Hire Purchase Finance - Meaning • Payment of Periodic instalments • Immediate possession of goods by the buyer • Ownership of goods with vendor until full and final payment • Vendor’s right to repossess the goods in case of default by buyer • Treatment of instalment as a hire charge till the payment of last instalment.
Hire purchase - definition • An agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of the agreement.
Rate of Interest • Types of Interest rates popularly used in Hire Purchase Transactions • Add on Rate of Interest • Flat Rate of Interest • Effective Rate of Interest
Process of Hire Purchase • The Dealer, contracts with finance co. for financing his hire purchase deals. • The customer selects the goods for HP, and dealer arranges for the complete set of documents. • Down payment by customer on completion of proposal form. • Dealer sends documents to finance co. with request to purchase the goods, and accept the HP transaction. • The finance co. signs the agreement and sends copy along with EMI details to dealer. • Dealer delivers the goods to the customer, property passes on to the finance co.. • Hirer pays EMIs, and on last payment , the ownership passes on to him, with loan completion certificate by the finance co.
HIRE PURHASE – Legal Framework • HP act 1972. • Two aspects of HPA – Bailment of goods , element of sale. • Essential Ingredients of Sale : Two parties, Goods, Money Consideration, Transfer of Ownership, Essentials of a valid contract. • Sale Vs Bailment : Sales – conveyance of property from seller to buyer for a price. Bailment : mere transfer of possession of goods to bailee, with no conveyance intended.
HIRE PURHASE – Legal Framework • Sale vs Hire Purchase : Differences : • In HP the possession of the goods with hirer, while ownership with original owner. • No agreement to buy, but only option to buy under certain conditions. • Ownership to hirer, only when he exercises his option by making full payment. • Destruction of goods before making the contract : destruction/damage, without the knowledge of the seller, such that goods do not match the description in Contract, then contract null and void.
HIRE PURHASE – Legal Framework • Destruction of goods, after Agreement to Sell but before Sale : damage without fault of buyer/seller, agreement is void, provided ownership is not passed on. • Document of Title to Goods : document which enables to deal with goods as owner. Eg. Cash Memo, bill of lading , dock warrant, lorry receipt, Railway receipt, Delivery order. • Earnest Money/Security Deposit : payment by buyer in advance, for due performance of contract. In case of default, liable to be forfeited, and contract goes off. • Conditions and Warranties : relating to nature and quality of goods and their fitness for the buyer’s purpose. Condition – stipulation which forms the basis of the contract. Warranty – stipulation which is subsidiary to the main purpose of the contract. Legal implications different for both.
Financial Evaluation • For the Hirer • Cost of Hire Purchase Vs Cost of Leasing • Cost of Hire Purchase is - Down payment + service charges + PV of hire purchase payments (Kd) – PV of depreciation tax shield (Kc) – PV of net salvage value (Kc). Cost of Leasing is - Lease management fee + PV of lease payments (Kd) – PV of tax shield on lease payments (Kc) + PV of interest tax shield on hire purchase (Kc)
Financial Evaluation • From the viewpoint of the Vendor : • NPV of Hire Purchase Plan: • - PV of the Hire purchase instalments • +Documentation and service fee • +PV of tax shield on initial direct cost. • _ Loan amount • _ PV of Interest tax of financial income • _ PV of Income tax of financial income • _PV of income tax on documentation
Lease Financing Ownership lies with vendor(lessor) Lessor(vendor) is entitled to claim depreciation tax shield HP Financing Ownership transferred to the hirer on the payment of last instalment. The hirer is entitled to claim depreciation tax shield Lease financing Vs Hire purchase Financing
Capitalization of the asset is done in the books of the leasing co. the entire lease payment is eligible for tax computation in the books of the lessee. Leasing used as a source of financing for high cost assets like ships, machinery, airplanes etc Capitalization of the asset is done in the books of the hirer. Only the hire -interest is eligible for the tax computation in books of hirer.. HP use as a source of finance for low cost assets as automobiles, office equipments etc. Lease financing Vs Hire purchase Financing….
No Down payment required for using leased assets. In Lessee’s books, leased assets shown as a note only. Not suitable for low capital enterprises , who desire to show strong asset position Down payment is required to be made for acquiring the asset, and margin of 20-25% maintained. In hirer’s books ,HP assets shown as an asset, and instalments payable as a liability. HP suitable for low capital enterprises , which need to show strong asset position. Lease financing Vs Hire purchase Financing….
An asset given on lease, is fixed asset for lessor. All receipts from lease, is shown in P&L, the Lessor’s books. The hire vendor will show the HP asset, as stock in trade, or as receivables. Only the interest portion, from instalments is taken to the hire vendor’s Profit & loss Account. Lease financing Vs Hire purchase Financing….