LMN trades in motor vehicles which are manufactured and supplied by their manufacturer, UK. Trading between the two entities is subject to a contractual agreement, the principal terms of which are as follows:
• LMN is entitled to hold on its premises up to 80 vehicles supplied by UK at any one time. LMN is free to specify the ranges and models of vehicle supplied to it. UK retains legal title to the vehicles until such time as they are sold to a third party by LMN.
• While the vehicles remain on its premises, LMN is required to insure them against loss or damage.
• The price at which vehicles are supplied is determined at the time of delivery; it is not subject to any subsequent alteration.
• When LMN sells a vehicle to a third party it is required to inform UK within three working days. UK submits an invoice to LMN at the originally agreed price; the invoice is payable by LMN within 30 days.
• LMN is entitled to use any of the vehicles supplied to it for demonstration purposes and road testing. However, if more than a specified number of kilometres are driven in a vehicle, LMN is required to pay UK a rental charge.
• LMN has the right to return any vehicle to UK at any time without incurring a penalty, except for any rental charge incurred in respect of excess kilometres driven.
Required:
Discuss the economic substance of the contractual arrangement between the two entities in respect of the recognition of inventory and of sales. Refer where appropriate to IAS 18, Revenue.