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 purchased on 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 buying, not to those that you're hiring. 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.

1. Add a bill for the asset

First, navigate to the 'Bills' tab at the top of the screen.

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Select ‘Add New Bill’ and follow the steps for adding a bill in FreeAgent.

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When adding a line item to the bill, enter the relevant details for the purchase, 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 category to select, please ask your accountant.

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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.

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Once you’ve entered all of the relevant information for the asset purchase, select ‘Save’ to complete the process. If you're buying several different assets on hire purchase, you’ll need to create a separate bill for each asset.

A record of the bill being created will appear in your Audit Trail report.

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2. Add a new bank account for the hire purchase agreement

Next, navigate to the 'Banking' tab at the top of the screen and select 'Bank Accounts' from the drop-down menu.

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From the 'Bank Accounts Summary' page, select 'New' and choose 'Bank Account'.

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Enter a name that clearly describes the asset in the ‘Account Name’ field and don't tick either the 'This is a personal account' or 'Make this my primary account' checkboxes.

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Select ‘Create new account’ at the bottom of the screen to complete the process. If you're buying several different assets on hire purchase, you’ll need to add a new bank account for each asset.

3. Mark the bill as paid

Next, add a manual bank transaction from the hire purchase bank account that you created for the asset as a bill payment dated the same day as the bill. Don’t use the 'Add a manual payment' button on the bill as this will pay it from your primary business bank account.

To do this, navigate to the ‘More’ button and select ‘Add Transaction’ from the drop-down menu in the top-right of the hire purchase bank account.

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Select ‘Bill Payment’ from the ‘Type’ drop-down menu and select the relevant bill from the ‘Bill’ drop-down menu.

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Select ‘Create and Finish’ at the bottom of the screen to complete the process.

A record of the manual bank transaction being created will appear in your Audit Trail report.

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4. 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.

To do this, navigate to the hire purchase loan payment in your business bank account and select ‘Transfer to Another Account’ from the ‘Type’ drop-down menu.

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Select the hire purchase bank account from the ‘Bank Account’ drop-down menu and select ‘Explain Transaction’ to complete the process.

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A record of the bank transaction being explained will appear in your Audit Trail report.

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5. Record any interest on the hire purchase agreement

If you're paying interest on the hire purchase agreement, you’ll also need to enter a manual bank transaction from the hire purchase bank account each month to reflect the interest.

To do this, navigate to the ‘More’ button and select ‘Add Transaction’ from the drop-down menu in the top-right of the hire purchase bank account.

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Select ‘Payment’ from the ‘Type’ drop-down menu and ‘Interest Payable’ from the ‘Category’ drop-down menu.

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Select ‘Create and Finish’ at the bottom of the screen to complete the process.

Calculating VAT

By following the steps above, FreeAgent will calculate the VAT correctly if you’re invoice accounting for VAT.

Please note that HMRC states that if you're buying an asset on hire purchase, you should account for VAT on the invoice basis when you "buy or sell goods using lease purchase, hire purchase, conditional sale or credit sale", even if you're normally cash accounting for VAT.

How you account for the VAT if you're cash accounting for VAT will depend on the VAT invoice that the asset supplier provides.

If they provide just one VAT invoice for the asset itself, then you won’t need to take any further action.

If the supplier provides a schedule of VAT invoices, with, in effect, a VAT invoice for each month's payment, you’ll need to create journal entries.

To do this, once you've recorded the original purchase of your asset, create the following journal entries dated the same day as your asset purchase:

  • Credit code ‘818 - VAT Reclaimed’
  • Debit code ‘823 - Deferred VAT’

Then, each month, once you've recorded your payment, create the following journals for the VAT on that payment only (your schedule from your hire purchase company will show the amount):

  • Credit code ‘823 - Deferred VAT’
  • Debit code ‘818 - VAT Reclaimed’

If you’re unsure which journals are required, please ask your accountant.

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