What is an open-ended lease?

At contract setup you agree the term and the permitted usage in kilometres or hours, and the lessor sets an estimated residual based on expected market conditions. Your rentals cover the depreciation from purchase price down to that residual, plus the lessor's margin. During the lease you operate the asset and keep up the required servicing and insurance; some contracts bundle maintenance or full-service options.

At the end the asset is returned and the lessor remarkets it. The realised market value, net of selling costs, is compared with the residual estimate. If the proceeds fall short, you pay the difference as a terminal payment; if they exceed the residual, you may receive a surplus credit, depending on the contract. Excess kilometres or hours and damage beyond fair wear and tear attract separate fees. The settlement is usually invoiced within a contract-specific window after the sale, to allow for remarketing and final valuation.

The difference is who wears the residual. Under an open-ended lease the lessee bears any shortfall, so the rentals are lower and the end-of-term outcome is a variable settlement. Under a closed-end lease the lessor bears the residual risk, the rentals are higher because that risk is priced in, and you simply hand the asset back and pay fixed charges for excess kilometres or damage.

Open-ended leases suit fleets and businesses comfortable with a variable terminal payment; closed-end leases suit private lessees and low-risk corporate users who want cost certainty. For accounting, the lessee recognises a right-of-use asset and a lease liability either way, while in the lessor's books an open-ended lease usually sits as a finance lease and a closed-end one as an operating lease.

Beyond the shortfall itself, the common end-of-lease charges are reconditioning if the asset exceeds the wear-and-tear thresholds, excess kilometre or hour fees, administrative and remarketing fees, and early termination penalties or indexation clauses. Check whether selling costs are netted from the sale proceeds and whether administration fees are added on top.

The risk can be reduced. A residual value guarantee from the manufacturer or another third party, or a lessor-agreed cap on the shortfall, limits the exposure for a higher periodic cost, and residual-risk or gap insurance can limit the cash you have to find. When negotiating, ask for market evidence behind the residual, agree wider usage bands, cap reconditioning fees, and require a transparent remarketing fee schedule. Red flags are residuals set solely by the lessor without a methodology, uncapped fees and vague fair wear and tear definitions.

Under AASB 16 the lessee recognises a right-of-use asset and a lease liability for most leases, with depreciation on the asset and interest on the liability, and amounts expected to be payable under a residual value guarantee are built into that liability. The finance or operating classification now belongs to the lessor's books. GST is generally payable on the rentals, while the GST treatment of the terminal settlement depends on whether it is a supply or an adjustment. Cars with private use by employees can attract fringe benefits tax. Rentals and terminal shortfalls are typically deductible business expenses when incurred to produce assessable income, but the timing can differ from the accounting recognition, so confirm the position with your accountant.