Financial Accounting · Lease Accounting

Operating Leases and Sale and Leaseback under AS 19

Updated 10 October 2026 · Fact-checked

Under AS 19, an operating lease is not a transfer of ownership risks, so the lessee expenses rent and the lessor records rent income, both on a straight-line basis over the lease term. In a sale and leaseback, first classify the lease; then treat profit or loss as the rules for that lease type require.

Understand Operating Leases and Sale and Leaseback

In an operating lease, the lessor keeps the asset on its balance sheet and keeps depreciating it. The lessee does not record the asset. The lessee simply charges rent to the statement of profit and loss.

The key rule is straight-line recognition. The lessee expenses rent evenly over the lease term, and the lessor recognises rent income evenly, even if cash payments are uneven (for example, rent that rises each year or a rent-free first year). The only exception is where another systematic basis better matches the pattern of the user's benefit. The difference between the expense and the cash paid sits in the balance sheet as a prepaid or accrued amount.

Charges for services such as insurance and maintenance are excluded from the straight-lining. The lessor also depreciates the leased asset and charges it as an expense in earning the lease income. Initial direct costs the lessor incurs to earn the operating lease revenue are either deferred and spread over the lease term in proportion to rent income, or expensed when incurred.

A sale and leaseback means you sell an asset and lease the same asset back. The sale price and the lease rentals are usually negotiated as a package, so they depend on each other. The accounting depends on the type of lease that results.

If the leaseback is a finance lease, any excess or deficiency of sale proceeds over carrying amount is not recognised at once by the seller-lessee. It is deferred and amortised over the lease term in proportion to depreciation of the leased asset. If it is an operating lease, the treatment depends on how the sale price compares with fair value, as set out below.

Key rules to remember

Lessee rent expense (operating lease): Annual expense = Total lease payments over the lease term ÷ Number of years in the lease term; Use this when rent is uneven and no other systematic basis is more representative. Exclude service charges such as insurance and maintenance.
Lessor rent income (operating lease): Annual income = Total lease rentals over the lease term ÷ Number of years in the lease term; Lessor also charges depreciation on the leased asset as an expense.
Prepaid or accrued rent: Difference = Straight-line expense − Cash paid in the year; If expense is more than cash paid, it is an accrued liability. If cash paid is more, it is a prepayment.
Sale and leaseback: finance lease: Profit or loss = Sale price − Carrying amount, deferred and amortised over the lease term in proportion to depreciation; Applies to the seller-lessee. It is not recognised immediately.
Sale and leaseback: operating lease, at fair value: Profit or loss = Sale price − Carrying amount, recognised immediately; Applies when it is clear the transaction is at fair value.
Sale and leaseback: operating lease, sale price below fair value: Profit or loss recognised immediately; a loss compensated by below-market future rentals is deferred and amortised in proportion to lease payments over the expected period of use; Check whether the loss is compensated by below-market rentals before deferring.
Sale and leaseback: operating lease, sale price above fair value: Excess of sale price over fair value = deferred and amortised over the expected period of use; The part up to fair value (Fair value − Carrying amount) is recognised immediately.
Sale and leaseback: operating lease, fair value below carrying amount: Loss recognised immediately = Carrying amount − Fair value; Applies to operating leases where fair value at the time of sale is below carrying amount.

How to solve Operating Leases and Sale and Leaseback questions

Use this order for any question on operating leases or sale and leaseback.

1Identify the party asked for: lessor, lessee, seller-lessee or buyer-lessor.
2Confirm the lease type (finance or operating) from the facts given. In a sale and leaseback, this decides the treatment.
3For a plain operating lease, add up all rentals over the whole lease term, including rent-free periods and step-ups, but exclude service charges.
4Divide by the lease term to get the straight-line annual figure. Compare it with cash paid to find the prepaid or accrued amount.
5For a lessor, also charge depreciation on the leased asset and treat initial direct costs as AS 19 permits.
6For sale and leaseback, compute carrying amount, sale price and fair value. Find the profit or loss on sale.
7Apply the rule: finance lease means defer and amortise; operating lease means test sale price against fair value and split the gain or loss into the immediate part and the deferred part.
8Write journal entries or the ledger extract, and state the amount charged to the statement of profit and loss for the year.

Quickest way: Three-line check for sale and leaseback

When to use it: Use this in MCQs and in the first minute of a written answer.

Ask: finance lease or operating lease?
If finance lease: profit or loss is deferred and amortised over the lease term in proportion to depreciation.
If operating lease: compare the sale price (SP), fair value (FV) and carrying amount (CA). SP = FV means recognise at once. SP below FV means recognise at once, unless a loss is compensated by below-market rentals, then defer. SP above FV means defer the excess over FV and recognise the rest at once. If FV is below CA, recognise the loss (CA − FV) immediately.

