How to record an asset bought on hire purchase when using cash basis accounting on the VAT Flat Rate Scheme

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 cash basis accounting and you’re on the VAT Flat Rate Scheme.

If your business uses the standard VAT scheme, follow these steps to record an asset bought on hire purchase when using cash basis accounting on the standard VAT scheme.

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, cars and motorcycles cannot be treated as costs on the cash basis of accounting. Capital allowances can usually be claimed on cars and motorcycles.

If you’re not sure whether you should claim capital allowances or record the asset purchase as a cost, please ask your accountant.

If you’re preparing your accounts using the traditional accruals basis of accounting, find out how to record an asset bought on hire purchase when using accruals basis accounting.

Be aware 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.

Claiming capital allowances on the asset purchase

To claim capital allowances on the capital asset purchase, such as for a car, follow these steps to record an asset bought on hire purchase.

Recording the asset purchase as a business cost

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

Assets costing £2,000 or more including VAT

If your business uses the VAT Flat Rate Scheme and the capital asset purchase is £2,000 or more, including VAT, you’ll usually be entitled to reclaim the VAT on the purchase of the asset, regardless of the VAT basis you use (cash or invoice).

This is quite a lengthy process, but each step is important to make sure you record the cost, interest and VAT correctly, so please follow the guidance closely.

1. Add a bill for the net amount of the purchase

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, select the relevant cost category from the ‘Spending Category’ drop-down menu. Don’t select one 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 category to select, please ask your accountant.

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Enter the amount of the purchase excluding VAT in the ‘Total Price’ field and select ‘Out of Scope’ from the ‘VAT Rate’ drop-down menu.

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

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

You 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 code ‘998 - Contra Account’ 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 net amount of the purchase.

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

4. Split the hire purchase payments

When payments for the hire purchase agreement are paid out of your business bank account, you’ll need to split the bank transaction between the hire purchase, VAT and interest.

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

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Choose the relevant bank account from the list.

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Select the transaction that relates to the hire purchase payment and then select 'More Options'. Alternatively, you can open ‘More Options’ by pressing the 'Alt' key or ‘Option’ key, depending on your device, at the same time as selecting a bank transaction.

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Explain the proportion that is hire purchase

Select ‘Bill Payment’ from the ‘Type’ drop-down menu, enter the amount of capital that’s being paid off the loan in this payment, excluding VAT, in the ‘Value’ field, and select the bill created for the purchase from the ‘Bill’ drop-down menu.

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Select ‘Create New Explanation’ at the bottom of the screen.

Explain the proportion that is VAT

Next, you’ll need to categorise the remaining balance of the bank transaction. You’ll notice that FreeAgent has created a new unexplained ‘Money Out’ transaction for the difference.

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To explain the remaining balance between VAT and interest, select the new transaction and select ‘More Options’. 

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Select ‘Other Money Out’ from the ‘Type’ drop-down menu, enter the amount of the transaction that is VAT in the ‘Value’ field and select ‘Payment from Contra Account’ from the ‘Category’ drop-down menu. Don’t choose ‘VAT’ or try to enter an amount of VAT, because you’ve already dealt with the VAT reclaim by creating the journal entries and you don’t want to risk double-counting it.

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Select ‘Create New Explanation’ at the bottom of the screen.

Explain the proportion that is interest

To explain the remaining balance, select the new unexplained ‘Money Out’ transaction that FreeAgent has created for the difference, select ‘Payment’ from the ‘Type’ drop-down menu and ‘Interest Payable’ from the ‘Category’ drop-down menu. The amount of this transaction should be the amount of interest that you’re paying to the hire purchase provider in this payment.

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Select ‘Explain Transaction’ to complete the process. A record of the bank transactions having been explained will appear in your Audit Trail report.

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Assets costing less than £2,000

If your business uses the VAT Flat Rate Scheme and the asset you are purchasing costs less than £2,000 including VAT, you’re not entitled to a VAT reclaim and FreeAgent will automatically handle this when you add a bill.

You’ll need to account for the interest on the hire purchase agreement payments separately to the capital repayments against the hire purchase arrangement bill by splitting the bank transactions.

1. Add a bill for the full amount of the purchase, including VAT

Navigate to the 'Bills' tab at the top of the screen.

HP_1.png

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, select the relevant cost category from the ‘Spending Category’ drop-down menu. Don’t select one 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 category to select, please ask your accountant.

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Enter the amount of the purchase including VAT in the ‘Total Price’ field and select ‘Auto’ from the ‘VAT Rate’ drop-down menu. FreeAgent won’t try to reclaim the VAT if you select ‘Auto’. 

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

2. Split the hire purchase payments

When payments for the hire purchase agreement are paid out of your business bank account, you’ll need to split the bank transaction between the hire purchase and interest payments.

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

HP_5.png

Choose the relevant bank account from the list.

long_10.png

Select the transaction that relates to the hire purchase payment and then select 'More Options'. Alternatively, you can open ‘More Options’ by pressing the 'Alt' key or ‘Option’ key, depending on your device, at the same time as selecting a bank transaction.

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Explain the proportion that is hire purchase

Select ‘Bill Payment’ from the ‘Type’ drop-down menu, enter the amount of capital that’s being paid off the loan in this payment, including VAT, in the ‘Value’ field, and select the bill created for the purchase from the ‘Bill’ drop-down menu.

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Select ‘Create New Explanation’ at the bottom of the screen.

Explain the proportion that is interest

Select the new unexplained ‘Money Out’ transaction that FreeAgent has created for the difference, select ‘Payment’ from the ‘Type’ drop-down menu and ‘Interest Payable’ from the ‘Category’ drop-down menu. The amount of this transaction should be the amount of interest that you’re paying to the hire purchase provider in this payment.

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Select ‘Explain Transaction’ to complete the process. A record of the bank transactions having been explained will appear in your Audit Trail report.

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