When a lease qualifies as an operating lease, what are the journal entries recorded by a lessor?

• A. Debit Cash, Credit Rental Income
• B. Debit Rental Income, Credit Cash
• C. Debit Depreciation Expense, Credit Cash
• D. Debit Assets, Credit Rent Payable

Answer: (A)

When a lease qualifies as an operating lease, the lessor recognizes rental income when the lease payments are received. The correct journal entry involves debiting cash to reflect the receipt of payment and crediting rental income, which recognizes the revenue earned from leasing the asset. This is consistent with the revenue recognition principle, where income is recognized when it is earned, and in the case of leases, it is earned as the lessor allows the lessee to use the asset.

This approach applies because operating leases do not transfer ownership of the asset by the end of the lease term, and therefore, the lessor retains the asset on their balance sheet. As a result, every period in which rental payments are made, the lessor simply records the cash received and the corresponding rental income, underlining the nature of operating leases where the income is recognized as it is earned, rather than when the associated costs are incurred.