How to record an asset bought on hire purchase when using cash 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 cash basis accounting and you don’t wish to claim capital allowances on the asset.

On cash basis accounting, most asset purchases should be deducted as a business cost rather than being entered as a capital asset and claiming capital allowances. However, land, buildings and cars cannot be treated as costs on the cash basis of accounting. Capital allowances can usually be claimed on cars.

If your business is preparing its accounts using cash basis accounting and you’re not sure whether you should claim capital allowances or record the asset purchase as a cost, please ask your accountant. The purchase would be recorded differently if you’re preparing your accounts using accruals 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 VAT Cash Accounting Scheme. Please check with your accountant if you’re unsure which method to use for your business.

First, you'll need to record 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.

Claiming capital allowances on the asset purchase

To enter the asset purchase that you’ll claim capital allowances on, for instance if you’re buying a car, please follow these steps to record an asset bought on hire purchase.

Not claiming capital allowances: recording the asset purchase as a business cost

You’ll usually reclaim all the VAT on assets bought using a hire purchase agreement on the date of purchase, rather than on the date of each payment. The way to record the capital asset purchase as a cost of the business depends on whether the asset you bought cost less than £2,000 or £2,000 or more including VAT.

How to record assets costing less than £2,000

First, add a bill and 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.

Hire purchase box ticked and highlighted.png

In the 'Bill Contents' section, select the relevant cost category from the ‘Spending Category’ drop-down menu. Don’t use any of the capital asset purchase categories from the ‘Assets and stock’ section. You can create custom categories if you need to. If you’re not sure which spending category to select, please ask your accountant.

Cost category highlighted.png

Enter the amount of the purchase in the ‘Total Price’ field and select ‘Auto’ from the ‘VAT Rate’ drop-down menu. Please note that if your business uses the VAT Flat Rate Scheme and the asset you purchased cost less than £2,000 including VAT, you’re not entitled to a VAT reclaim and FreeAgent won’t try to reclaim the VAT.

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.

Total price and VAT rate highlighted.png

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.

How to record expensed assets costing £2,000 or more including VAT if your business is using the VAT Flat Rate Scheme

1. Add a bill for the VAT-inclusive amount of the purchase

First, add a bill and select that the bill totals will be entered ‘Including VAT’ and tick the ‘Hire purchase’ checkbox in the ‘Bill Details’ section.

VAT and hire purchase highlighted.png

In the 'Bill Contents' section, select the relevant cost category from the ‘Spending Category’ drop-down menu. Don’t use any of the capital asset purchase categories from the ‘Assets and stock’ section. You can create custom categories if you need to. If you’re not sure which spending category to select, please ask your accountant.

Cost category highlighted.png

Enter the amount of the purchase including VAT in the ‘Total Price’ field but select ‘0%’ from the ‘VAT Rate’ drop-down menu. The VAT reclaim is dealt with separately.

Price and VAT highlighted.png

Once you’ve entered all of the relevant information for the purchase, select ‘Save and Review’ to complete the process.

2. Create journal entries to reclaim the VAT in box 4 of your VAT return

Next, you’ll need to create the following journal entries dated the same date as the purchase:

  • Debit code ‘818 - VAT Reclaimed’ for the amount of VAT you’re reclaiming
  • Credit the code for the same cost category you allocated the bill to, for the amount of VAT you’re reclaiming

This will add the VAT you’re reclaiming to box 4 of your VAT return. If you’re unsure how much VAT to reclaim, please ask your accountant.

3. Adjust box 7 of your VAT return

You’ll also need to adjust box 7 of your VAT return by the amount of the bill excluding VAT.

Box 7 adjustment highlighted.png

If you’re unsure how much to adjust box 7 of your VAT return by, please speak to your accountant.

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).

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

Example of liability category in show transactions report.png

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, you’ll need to create the relevant journal entries, typically between accounts ‘793’ and ‘792’. If you're unsure which journal entries to create, please ask your accountant.

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.

Example of HP transaction being split.png

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

Did you find this article useful?