Case: 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, DiamondsLast. 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 DiamondsForever 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.
Requirement 1: Inventory
You are the new audit senior on the 2017 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 2: Sales Transaction
Assume that the sales transaction outlined below has been selected for detailed testing as part of the 2017 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 DiamondsForever during 2017, 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. DiamondsForever 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.
In relation to this transaction, you are required to discuss and answer below questions.
1. Discuss and determine the key account balance assertions that may be at risk for the diamond inventory.
2. 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?
(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?
(e) the classification assertion-in other words, how do you know that the sale was recorded in the proper accounts?