Operating Lease Treatment by Lessors

In an operating lease, lessors receive periodic interest payments against the leased asset but the asset remains on their balance sheet and they continue to depreciate it in line with its fixed asset accounting policy.

Accounting for operating leases is simple: the lessor just need to record the periodic rental payments received from the lessee on some systematic basis which is mostly the straight line method. There is no periodic interest income related to operating lease.

Example

Company OL leased construction equipment on monthly rental of $10,000 to Company LO on 1 January 2012 for 6 months. Company LO paid $60,000 on 1 January and Company OL passed the following journal entry:

Cash60,000
Unearned Lease Rental Revenue60,000

The cost of the asset is $300,000 and Company OL depreciates it over 5 years.

Company OL, the lessor should record the lease rental income equally over the life of the lease term despite the fact that the payment was received in January. Company OL will record lease rental income of $10,000 per month for the six month as follows:

Unearned Lease Rental Revenue10,000
Lease Rental Revenue10,000

During the six months Company OL shall also record depreciation expense of $40,000 (0.5 multiplied by $300,000 divided by 5).

Written by Obaidullah Jan