we have one Ledger and one OU but with 2 legal entities (LE1 & LE2).

when user tries to create an invoice under LE1 , it allows to choose Expense line BSV (balancing segment) from other Legal Entity (LE2).

why system allows this ?.

In such case, system tries to create INTERCOMAPNY lines after payment.

another point is;
though we have INTERCOMPANY setup exits (with Others & Others for both LE and BSV), still it gives accounting error that Intercompany setup does't exist. Do we need to explicitly setup INTERCOMPANY between LE1 and LE2 ?

Operating units are tied to ledgers and hence all available values are visible in company segment. You specify default legal context when defining operating units. The chosen legal entity will own the resulting transactions. However the resulting transactions could be entered against any balancing segment value. Oracle does not validate the balancing segment value entered at invoice distribution against the legal context chosen at header. From GL perspective the chosen balancing segment value is what matters.

Lets say BSV 01 and 02 belong to LE1 and 03 and 04 belong to LE2.

You can make LE1 the owner of the invoice with following lines:

DB: 01-EXPENSE $100
DB: 02-EXPENSE $100
CR: 01-LIABILITY $100
CR: 02-LIABILITY $100

You can pay this invoice from the bank account of LE1 and hence intercompany journal would be generated.

DB: 01-LABILITY $100
DB: 02-LIABILITY $100
CR: 01-CASH $200

You can restrict available values using security rules or personalizations if you like.

You should be able to create complex personalizations on invoice lines screen where system will not let you enter balancing segment value if it is not in agreement with chosen legal context at the header level. Customizations option is always there. Oracle performs no validation. AS far as Oracle is concerned LE1 can own a transaction that is touching BSV's of LE2. According to Oracle, this is done to make room for complex business needs.

Your intercompany rules should kick in. Make sure the intercompany setup is completed.