Hire purchase as a financial service.pptx

Hire Purchase - Meaning
Hire purchase is an arrangement for buying expensive goods, where the buyer makes an initial down payment and pays the balance plus interest in installments.
The term hire purchase is commonly used in the United Kingdom and it's more commonly known as an installment plan in the United States.

Hire Purchase - Meaning
According to the Hire Purchase Act of 1972, the term ‘hire purchase’ is defined as , “ 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, and includes an agreement under which:
A. Possession of goods is delivered by the owner thereof to a person on the condition that such person pays the agreed amount in periodic payments.
The property of the goods is to pass to such a person on the payment of the last of such instalment
Such a person has a right to terminate the agreement any time before the property so passes.”

Features of Hire Purchase
The asset ownership is transferred to the buyer only after the final installment is paid.
Buyer pays for the asset in regular installments, which includes both the principal amount and the interest.
Asset itself serves as security. In case the buyer fails to pay installments, the seller can repossess the asset.
The buyer has the option to buy the asset at any time by paying the remaining installments in one go.

Interest is charged over unpaid balance instead of the original price of the asset.
Until the final payment is made, the maintenance of asset remains the responsibility of the buyer, not the seller.
Buyer can terminate agreements at any time before taking ownership of the asset.
Interest is charged over unpaid balance instead of the original price of the asset.
Until the final payment is made, the maintenance of asset remains the responsibility of the buyer, not the seller.
Buyer can terminate agreements at any time before taking ownership of the asset.
Interest is charged over unpaid balance instead of the original price of the asset.
Until the final payment is made, the maintenance of asset remains the responsibility of the buyer, not the seller.
Buyer can terminate agreements at any time before taking ownership of the asset.

Rights of Hirer
The hire purchase act of 1972, provides the following rights to the hirer
Rights of Protection
It is not possible for the hire vendor to terminate the hire purchase agreement on account of default in payment of hire charges by the hirer, or due to unauthorized act or breach of express conditions, unless the hire vendor gives notice in writing to the hirer in this regard

Right of Notice
When the hire charges are weekly, or for a period less than that, one week notice is to be given, and in all other cases a two weeks notice is to be given.
Right of Repossession:
The right of repossession is not available to the hire vendor, unless sanctioned by the court in the following cases:
1. one half of the price has been paid where the

1. Hire Purchase Finance Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 1

2. Hire Purchase - Meaning Hire purchase is an arrangement for buying expensive goods, where the buyer makes an initial down payment and pays the balance plus interest in installments . The term hire purchase is commonly used in the United Kingdom and it's more commonly known as an installment plan in the United States. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 2

3. Hire Purchase - Meaning According to the Hire Purchase Act of 1972, the term ‘hire purchase’ is defined as , “ 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, and includes an agreement under which: A. Possession of goods is delivered by the owner thereof to a person on the condition that such person pays the agreed amount in periodic payments. The property of the goods is to pass to such a person on the payment of the last of such instalment Such a person has a right to terminate the agreement any time before the property so passes.” Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 3

4. Features of Hire Purchase The asset ownership is transferred to the buyer only after the final installment is paid. Buyer pays for the asset in regular installments, which includes both the principal amount and the  interest . Asset itself serves as security. In case the buyer fails to pay installments, the seller can repossess the asset. The buyer has the option to buy the asset at any time by paying the remaining installments in one go. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 4

5. Features of Hire Purchase Interest is charged over unpaid balance instead of the original price of the asset. Until the final payment is made, the maintenance of asset remains the responsibility of the buyer, not the seller. Buyer can terminate agreements at any time before taking ownership of the asset. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 5

6. Rights of Hirer The hire purchase act of 1972, provides the following rights to the hirer Rights of Protection It is not possible for the hire vendor to terminate the hire purchase agreement on account of default in payment of hire charges by the hirer, or due to unauthorized act or breach of express conditions, unless the hire vendor gives notice in writing to the hirer in this regard. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 6

7. Rights of Hirer Right of Notice When the hire charges are weekly, or for a period less than that, one week notice is to be given, and in all other cases a two weeks notice is to be given. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 7

8. Rights of Hirer Right of Repossession: The right of repossession is not available to the hire vendor , unless sanctioned by the court in the following cases: 1. one half of the price has been paid where the hire purchase price is less than Rs. 15,000 (Rs. 5,000 in the case of motor vehicles). 2. Three fourth of the price has been paid where the hire purchase price is not less than Rs. 15,000 ( Rs. 5,000 in the case of motor vehicles ). Three fourth or such higher proportion, not exceeding nine—tenth, where the hire purchase price is not less than Rs. 15,000 Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 8

9. Rights of Hirer Right of Statement The hirer has the right to obtain a statement on payment of Re.1, containing details such as the amount paid by the hirer, the amount and the date upon which the instalment becomes due but not been paid, the amount of instalment, which will become payble etc. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 9

10. Rights of Hirer Right to excess Amount The hirer has the right to obtain any amount in excess of the value of goods repossessed, over and above the amount of instalments which will become payable etc. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 10

11. Type of interest rate used in Hire purchase Financing Add-On rate of interest Add-on rate of interest refers to that rate of interest which is chargeable in hire purchase as a percent of the original cash price of the asset. In other words, the hire purchase agreement will not specify a rate, but will only specify the total quantum of interest. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 11

12. Type of interest rate used in Hire purchase Financing Flat rate of interest It is the discount rate applied to a figure from which the amount of discount is deducted at the outset. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 12

13. Type of interest rate used in Hire purchase Financing Effective Rate of Interest Effective rate of interest, also known as true rate of interest, arrived at by trial and error, at which the total present value of the stream of instalments is equal to the cash price of the asset bought on hire purchase. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 13

14. Difference Between Leasing and Hire Purchase Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 14

15. Difference Between Leasing and Hire Purchase Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 15 Feature Hire Purchase Leasing Ownership The asset ownership is transferred to the hirer at the end of the payment term upon completion of all installments. The asset ownership remains with the lessor throughout the lease term. Payment Structure The cost of the asset is divided into equal installments, including interest, that hirer pays over a specific period. The lessee makes periodic payments for the use of the asset without any intention of ownership transfer. Duration The payment term is relatively longer and can range from months to years. The lease term is usually shorter and can be customized according to the lessee’s requirements.

