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CMA Intermediate · Financial Accounting · Hire Purchase and Installment Sale Transactions

Under the Hire Purchase System, in the books of the hirer when the asset is recorded at full cash price, what is the correct treatment of the interest included in each installment?

The interest is charged to the Statement of Profit and Loss as a finance cost for the period it relates to. The asset is capitalised only at its cash price, so interest embedded in installments is a period expense, not part of the asset cost.

  1. AIt is capitalised and added to the asset's cost
  2. BIt is debited to Interest Suspense and written off at the end of the agreement
  3. CIt is charged to the Statement of Profit and Loss as finance cost for the period to which it relatesCorrect
  4. DIt is credited to the hire vendor's account

Explanation

With the asset recorded at cash price (Asset Account debited, Vendor credited), the interest is an expense of each period and is debited to Interest Account, then transferred to the profit and loss statement. Capitalising it would overstate the asset's cost beyond cash price.

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