Hire Purchase - worked example in the book of purchaser

Interest payable on hire purchase

When we deal with a hire purchase, we must be ready to be charged interest. This is because the amount cost of asset acquired is not being paid fully. Therefore the balance is being charged interest to compensate the ‘loss’ on income by the seller in the sense that they could get the full amount of the money when they sold the asset to you. By taking such risk because you and the seller had made a hire purchase agreement on the transaction they charged you interest. From here they made some profit from it. It is riba’ right?

Go for Islamic financing….

Here are some examples on the hire purchase transaction

Example 1.

Sabrina wants to purchase a computer costing RM2,000 in 2019. She has done her calculation and she can’t afford to pay on a lump sum payment. So she decided to go for instalments. The hire purchase price is RM2,300 payable in two instalments at the end of each year. Minimum payment is RM1,000 plus interest. The interest on hire purchase is 10% per annum.

Year 1	Cash price	RM2,000
	Add: interest 10%	200
	Amount owing at the end of year 1	2,200
	Less: 1st instalment	(1,200)
	Balance at the end of the year 1	1,000
Year 2	Add: interest 10%	100
	Amount owing at the end of year 2	1,100
	Less: 2nd instalment	(1,100)
	Balance at the end of year 2	-nil-

That is what we call unequal instalments. The situation was based on the sentence ‘Minimum payment is RM1,000 plus interest’. So the minimum payment was added to the reducing interest charged each year.

Example 2

We use the same situation as example 1 but this time we change the persons name. I guess many people will have the chance the computer.

Sofea wants to purchase a computer. The cost is still RM2,000 but cash. Since she had no money to pay in full so she decided to pay by instalments. The hire purchase price is not mentioned but the agreement shows that she has to pay equal instalment of RM1,152 each year for two years. Interest of 10% per annum applies on the balance of each year.

So here we go…

Year 1	Cash price	RM2,000
	Add: interest 10%	200
	Amount owing at the end of year 1	2,200
	Less: 1st instalment	(1,152)
	Balance at the end of the year 1	1,048
Year 2	Add: interest 10%	104
	Amount owing at the end of year 2	1,152
	Less: 2nd instalment	(1,152)
	Balance at the end of year 2	-nil-

We call the above method is equal instalments. By adding all together we can see that the total payment paid in order for Sofea to own the computer is RM2,304, quite same with the hire purchase price indicated in example 1.

The journal entries.

In the book of purchaser. (for example 1)

Purchased the computer at cost
Dr	Asset - Computer		2,000
	Cr	HP creditor			2,000
Hire purchase interest (1st year)
Dr	HP Interest		200
	Cr	HP creditor			200
1st instalment
Dr	HP creditor			1,200
	Cr	Bank			1,200
Hire purchase interest (2nd year)
Dr	HP Interest		100
	Cr	HP creditor			100
2nd instalments
Dr	HP creditor		1,100
	Cr	Bank			1,100

You can apply the same for the second example. Actually I’m just tired to do that. Learn ok?

What about in the book of seller?

Coming to you this summer at the cinema near you and watch out what will happen to the seller…..