16. Difference Between Leasing and Hire Purchase Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 16 Feature Hire Purchase Leasing Upfront Cost The hirer typically pays a down payment upfront , which is a percentage of the asset’s total cost. Leasing may require a smaller upfront payment compared to hire purchase. Maintenance The hirer is responsible for the maintenance and repairs of the  asset . The lessor often retains responsibility for the maintenance and repairs of the leased asset. Risk and Ownership Transfer The hirer assumes the risk of asset ownership, including  depreciation  and obsolescence. The lessor retains ownership and assumes the risk associated with the asset, reducing the lessee’s risk exposure.

17. Difference Between Leasing and Hire Purchase Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 17 Feature Hire Purchase Leasing Return or Upgrade The hirer can return the asset if they can no longer make payments or choose to upgrade to a different asset by entering into a new agreement. The lessee has options to return the asset, extend the lease, purchase the asset at a predetermined price, or lease a new upgraded asset. Tax Benefits The hirer may be eligible for tax benefits such as depreciation and interest deductions. The lessor may be eligible for tax benefits, and the lessee may have the advantage of deducting lease payments as operating expenses. Financing Hire purchase is a form of financing where the hirer gradually pays for the asset over time. Leasing is a contractual arrangement f or the use of an asset without ownership transfer.

18. Difference Between Leasing and Hire Purchase Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 18 Feature Hire Purchase Leasing Depreciation The hirer(Owner) is entitled to claim depreciation tax shield Lessor , and not the lessee, is entitled to claim depreciation tax shield Capitalization Capitalization of the asset is done in the books of the hirer Capitalization of the asset is done in the books of the lessor, the leasing company Salvage Value The hire can claim benefit of salvage value as the prospective owner of the asset. The lessor , and not the lessee, has the right to claim the benefit of salvage value

19. Difference Between Leasing and Hire Purchase Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 19 Feature Hire Purchase Leasing Reporting The asset bought on hire purchase will be shown as an asset , and amount of instalments payable to the hire purchase vendor as a liability In the books of lessee, leased asset are disclosed by way of note only Suitability It is highly suitable for the low-capital enterprises which need to show a strong asset position in their balance sheets. It is not suitable for the low-capital enterprises which need to show a strong asset position in their balance sheets.

20. Difference Between Leasing and Hire Purchase Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 20 Feature Hire Purchase Leasing Nature of the asset The hire vendor normally shows the asset let under HP either as stock in trade or as receivables An asset given on lease by a leasing company is considered as the fixed asset of the lessor Receipts Only the interest portion is taken into the hire vendors profit and loss account All receipts from the lessee is taken into the lessors profit and loss account

21. Method of Reporting Hire Purchase Disclosure in Hirer Books: 1. The annual interest and depreciation charge must be debited to the profit and loss account every year, until the loan is paid off. 2. The principal component of outstanding hire purchase each year must be shown in the balance sheet by way of current liability of hire purchase outstanding within one year, and by way of secured loan of hire purchase outstanding for periods more than one year. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 21

22. Disclosure in Hire Vendor books 1. Cost of HP deal shall be debited to P & L account 2.The interest received from the hirer each year constitutes finance income, and shall be credited to P&L account. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 22

23. Methods of Interest Calculation Effective Rate of Interest ( ERI) The effective rate of interest method, also known as annual percentage method, is a method of interest calculation where the effective rate of interest is determined by the IRR technique. ERI is the rate of interest, which equates the PV of all future annual instalment payments, with the HP principal payable at the beginning of the hire purchase contract. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 23

24. Step 1= Find HP principal = cost of asset – down payment Step 2 = Find total interest amount of the HP period =( HP principal * flat rate of interest*HP period of years) Step 3 = Find total HP amount = ( step 1 + step 2) Step 4 = Find annual instalment amount = step 3 / no of instalments Step 5 = Find effective ERI Rate of interest --  PV of future annual instalments=PV of HP principal amount payable Step 6 = Find annual interest amount = Total principal outstanding at the beginning * ERI Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 24

25. Sum of years digits methods: Under this method, the annual amount of interest is determined as follows: Annual amount of interest = (Number of years of remaining HP period including the current year / Total of all digits representing the period of HP) *Total amount of interest for HP period. Total amount of interest for HP period = Total amount payable *Flat rate of interest. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 25

26. Straight-Line Method: Under this method, the annual amount of interest is determined as an equated annual financial charge as follows: Annual amount of interest = Total amount of interest for HP period / No of HP periods. Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 26

27. References Dr.S . Gurusamy , Merchant Banking and Financial Services, New Delhi: Tata McGraw Hill M.Y. Khan, Financial Services, New Delhi: Tata McGraw Hill Dr.R.K.Sudhamathi, Associate Professor, MBA, NGPiTech 27