Inventory Familiarization Project

Diamonds Forever Inventory Familiarization Project

Instructions/Descriptions

Diamonds Forever Inventory Familiarization Project

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MODULE 1: CASE FOR COMPLETION Background of the Company: Diamonds Forever

Diamonds Forever has been operating in the diamond business for four years and deals almost exclusively in investment diamonds. Although they occasionally purchase other stones, these purchases are on the basis of special order requests from existing clients. These special order stones are bought from local suppliers and are generally sold within a few days and, as such, they are never material to the total inventory.

Diamonds Forever purchases both certified individual diamonds and non-certified parcels of diamonds from a single supplier, Diamonds Last. The certified diamonds arrive wrapped in individual soft paper wrappers that show the diamond categorization details on the front. The recorded details include color (which indicates quality), cut (which indicates shape), clarity (which indicates defects), and carat (which indicates weight).

A unique inventory number is assigned to each diamond wrapper and is written on the top right-hand corner of the front of the wrapper. These details are also recorded in the inventory records, along with the purchase price extracted from the supplier invoice. The inventory of wrapped diamonds is stored in inventory number order in a diamond storage box holding similarly classified diamonds. The storage boxes are held in the safe located in the CEO’s office. The CEO is the only person to have the safe code.

The non-certified diamonds included in each purchase arrive as a single diamond parcel in a zip-seal plastic bag. The total carat weight is shown on the front of this bag. The diamonds purchased as a diamond parcel are sorted and split into smaller parcels. These smaller parcels are constructed by sorting and categorizing the purchased parcel of diamonds according to color, cut, clarity, and carat.

The categorized diamonds are then stored in parcels in small pre-numbered zip- seal plastic bags. These parcels are sold by Diamonds Forever according to the parcel carat weight. Each of the categorized diamond parcel bags includes an inventory record sheet identifying the parcel number, the total quantity and total carat weight of the diamonds in the parcel, as well as the color, cut, clarity, and carat of each diamond in the parcel.

This inventory record sheet is used as a subsidiary inventory record, with only the total number, total carat weight, and apportioned purchase price of the diamonds included in the main inventory records. To establish the purchase price of each small parcel, the total purchase price of the original purchased parcel is apportioned on a per-carat basis using the following formula: total purchase price 3 (carat weight of small parcel/ total carat weight of purchased parcel).

Similar to the individually wrapped diamonds, the diamond parcel zip-seal bags are stored in inventory number order in a diamond storage box. The storage boxes are held in the safe located in the CEO’s office, along with the storage boxes for the individually wrapped certified diamonds.

Instructions and Requirements for Completing Module 1 in the Classroom

You are the new audit senior on the 20X1 year-end audit of Diamonds Forever. In planning for this audit, your audit manager has asked you to familiarize yourself with both the physical inventory and the inventory recording system for the diamond parcels. Your audit manager has asked that you specifically consider the key audit assertions that need to be considered in relation to the audit of the diamond parcel inventory and the individually wrapped certified diamonds.

Requirement 1: Inventory

Using the sample inventory diamond parcel and the sample of individually wrapped certified diamonds provided, familiarize yourself with both the physical diamond inventory and the diamond inventory record for the diamond parcel as well as the wrapped diamonds.

Discuss and complete Answer Template A. As part of your inventory familiarization process, you are required to discuss and provide answers to the following two questions by completing Answer Template A, provided in Exhibit 1. [Note: To assist you in answering the questions, Answer Template A lists the account balance assertions]:

(a) Discuss and determine the key Account Balance Assertions that may be at risk for the diamond inventory, and

(b) Discuss and determine whether the sample of individually wrapped certified diamonds and the sample inventory parcel, including the inventory record, provides evidence that indicates any specific Account Balance Assertion is at risk for the 20X1 year-end audit.

EXHIBIT 1 Answer Template A: Inventory Familiarization

Note: To assist you in completing this Answer Template, recall that the Account Balance Assertions include: Existence, Rights and Obligations, Completeness, and Valuation and Allocation.

Answer Template B: Transaction-Level Assertions for Sales and Purchases

Requirement 2: Sales Transaction

Assume that the sales transaction outlined below has been selected for detailed testing as part of the 20X1 year-end audit procedures:

Sales transaction details. A new client, Innovative Investments, placed an urgent purchase order with DiamondsForever four days prior to year-end for the following diamonds:

Five Rose-colored diamonds (one carat, F color rating, brilliant cut) with a sale price of $25,000 each; and

Ten White diamonds (one carat, G color rating, princess cut) with a sale price of $6,000 each.

This order was able to be filled using two diamond parcels currently in the Diamonds Forever inventory. Specifically, diamond parcel number PX1-5 and diamond parcel number PX1-7, which were the 5th and 7th diamond parcels, respectively, constructed from diamonds purchased by Diamonds Forever during 20X1, were identified as containing diamonds matching this order.

To ensure these diamonds were not able to be sold to another client, the inventory records and the sales journal were updated to reflect this transaction one day after receiving the order. Diamonds Forever shipped diamond parcel PX1-5 to Innovative Investments on the last day of the financial year, and diamond parcel PX1-7 was shipped on the first day of the new financial year.

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In relation to this transaction, you are required to discuss and provide answers to the following five-part question by completing Panel A of Answer Template B, provided in Exhibit 1: What evidence would you need to obtain in order to support each of the following five assertions for this recorded transaction?

(a) the occurrence assertion—in other words, how do you know that the sale to Innovative Investments actually took place?

(b) the completeness assertion—in other words, how do you know that the entire sale was recorded?

(c) the accuracy assertion—in other words, how do you know that the details of the sale, e.g., the sale amount, were correctly recorded?

4. (d) the cut-off assertion—in other words, how do you know that the transaction was recorded as a sale in the correct accounting period?
5. (e) the classification assertion—in other words, how do you know that the sale was recorded in the proper accounts?

Requirement 3: Purchases Transaction

Assume that the purchases transaction outlined below has been selected for detailed testing as part of the 20X1 year-end audit procedures:

Purchase transaction details. JGems, a valued customer of Diamonds Forever, placed an order for three sapphires of approximately one carat each on November 30, 20X1. Diamonds- Forever recorded a purchase for the three stones on December 5, when they were able to source the required stones from September Stones. September Stones delivered the stones in two separate parcels on December 20 (consisting of one 1.1 carat sapphire) and 14 days later (consisting of two sapphires, each 1.2 carats). In both cases, the sapphires were sold and delivered to JGems two days after taking delivery.

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In relation to this transaction, you are required to discuss and provide answers to the following five-part question by completing Panel B of Answer Template B, provided in Exhibit 1: What evidence would you need to obtain in order to support each of the following five assertions for this recorded transaction?

1. (a) the occurrence assertion—in other words, how do you know that the purchase actually took place?
2. (b) the completeness assertion—in other words, how do you know that the entire purchase was recorded?
3. (c) the accuracy assertion—in other words, how do you know that the details of the purchase, e.g., the purchase amount, were correctly recorded?
4. (d) the cut-off assertion—in other words, how do you know that the transaction was recorded as a purchase in the correct accounting period?

5. (e) the classification assertion—in other words, how do you know that the purchase was recorded in the proper accounts?

Diamonds Forever Inventory Familiarization Project

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