Advanced Accounting · AS 19 Leases

AS 19 Operating Leases for Lessee and Lessor

Updated 4 October 2026 · Fact-checked

An operating lease is any lease that is not a finance lease. The lessee charges lease rentals to the Statement of Profit and Loss on a straight-line basis. The lessor shows the asset in its books, depreciates it, and recognises lease income on a straight-line basis. Use another systematic basis only if it fits the time pattern of benefit better.

Understand Operating Leases for Lessee and Lessor

A lease is an agreement where the lessor gives the lessee the right to use an asset for an agreed period in return for payment. Under AS 19, a lease is an operating lease when it does not transfer substantially all the risks and rewards of ownership. Everything that is not a finance lease falls here.

Because ownership risks stay with the lessor, the asset never moves to the lessee's balance sheet. The lessee treats the lease like a rent contract. The lessor keeps the asset as its own and earns income from it.

The key idea is straight-line recognition. Rentals may be uneven, for example a rent-free first year or fixed yearly escalation. AS 19 says the lessee should still charge the expense on a straight-line basis over the lease term. It also says the lessor should recognise the income on a straight-line basis. The exception is another systematic basis that better represents the time pattern of the user's benefit, or of the lessor's benefit from the asset, even if payments are not on that basis.

The lessor has two more tasks. It depreciates the leased asset on the same basis as its normal depreciation policy for similar owned assets. It also deals with initial direct costs, such as commission and legal fees incurred to arrange the lease. In an operating lease, the lessor either recognises these costs immediately as an expense or allocates them over the lease term against the lease income.

The common exam pattern is a lease with uneven rentals. You total all rentals over the lease term, divide by the number of years, and get the yearly straight-line figure. Then you compare it with the cash actually paid or received and show the difference as an accrued or prepaid (deferred) amount.

Key rules to remember

Straight-line annual lease expense or income: Annual amount = Total lease rentals over the lease term ÷ Number of years in the lease term; Use this when rentals are uneven, unless another systematic basis better reflects the time pattern of benefit. Include rent-free periods in the lease term.
Difference between straight-line charge and cash: Difference = Straight-line amount − Cash rental for the year; For the lessee, positive = accrued liability (outstanding lease rent); negative = prepayment. For the lessor, positive (income > cash received) = accrued income receivable; negative = deferred or advance income.
Lessor's annual depreciation on leased asset: Depreciation as per the lessor's normal policy for similar owned assets (e.g. (Cost − Residual value) ÷ Useful life); Depreciation is based on the asset's useful life, not on the lease term.
Initial direct costs, lessor (operating lease): Expense immediately, or allocate over the lease term against lease income; Pick one method and apply it consistently. Do not add these costs to the asset's cost.
Lessor's net income from the lease: Net income = Lease income − Depreciation − Initial direct costs charged (and other operating costs); Use this when the question asks for the lessor's profit for a year.

How to solve Operating Leases for Lessee and Lessor questions

Use this order for any operating lease question. It works whether the question is from the lessee's or the lessor's side.

1Confirm the lease is an operating lease. Look for statements such as 'ownership is not transferred' or 'the lease is cancelled' or any question that says treat as operating lease.
2Identify whose books you are writing in: lessee or lessor. Note what is asked: expense, income, journal entry or net profit.
3Find the lease term, including any rent-free period, and list the rental for each year.
4Add all rentals and divide by the number of years to get the straight-line amount, unless the question gives a better basis.
5Compare the straight-line amount with the cash rental for each year. The difference goes to prepaid or accrued lease rent (lessee) or accrued or deferred lease income (lessor).
6For the lessor, compute depreciation on the asset using its own policy and useful life. Then deal with initial direct costs: expense immediately or spread over the lease term.
7Pass the journal entries or show the Statement of Profit and Loss extract. State the amounts and the basis clearly.
8Add a one-line closing statement, for example: 'Lessee charges ₹X per year as per AS 19.'

Quickest way: Total ÷ years, then adjust for cash

When to use it: Use for MCQs and for the calculation part of written answers when rentals are uneven or a rent-free period exists.

Add every rental over the full lease term. Count rent-free years as zero but include them in the term.
Divide by the number of years. This is the yearly expense for the lessee and income for the lessor.
Subtract cash for that year from the straight-line amount. Lessee: positive = accrued liability, negative = prepayment. Lessor: positive (income > cash) = accrued income receivable, negative = deferred or advance income.
For MCQs, eliminate options showing cash rental as the expense. Also eliminate options showing the lessee recording the asset or the lessor depreciating over the lease term when useful life differs.
In written answers, show three parts: total rental, annual charge, journal entry. Each part earns step marks.

