Audit of Hire Purchase and Leasing Companies

Generally speaking, hire-purchase agreement means an agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of the agreement and includes an agreement under which:

  1.  possession of goods is delivered by the owner thereof to a person on condition that such person pays the agreed amount in periodical instalments, and
  2. the property in the goods is to pass to such person on the payment of the last of such instalments, and
  3. such person has a right to terminate the agreement at any time before the property so passes. Thus hirer means the person who obtains or has obtained possession of goods from an owner under a hire- purchase agreement and owner means the person who lets or has let, delivers or has delivered possession of goods to a hirer under a hire-purchase agreement in order to complete the purchase of, or the acquisition of property in the goods of which the agreement relates; and includes any sum so payable by the hirer under the hire- purchase agreement by way of a deposit or other initial payment.

While checking the hire- purchase transaction, the auditor may examine the following :
1. Hire purchase agreement is in writing and is signed by all parties.
2. Hire purchase agreement specifies clearly :

  • The hire-purchase price of the goods to which the agreement relates;
  •  The cash price of the goods, that is to say, the price at which the goods may be purchased by the hirer for cash;
  • The date on which the agreement shall be deemed to have commenced;
  • The number of instalments by which the hire- purchase price is to be paid, the amount of each of those instalments, and the date, or the mode of determining the date, upon which it is payable, and the person to whom and the place where it is payable; and
  • The goods to which the agreement relates, in a manner sufficient to identify them.

3. Ensure that payments are being received regularly as per the agreement. In a lease agreement, a party (called ‘lessee’) acquires the right to use an asset for an agreed period of time in consideration of payment of rent to another party (called ‘lessor’). In certain lease agreements, the legal ownership of the asset remains with the lessor (the leasing company), but in substance, all the risks and rewards of ownership of the asset are transferred to the lessee. In other words, the lease is, in effect, a financing arrangement. Such leases are termed as finance leases. An operating lease, on the other hand, is a simple arrangement where, in return for rent, the lessor allows the lessee to use the asset for a certain period. A normal financial lease transaction usually goes through the following modality: The lessee will select the equipment, and satisfy himself about its functional fitness and specifications, the lessor has no participation at this stage. Having chosen the equipment, the lessee approaches a lessor, either directly or through a leasebroking agency. The lease agreement is broadly negotiated and the rates are finalised. The lessor places an order on the manufacturer as chosen by the lessee. The manufacturer delivers the equipment at the site of the lessee, and the latter gives notice of acceptance to the lessor. The lease agreement giving detailed terms of contract is signed between the parties. Leases will normally be full pay-out, with term varying as per requirements.
During the lease period, the lessee :

  • Will pay rentals regularly at periods agreed-upon, which are usually each calendar month;
  • Will keep the equipment in good repair and working condition, etc.
  • Will be entitled to any manufacturer’s warranties or after-sales services.

At the end of the lease period, the equipment shall retreat to the lessor. The lessee may, however, be given a renewal right, or may be allowed to participate in purchase of the equipment when the lessor intends to sell it. No purchase option shall be given to the lessee in the lease agreement itself. In respect of leasing transaction entered into by the leasing company, the following procedures may be adopted by the auditor.
1. the object clause of leasing company to see that the goods like capital goods, consumer durables etc. in respect of which the company can undertake such activities. Further, whether company can undertake financing activities or not.
2. Whether there exists a procedure to ascertain the credit analysis of lessee like lessee’s ability to meet the commitment under lease, past credit record, capital strength, availability of collateral security, etc.
3. The lease agreement should be examined and the following points may be noted:

  • the description of the lessor, the lessee, the equipment and the location where the equipment is to be installed. (The stipulation that the equipment shall not be removed from the described location except for repairs. For the sake of identification, the lessor may also require plates or makings to be attached to the equipment).
  •  the amount of tenure of lease, dates of payment, late charges, deposits or advances etc. should be noted.
  • whether the equipment shall be returned to the lessor on termination of the agreement and the cost shall be borne by the lessee.
  • whether the agreement prohibits the lessee from assigning the subletting the equipment and authorises the lessor to do so.

4. Examine the lease proposal form submitted by the lessee requesting the lessor to provide him the equipment on lease.
5. Ensure that the invoice is retained safely as the lease is a long-term contract.
6. Examine the acceptance letter obtained from the lessee indicating that the equipment has been received in order and is acceptable to the lessee.
7. See the Board resolution authorising a particular director to execute the lease agreement has been passed by the lessee.
8. See that the copies of the insurance policies have been obtained by the lessor for his records.

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