A hire purchase agreement is booked as if the business had bought the asset with a loan: the asset goes on the balance sheet at its cash price when the agreement starts, the amount still owed is a liability, and each payment is split between interest, charged to profit, and capital, which reduces the liability. VAT on the full cash price is usually paid and reclaimed at the start, and capital allowances are available on the whole cash price once the asset is in use.

What makes hire purchase different from a lease or a loan?

HMRC’s VAT Notice 701/49 describes hire purchase as an agreement for the hire of goods for periodic payments, where the hirer has the option to purchase. Legal title stays with the finance company until the last payment, often including a small option to purchase fee, has been made.

In substance, though, most hire purchase is a financed purchase. HMRC’s Business Income Manual at BIM45355 says most hire purchase contracts are of a financing nature: the purchase option is usually exercisable at a nominal amount, so the hirer can be expected to take it up, and the “hire” element of the payments is equivalent to interest. Accounting follows that substance rather than the legal form, which is why the bookkeeping looks like an asset bought with borrowed money. For a bank loan used to buy an asset outright, see recording business loans and interest.

Which accounting rules apply?

FRS 102, periods beginning on or after 1 January 2026. The revised Section 20 no longer splits lessee arrangements into finance and operating leases. A lessee recognises an asset and a liability for leases other than short term and low value ones (paragraph 20.5). A short term lease must have a term of 12 months or less, and the glossary says a lease containing a purchase option is not short term, so a hire purchase agreement cannot use that exemption. The liability is measured at the present value of the payments not yet made (paragraph 20.49), interest is charged so as to give a constant periodic rate on the remaining balance (paragraph 20.63), and where ownership passes to the lessee, the asset is depreciated over its own useful life rather than the agreement term (paragraph 20.58). See the FRS 102 2026 amendments and the lease exemptions.

FRS 105 micro entities, and FRS 102 before the 2026 changes. These still classify leases as finance or operating. FRS 105 paragraph 15.6 lists transfer of ownership by the end of the term, and a purchase option priced so that exercise is reasonably certain, as situations that normally make a lease a finance lease. The lessee recognises the asset and the obligation at the lower of fair value and the present value of the minimum payments (paragraph 15.10), and allocates the finance charge to give a constant periodic rate of interest on the outstanding balance (paragraph 15.12).

Under any of these frameworks a typical hire purchase deal ends up in the same place: asset on the balance sheet, liability for the finance, interest spread over the term.

What are the entries when the agreement starts?

VAT Notice 701/49 paragraph 4.2 says the full amount of VAT on the goods is accounted for at the time of supply, while the credit charge is exempt where it is separately disclosed. So the business usually pays the VAT with the deposit and reclaims it on its next return, subject to the normal input tax rules.

Entry Debit Credit
Asset at cash price, excluding VAT Fixed asset cost
VAT on the full cash price VAT input tax
Deposit and VAT paid Bank
Amount financed Hire purchase liability

Under FRS 105, paragraph 15.10 adds any initial direct costs of the lessee, meaning incremental costs of negotiating and arranging the deal, to the amount recognised as the asset. Read the agreement carefully to see whether a fee is really an arrangement cost or simply part of the finance charge.

How are the monthly payments posted?

Each payment is split: debit the hire purchase liability with the capital element, debit interest payable with the interest element, credit bank with the total. The finance company’s statement often shows the split, but it may use a different method from the constant rate approach required by the standards, so check it rather than copying it blindly. A schedule worked out once at the start, by payment, avoids errors later.

What does a full example look like?

Illustration only. A business acquires a machine with a cash price of £12,000 plus VAT of £2,400. It pays a deposit of £2,000 plus the £2,400 VAT, and finances £10,000 over three years at an implicit rate of 7%, with annual payments in arrears of £3,810.52. Annual payments keep the arithmetic simple; real agreements are usually monthly.

Year Opening liability Interest at 7% Payment Closing liability
1 £10,000.00 £700.00 £3,810.52 £6,889.48
2 £6,889.48 £482.26 £3,810.52 £3,561.22
3 £3,561.22 £249.30 £3,810.52 nil

At the start the machine is capitalised at £12,000, VAT input tax of £2,400 is debited, bank is credited with £4,400 and the liability with £10,000. Year 1’s payment is posted as interest £700 and capital £3,110.52. The machine is depreciated over its own useful life, say eight years, not over the three year agreement, because ownership will pass.

At the end of year 1 the closing liability of £6,889.48 is split for the balance sheet. The capital that will be repaid in year 2, £3,328.26, is a creditor due within one year; the remaining £3,561.22 is due after more than one year. FRS 102 paragraph 4.7 classifies a creditor as due within one year when the business has no unconditional right to defer settlement for at least 12 months.

How does hire purchase work for tax?

Capital allowances. Section 67 of the Capital Allowances Act 2001 treats the person paying under a hire purchase contract as the owner as soon as they are entitled to the benefit of the contract. HMRC’s Capital Allowances Manual at CA23310 explains that this lets the business claim plant and machinery allowances on payments still to be made as soon as the asset is brought into use. So the whole £12,000 in the example qualifies when the machine starts work, not as instalments are paid. The annual investment allowance can cover it, but GOV.UK confirms AIA cannot be claimed on business cars. Lease purchase contracts have extra conditions in CA23310.

Interest. The interest is a revenue cost. BIM45355 says the accounting method that spreads the interest element over the term under generally accepted accounting practice should be followed for tax. GOV.UK’s guidance for the self employed lists hire purchase interest as an allowable financial cost, while repayments of finance arrangements are not deductible.

VAT. Input tax is reclaimed on the cash price at the outset, not instalment by instalment, and there is no VAT on the exempt credit charge. Cars have their own input tax block; see VAT on cars, vans and fuel.

What happens at the end of the agreement?

Once the final payment and any option fee are made, the liability is nil and legal title passes. No further entries are needed beyond posting the last payment; the asset continues to be depreciated and is eventually disposed of in the normal way. If the agreement is settled early, the settlement figure is posted against the liability and any difference goes to interest. If the asset is returned or repossessed, it is derecognised and the remaining liability is settled or released.

What mistakes come up most often?

  • Expensing each payment as if it were rent, which leaves the asset and the debt off the balance sheet and overstates costs.
  • Capitalising only the deposit or only the payments made so far.
  • Claiming capital allowances as payments are made rather than on the full cash price when the asset is brought into use.
  • Reclaiming VAT on each instalment, or reclaiming VAT on the credit charge, which is exempt.
  • Depreciating over the agreement term when ownership will pass and the asset will last longer.
  • Showing the whole liability as long term instead of splitting out the capital due in the next 12 months.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.