometimes buyer has to mortgage his property as a collateral if he/she is not a reputed buyer in the eyes of the bank
• The total amount paid is more than what would have been id the payment were made in one go
• If the buyer defaults due to any reason, he might lose all the paid installments, depending on the policy of the bank and the dealer
• If the buyer defaults, it is a loss it the seller
For example, there are many electronic stores offering installment plans in tie-up with financing companies which allow the consumers to buy expensive goods which they otherwise cannot afford like LED televisions etc.