How to Account for a Lease

Leasing is a widespread way to finance vehicles, machinery and equipment without tying up cash in the purchase. But “lease” is not a single accounting category: depending on how the contract is structured, the asset may stay off the balance sheet or enter it as a fixed asset with a corresponding liability. Knowing which case you are in determines the year’s result and the structure of the balance sheet.

Two types of lease

The underlying economic distinction is between two forms:

Operating lease: it resembles a rental. The user pays an instalment to use the asset for a period, at the end of which the asset returns to the leasing company. The risks and rewards of ownership remain with the lessor.
Finance lease: it resembles a purchase by instalments. The term covers most of the asset’s useful life, often with a purchase option at a modest value. In substance the user bears the risks and rewards of ownership, even though they are not formally the owner until the buy-out.

The classification does not depend on the label of the contract but on the economic substance: term relative to useful life, presence and value of the purchase option, allocation of risks.

How to record an operating lease

In an operating lease the treatment is straightforward:

The periodic instalment goes directly to expense in the income statement, among operating costs.
The asset does not appear under assets in the user’s balance sheet, because they are not its economic owner.
Any instalments paid across the year-end are delimited with accruals and deferrals.

This is the simplest case and often the most frequent for vehicles and equipment on a short-to-medium term.

How to record a finance lease

When the substance is that of a financed purchase, the approach changes:

The asset is capitalised under assets as a fixed asset, at its value, and depreciated over its useful life.
As a counterpart, a lease liability is recorded under liabilities, equal to the residual commitment.
Each instalment is split into two parts: the principal portion, which reduces the liability, and the interest portion, which goes to expense among financial charges.

In this way the income statement takes in depreciation and interest rather than the entire instalment, and the balance sheet reflects both the asset and the liability.

The Swiss framework

The Code of Obligations does not impose a rigid scheme like some international standards, but requires a representation that is true and consistent with the economic substance, in compliance with the prudence principle. In SME practice many leases are treated as operating, with the instalment as an expense, when this adequately reflects the transaction. In cases where the contract is substantially equivalent to a purchase, capitalisation is the more correct representation.

Two practical aspects not to overlook:

VAT: on lease instalments the tax is as a rule shown on the invoice and recoverable as input tax, if the asset serves the taxable activity. It must be managed on the individual instalments.
Multi-year consistency: once a treatment is chosen for a contract, it must be maintained for its entire term.

Common mistakes

Treating as a full expense a finance lease that is equivalent to a purchase, keeping the asset and the liability off the balance sheet.
Failing to split the finance-lease instalment into a principal portion and an interest portion.
Forgetting the year-end adjustments on instalments straddling the financial year.
Not capitalising the asset when the purchase option makes the acquisition effectively certain.

In summary

The economic substance, not the label, decides the treatment.
Operating lease: instalment as an expense, asset off the balance sheet.
Finance lease: asset capitalised and depreciated, liability under liabilities, instalment split into principal and interest.
VAT on the instalments and consistency over time must always be overseen.

How we help you

We analyse leasing contracts to classify them correctly and set up the accounting treatment that best fits the economic substance, in compliance with the Code of Obligations and VAT management. We account for your leases.