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Why do entities opt for hire (d) Payment flexibility: Some entities
purchase agreement? experience high variations in cash
These are some reasons entities decide flow from one period to another.
to enter a hire purchase agreement with Thus, in hire purchase agreements,
customers: entities can arrange their payment
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(a) Capital Conservation: Hire terms with the vendor in such a way
purchase enables companies to save that a large part of the payments is
money for operational costs or other made during periods when their cash
investments. They can spread the cost flow is favourable.
over time rather of paying the entire (e) Options to upgrade: Some hire
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purchase price all at once, which can purchase agreements allow entities
be helpful for managing cash flow. to upgrade to newer models or larger
(b) Immediate Use: In order to capacity during the period of contract.
maintain or grow their operations, This gives entities flexibility in
businesses may require machinery, responding to shifting business needs
equipment, or cars right now. They without having to pay hefty upfront
can obtain these assets through hire expenses.
buy instead of holding off till they
have enough money to make an Exercise 8.2
outright purchase. Likangaga company is facing financial
difficulties, and one of the solutions
(c) Reduction of tax payable: proposed is to replace the current
In some countries, hire purchase machines with new ones. It is projected
interest is an allowable deduction in that the replacement of the machines
calculating taxable income. Lower will improve the company’s financial
taxable income means lower taxes. cash flows in the future. The CEO
Thus, businesses take advantage of believes that machines can be acquired
this opportunity to reduce their tax on a hire purchase basis. As a financial
payable. Furthermore, including expert, advise the CEO of Likangaga
assets acquired on hire purchase in Ltd on whether he should proceed with
their books of accounts leads to an hire purchase arrangements or explore
increase in depreciation, specifically alternative financial options, cantering
for non-current assets. Just like hire your answers on the long-term financial
purchase interest, depreciation is an implications of entering into a hire
allowable deduction which results in purchase agreement.
lower tax payable.
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