How to record an asset bought on hire purchase when using accruals basis accounting

This article explains how to record a capital asset that was bought using a hire purchase (HP) agreement if you’re preparing your accounts using accruals basis accounting.

Please note that this only applies to assets that you're effectively buying, not to those that you're renting or to a scenario such as hiring a car from a car rental company. It can be difficult to distinguish between the two if the legal arrangement for the asset is complex. Please check with your accountant if you're unsure.

The purchase would be recorded differently if you’re preparing your accounts using cash basis accounting.

Please note that you could be preparing your accounts on one basis but your VAT on another. For example, you could be preparing your accounts using the traditional method but your VAT returns using the cash accounting scheme. Please check with your accountant if you’re unsure which basis you should be using for your accounts.

First, you'll add a bill for the purchase, which will also record the liability in your accounts, and then you’ll need to explain the hire purchase loan repayments.

For any purchases where you previously created a dummy bank account to represent the HP agreement, you should continue to explain the bank transactions as transfers between the dummy bank account and your business account, rather than following the steps below, until the agreement has been repaid in full. Similarly, if you’ve been explaining the repayments to the ‘Payment of HP Agreement’ category, you should continue to do this until the agreement has been repaid in full.

1. Add a bill for the asset

First, navigate to the 'Bills' tab at the top of the screen, select ‘Add New Bill’ and follow the steps for adding a bill in FreeAgent.

Enter the date that the hire purchase agreement ends in the ‘Due On’ field and tick the ‘Hire purchase’ checkbox in the ‘Bill Details’ section. You can also add the details of the hire purchase agreement with the finance company in the ’Comments’ box if you wish.

Enter the details for the purchase in the 'Bill Contents' section, including selecting the relevant asset purchase category from the bottom of the ‘Spending Category’ drop-down menu. You can create custom categories if you need to. If you’re unsure which spending category to select, please ask your accountant.

If your business is VAT-registered, the VAT will be accounted for on the date of the bill, regardless of whether you're preparing your accounts using accruals basis accounting or cash basis accounting.

Select the asset's useful life from the ‘Asset Life’ drop-down menu. If the asset’s useful life will be longer than seven years, find out how to record a capital asset with a long useful life.

Once you’ve entered all of the relevant information for the asset purchase, select ‘Save and Review’ to complete the process. If you need to record additional costs for the purchase, such as insurance, you can add multiple line items to the bill.

If you're buying several different assets on hire purchase, you’ll need to create a separate bill for each asset.

What happens next?

The amount that you’re due to pay for the bill, also known as its balance, will automatically be posted to the hire purchase liability category (code ‘793 - Hire Purchase Liability > 1 Year in FreeAgent: [X]' where X is the bill reference number).

You can view this balance by navigating to the Show Transactions report or Balance Sheet in FreeAgent.

Please note that the liability account will record the balance as due to be repaid in more than one year. If you need to show any of the liability as due to be repaid in less than one year, for example if you have a limited company account type and need this to be reflected on your Final Accounts report, you’ll need to create the relevant journal entries, typically between accounts ‘794’ and ‘795’. If you're unsure which journal entries to create, please ask your accountant.

2. Explain the hire purchase loan repayments

As you pay off the asset each month, you'll need to explain each payment in your business bank account in FreeAgent once the relevant bank transaction has been imported into your FreeAgent account via a bank feed or uploaded from a bank statement.

If you need to allocate some of the repayment as interest, you can split the bank transaction between the bill payment and the amount of interest. You should use ‘Bill Payment’ as the ‘Type’ to explain the bill payment and use the ‘Interest Payable’ category to explain the interest. Don’t use the ‘Payment of HP Agreement’ category as this won’t add the payment to the bill or reduce the hire purchase liability in your accounts.

Select ‘Explain Transaction’ to complete the process.

Repeat this process every time you pay part of the hire purchase agreement until the bill has been paid off in full.