When a firm purchases an asset with debt, both the asset and the liability appear on the firm’s balance sheet. If a lease meets at least one of a number of criteria, it must be capitalized. This means that the present value of the lease appears as both an asset and a liability. A lease escapes capitalization if it does not meet any of these criteria. Leases not meeting the criteria are called operating leases, though the accountant’s definition differs somewhat from the practitioner’s definition.

Operating leases do not appear on the balance sheet. For cosmetic reasons, many firms prefer that a lease be called operating. LO.1