Common mistakes in Operating Leases for Lessee and Lessor

Charging the cash rental paid in the year as the expense.
Students follow the actual payments, as in cash accounting.
Fix: When rentals are uneven, compute total ÷ years and charge that amount each year. Cash only decides the prepaid or accrued figure.
Leaving out a rent-free period when counting years.
It looks like no payment means no year.
Fix: The rent-free period is part of the lease term. Include it in the denominator.
Capitalising the leased asset in the lessee's books.
Students mix up finance lease treatment with operating lease treatment.
Fix: In an operating lease the lessee records only rent expense. The asset stays in the lessor's books.
Depreciating the leased asset over the lease term in the lessor's books.
Students link depreciation to the contract period.
Fix: The lessor depreciates on its normal policy for similar assets, based on useful life.
Adding initial direct costs to the cost of the asset by the lessor.
The finance lease rule on direct costs creates confusion.
Fix: For an operating lease, expense them immediately or allocate them over the lease term against income. They do not increase the asset's cost.
Reversing the prepaid and accrued entries between lessee and lessor.
Students forget that one side's expense is the other side's income.
Fix: Lessee: charge more than cash means a liability. Lessor: income more than cash received means a receivable.

Worked examples

Example 1

A Ltd. (lessee) takes machinery on an operating lease for 4 years. The annual rentals are ₹2,00,000 in year 1, ₹3,00,000 in year 2, ₹3,00,000 in year 3 and ₹4,00,000 in year 4. No other systematic basis is more representative. Compute the lease rent to be charged each year and show the effect of year 1 and year 2 on the books.

Show the solution

Total rentals = 2,00,000 + 3,00,000 + 3,00,000 + 4,00,000 = ₹12,00,000.
Straight-line charge = 12,00,000 ÷ 4 = ₹3,00,000 per year.
Year 1: charge ₹3,00,000, cash paid ₹2,00,000. Difference ₹1,00,000 is accrued lease rent (liability).
Year 1 entry: Lease Rent A/c Dr. ₹3,00,000; To Bank A/c ₹2,00,000; To Outstanding Lease Rent A/c ₹1,00,000.
Year 2: charge ₹3,00,000, cash paid ₹3,00,000. No change. Accrued balance remains ₹1,00,000.
Year 2 entry: Lease Rent A/c Dr. ₹3,00,000; To Bank A/c ₹3,00,000.
(Year 3 also has charge equal to cash, so the balance stays at ₹1,00,000. Year 4: charge ₹3,00,000, cash ₹4,00,000, which clears the ₹1,00,000 accrued balance.)

Answer: Lease rent of ₹3,00,000 is charged every year. Year 1 creates an outstanding lease rent of ₹1,00,000, and it remains until year 4, when it is cleared.

Example 2

B Ltd. (lessor) leases equipment costing ₹10,00,000 to C Ltd. under a 3-year operating lease. Rentals are nil in year 1, ₹6,00,000 in year 2 and ₹6,00,000 in year 3. The equipment has a useful life of 5 years and no residual value, and B Ltd. depreciates such assets on the straight-line basis. B Ltd. incurred initial direct costs of ₹60,000 and charges them over the lease term. Compute B Ltd.'s net income from the lease for year 1.

Show the solution

Total rentals = 0 + 6,00,000 + 6,00,000 = ₹12,00,000.
Lease income per year (straight line over 3 years) = 12,00,000 ÷ 3 = ₹4,00,000.
Year 1 cash received is nil, so the ₹4,00,000 is accrued lease income (receivable).
Depreciation = 10,00,000 ÷ 5 = ₹2,00,000 per year. It follows useful life, not the 3-year lease term.
Initial direct costs charged to year 1 = 60,000 ÷ 3 = ₹20,000.
Net income for year 1 = 4,00,000 − 2,00,000 − 20,000 = ₹1,80,000.

Answer: B Ltd.'s net income from the lease for year 1 is ₹1,80,000, even though no cash was received.

Exam tips

Check whether the question says the lease is operating or asks you to classify it. If the classification is not given, test for transfer of risks and rewards first.
Write the total rentals and the division on separate lines. Examiners award marks for the method even if the final figure goes wrong.
In lessor questions, calculate depreciation on useful life and lease income on lease term. Keep the two bases separate.
Read for rent-free periods and fixed escalations in MCQs. They almost always signal a straight-line adjustment.
End each answer with a short statement naming AS 19 and the basis used, for example straight line.

Practice questions from AS 19 Leases

Operating Leases for Lessee and Lessor in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Operating Leases for Lessee and Lessor: frequently asked questions

Why does AS 19 require straight-line rent even when payments are uneven?

The benefit from using or leasing the asset is spread across the lease term. Charging cash paid would put too little expense in early years or too much in later years. Straight line matches the expense or income to the period of use. The exception is another systematic basis that better reflects the time pattern of benefit.

How does a lessor treat initial direct costs in an operating lease?

The lessor either recognises them as an expense immediately or allocates them over the lease term against the lease income. They are not added to the cost of the leased asset. Apply the chosen method consistently.

Does the lessee show the leased asset in its balance sheet in an operating lease?

No. The lessee records only the lease payments as an expense in the Statement of Profit and Loss. The lessor keeps the asset in its balance sheet and depreciates it.

Is the rent-free period part of the lease term?

Yes. Count it when you work out the number of years for the straight-line calculation. Include its zero rental in the total and divide by the full term.