## Operating Lease Accounting – Straight-Line (SLM) Basis
### Core Principle
AS 19 requires lease income (lessor) and lease expense (lessee) to be recognised on a straight-line basis over the lease term, even if actual cash payments vary year to year.
> Average Rent p.a. = Total Lease Rentals over lease term ÷ Number of years
---
### The Lease Equalisation Account
When actual cash received/paid ≠ average rent recognised in P&L, the difference goes to Lease Equalisation A/c (a balance sheet item).
| Situation | Effect on Lease Equalisation A/c |
|---|
| Cash received/paid < Avg Rent | Debit (receivable/prepaid nature) |
| Cash received/paid > Avg Rent | Credit (deferred income/liability nature) |
---
### Journal Entry Framework
#### In Lessor's Books
Year when actual cash receipt < Avg Rent:
```
Cash/Bank A/c Dr (actual rent received)
Lease Equalisation A/c Dr (shortfall)
To Lease Rent Income (P&L) (avg rent)
```
Year when actual cash receipt > Avg Rent:
```
Cash/Bank A/c Dr (actual rent received)
To Lease Rent Income (P&L) (avg rent)
To Lease Equalisation A/c (excess)
```
#### In Lessee's Books
Year when actual cash paid < Avg Rent:
```
Lease Rent Expense (P&L) Dr (avg rent)
To Cash/Bank A/c (actual rent paid)
To Lease Equalisation A/c (shortfall – accrued liability)
```
Year when actual cash paid > Avg Rent:
```
Lease Rent Expense (P&L) Dr (avg rent)
Lease Equalisation A/c Dr (excess paid – recoverable)
To Cash/Bank A/c (actual rent paid)
```
---
### Key Point: No Depreciation for Lessee
In an operating lease, the lessee never records the asset on its balance sheet → no depreciation entry in lessee's books. (Contrast with finance lease where lessee does record asset + depreciation.)
### Example 1
Example – AK Ltd (Lessee) & BB Ltd (Lessor): 5-Year Operating Lease
AK Ltd took a studio on lease from BB Ltd for 5 years. Lease rentals:
| Year | Rent Payable |
|---|
| 1 | ₹1,00,000 |
| 2 | ₹1,10,000 |
| 3 | ₹1,20,000 |
| 4 | ₹1,30,000 |
| 5 | ₹1,40,000 |
| Total | ₹6,00,000 |
Average Rent = 6,00,000 ÷ 5 = ₹1,20,000 p.a.
---
BB Ltd's Books (Lessor) – Journal Entries:
Year 1 (Cash ₹1,00,000 < Avg ₹1,20,000 → Equalisation Dr):
```
Cash/Bank A/c Dr 1,00,000
Lease Equalisation A/c Dr 20,000
To Lease Rent Income (P&L) 1,20,000
```
(Equalisation balance: −20,000, shown as Current Asset in B/S)
Year 2 (Cash ₹1,10,000 < Avg ₹1,20,000):
```
Cash/Bank A/c Dr 1,10,000
Lease Equalisation A/c Dr 10,000
To Lease Rent Income (P&L) 1,20,000
```
Year 3 (Cash = Avg ₹1,20,000, no equalisation):
```
Cash/Bank A/c Dr 1,20,000
To Lease Rent Income (P&L) 1,20,000
```
Year 4 (Cash ₹1,30,000 > Avg → Equalisation Cr):
```
Cash/Bank A/c Dr 1,30,000
To Lease Rent Income (P&L) 1,20,000
To Lease Equalisation A/c 10,000
```
Year 5 (Cash ₹1,40,000 > Avg → Equalisation Cr ₹20,000):
```
Cash/Bank A/c Dr 1,40,000
To Lease Rent Income (P&L) 1,20,000
To Lease Equalisation A/c 20,000
```
(Equalisation fully clears to nil over 5 years)
---
AK Ltd's Books (Lessee) – Journal Entries:
Year 1 (Paid ₹1,00,000 < Avg ₹1,20,000 → accrued liability):
```
Lease Rent Expense (P&L) Dr 1,20,000
To Cash/Bank A/c 1,00,000
To Lease Equalisation A/c 20,000
```
Year 2:
```
Lease Rent Expense (P&L) Dr 1,20,000
To Cash/Bank A/c 1,10,000
To Lease Equalisation A/c 10,000
```
Year 3:
```
Lease Rent Expense (P&L) Dr 1,20,000
To Cash/Bank A/c 1,20,000
```
Year 4 (Paid ₹1,30,000 > Avg → reverse equalisation):
```
Lease Rent Expense (P&L) Dr 1,20,000
Lease Equalisation A/c Dr 10,000
To Cash/Bank A/c 1,30,000
```
Year 5:
```
Lease Rent Expense (P&L) Dr 1,20,000
Lease Equalisation A/c Dr 20,000
To Cash/Bank A/c 1,40,000
```
(Equalisation A/c balance = nil at end of lease — self-checking)