Finance lease

What it means

A finance lease is a form of leasing in which the lessee uses an asset for most of its useful life, pays almost its whole price through the instalments and usually buys it at the end for a residual, often nominal price. Economically it is a purchase on instalments, even though the lessor formally remains the owner until the end.

Under the substance over form principle, Slovak accounting therefore has the lessee, not the lessor, carry and depreciate the asset. The instalments are split into principal, which reduces the liability, and interest or fees, which are an expense.

The opposite is an operating lease, where the lessee merely uses the asset, pays rent as an expense and the asset stays with the lessor. The difference lies not in the contract’s title but in who bears the risks and rewards of ownership.

How it works in practice

When bringing a finance-leased asset into the books, we work from the contract and the repayment schedule. The acquisition cost the lessee depreciates is the asset’s price without finance charges. Interest and fees are expensed over the contract term according to the schedule.

For tax, the lessee claims the depreciation if the contract meets the statutory conditions, such as transfer of ownership at the end and a minimum lease term. If it does not, the tax treatment may differ from the accounting treatment and has to be tracked separately.

Finance leases are most common for company cars, machinery and equipment. For VAT, when an asset is supplied under a finance lease the tax is usually charged at once on the whole amount rather than per instalment, which affects both cash flow and the deduction.

What to watch out for

A common mistake is expensing finance lease instalments in full as if they were rent. Costs are then overstated, and both the asset and the liability to the leasing company are missing from the balance sheet. It comes out at an audit or a loan application.

Early termination, for example after a total loss or a sale, leads to complex settlements with the leasing company and the insurer. We recommend going through them with the accountant before signing any agreement so that the gain or loss is recorded correctly.