Common mistakes in Operating Leases and Sale and Leaseback

Charging rent to the profit and loss account as per cash paid each year
Students follow the payment schedule instead of the standard.
Fix: Total all rentals over the lease term and spread them evenly, unless another systematic basis is more representative of the user's benefit.
Including insurance and maintenance charges in the straight-lined amount
The agreement quotes one lump sum, so everything gets averaged.
Fix: Separate service charges first. AS 19 excludes them from straight-lining.
Deferring the whole profit in a sale and leaseback that results in an operating lease at fair value
Students apply the finance lease rule to every case.
Fix: Classify the lease first. Operating lease at fair value means immediate recognition.
Recognising the whole gain at once when the sale price is above fair value
Students look at sale price minus carrying amount only.
Fix: Split the gain. Recognise fair value minus carrying amount immediately; defer the excess of sale price over fair value and amortise it over the period of expected use.
Forgetting depreciation in the lessor's books
Students treat the lessor like a seller of the asset.
Fix: The lessor still owns the asset, so it depreciates it and charges depreciation as an expense in earning the lease income.
Showing the asset in the lessee's books for an operating lease
Confusion with finance lease accounting.
Fix: In an operating lease, the lessee records only the rent expense and any prepaid or accrued rent.

Worked examples

Example 1

Aarav Traders takes a machine on an operating lease for 4 years from 1 April. The rent is ₹1,00,000 in year 1, ₹1,20,000 in year 2, ₹1,40,000 in year 3 and ₹1,60,000 in year 4. No other systematic basis is more representative. Show the rent expense and the accrued rent at the end of each year.

Show the solution

Total rentals = 1,00,000 + 1,20,000 + 1,40,000 + 1,60,000 = ₹5,20,000.
Straight-line expense per year = 5,20,000 ÷ 4 = ₹1,30,000.
Year 1: expense 1,30,000; paid 1,00,000; accrued rent = 30,000 (cumulative 30,000).
Year 2: expense 1,30,000; paid 1,20,000; accrued 10,000 added (cumulative 40,000).
Year 3: expense 1,30,000; paid 1,40,000; 10,000 reversed (cumulative 30,000).
Year 4: expense 1,30,000; paid 1,60,000; 30,000 reversed (cumulative nil).
Year 1 entry: Rent A/c Dr ₹1,30,000 to Bank ₹1,00,000 and to Outstanding Rent ₹30,000.

Answer: Rent expense is ₹1,30,000 every year. Accrued rent at year-end is ₹30,000, ₹40,000, ₹30,000 and nil for years 1 to 4.

Example 2

Meera Ltd sells equipment with carrying amount ₹8,00,000 and leases it back under an operating lease. Fair value is ₹10,00,000. Case A: sale price ₹10,00,000. Case B: sale price ₹11,50,000. The asset is expected to be used for 5 years. State the profit recognised immediately and the amount deferred in each case.

Show the solution

Case A: sale price equals fair value, so the transaction is established at fair value.
Profit = 10,00,000 − 8,00,000 = ₹2,00,000, recognised immediately.
Case B: sale price is above fair value.
Profit up to fair value = 10,00,000 − 8,00,000 = ₹2,00,000, recognised immediately.
Excess over fair value = 11,50,000 − 10,00,000 = ₹1,50,000, deferred.
Amortise the deferred amount over the period of expected use: 1,50,000 ÷ 5 = ₹30,000 per year.

Answer: Case A: profit ₹2,00,000 recognised immediately, nothing deferred. Case B: ₹2,00,000 recognised immediately and ₹1,50,000 deferred, amortised at ₹30,000 per year over 5 years.

Exam tips

Always state the lease type before computing a sale and leaseback. Examiners award a mark for classification.
In straight-line problems, show the total rentals, the division by the lease term and the prepaid or accrued balance. These are step marks.
In MCQs, watch for words such as at fair value, below fair value and compensated by below-market rentals. They change the answer.
Write the journal entry with narration. Always mention the statement of profit and loss as the place of charge.
Quote AS 19 in a line when explaining treatment, for example that a finance lease gain or loss is deferred and amortised in proportion to depreciation.

Practice questions from Lease Accounting

Operating Leases and Sale and Leaseback 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 and Sale and Leaseback: frequently asked questions

Why is rent straight-lined in an operating lease?

AS 19 requires lease payments to be expensed on a straight-line basis over the lease term, even if payments are not on that basis. The exception is where another systematic basis is more representative of the time pattern of the user's benefit.

Does the lessor depreciate the asset in an operating lease?

Yes. The lessor keeps the asset and charges costs, including depreciation, incurred in earning the lease income as an expense.

How is profit treated in a sale and leaseback that is a finance lease?

The seller-lessee does not recognise the excess of sale proceeds over carrying amount as income at once. It is deferred and amortised over the lease term in proportion to the depreciation of the leased asset.

What if the sale price is below fair value in an operating leaseback?

Any profit or loss is recognised immediately. The exception is a loss that is compensated by future lease payments at below market price. That loss is deferred and amortised in proportion to the lease payments over the period the asset is expected to be used.