Calculation of Interest Charge - SS3 Accounting Lesson Note

In a hire purchase agreement, the seller charges interest on the outstanding balance of the purchase price, which is included in the regular installment payments made by the buyer. The interest charge is usually expressed as a percentage of the outstanding balance, and it varies depending on the terms of the agreement.

For example, let's say that a buyer purchases a car with a hire purchase agreement that has the following terms:

Purchase price of the car: ₦1,000,000

Deposit: ₦200,000

Term of the agreement: 24 months

Interest rate: 10% per annum

To calculate the interest charge on the outstanding balance at the end of each month, we can use the following formula:

Interest charge for the month = (Outstanding balance x Interest rate / 12)

Where:

Outstanding balance = Purchase price - Deposit - Total instalment payments made

Let's assume that the buyer has made 6 instalment payments of ₦40,000 each, and we want to calculate the interest charge on the outstanding balance at the end of the 7th month.

The outstanding balance at the end of the 6th month can be calculated as follows:

Outstanding balance = ₦1,000,000 - ₦200,000 - (₦40,000 x 6)

= ₦540,000

The interest charge for the 7th month can be calculated as follows:

Interest charge for the month = (₦540,000 x 10% / 12)

= ₦4,500

Therefore, the total instalment payment for the 7th month would be:

Total installment payment for the month = ₦40,000 + ₦4,500

= ₦44,500