Carpart, a public limited company, is a vehicle part manufacturer, and sells vehicles purchased from the manufacturer.
Carpart has entered into supply arrangements for the supply of car seats to two local companies, Vehiclex and Autoseat.
(i) Vehiclex
This contract will last for five years and Carpart will manufacture seats to a certain specification which will require the construction of machinery for the purpose. The price of each car seat has been agreed so that it includes an amount to cover the cost of constructing the machinery but there is no commitment to a minimum order of seats to guarantee the recovery of the costs of constructing the machinery. Carpart retains the ownership of the machinery and wishes to recognise part of the revenue from the contract in its current financial statements to cover the cost of the machinery which will be constructed over the next year. (4 marks)
(ii) Autoseat
Autoseat is purchasing car seats from Carpart. The contract is to last for three years and Carpart is to design, develop and manufacture the car seats. Carpart will construct machinery for this purpose but the machineryis so specific that it cannot be used on other contracts. Carpart maintains the machinery but the know-how has been granted royalty free to Autoseat. The price of each car seat includes a fixed price to cover the cost of the machinery. If Autoseat decides not to purchase a minimum number of seats to cover the cost of the machinery, then Autoseat has to repay Carpart for the cost of the machinery including any interest incurred.
Autoseat can purchase the machinery at any time in order to safeguard against the cessation of production by Carpart. The purchase price would be the cost of the machinery not yet recovered by Carpart. The machinery has a life of three years and the seats are only sold to Autoseat who sets the levels of production for a period.
Autoseat can perform. a pre-delivery inspection on each seat and can reject defective seats. (9 marks)
(iii) Vehicle sales
Carpart sells vehicles on a contract for their market price (approximately $20,000 each) at a mark-up of 25%
on cost. The expected life of each vehicle is five years. After four years, the car is repurchased by Carpart at 20% of its original selling price. This price is expected to be significantly less than its fair value. The car must be maintained and serviced by the customer in accordance with certain guidelines and must be in good condition if Carpart is to repurchase the vehicle.
The same vehicles are also sold with an option that can be exercised by the buyer two years after sale. Under this option, the customer has the right to ask Carpart to repurchase the vehicle for 70% of its original purchase price. It is thought that the buyers will exercise the option. At the end of two years, the fair value of the vehicle is expected to be 55% of the original purchase price. If the option is not exercised, then the buyer keeps the vehicle.
Carpart also uses some of its vehicles for demonstration purposes. These vehicles are normally used for this
purpose for an eighteen-month period. After this period, the vehicles are sold at a reduced price based upon their condition and mileage. (10 marks)
Professional marks will be awarded in question 3 for clarity and quality of discussion. (2 marks)
Required:
Discuss how the above transactions would be accounted for under International Financial Reporting Standards in the financial statements of Carpart.
Note. The mark allocation is shown against each of the arrangements above.