DGSE is a publicly traded jewelry retailer located in Texas. The company buys and sells jewelry, diamonds, watches, rare currency, and precious metals. The company’s CFO, John Benson, took advantage of the company’s weak internal controls around inventory to perpetrate a fraud that overstated ending inventory by a material amount. The company’s board of directors became aware of the fraud and alerted the SEC so that users of the financial statements would realize that they could no longer rely on the assertions and disclosures made in those financial statements. The board hired a forensic accounting firm to investigate, discovering the following:

1. No standard, formalized process for reconciling intercompany accounts 

2. Lack of regular inventory counts and matching to the general ledger 

3. Lack of documentation to identify the reason for accounting adjustments 

4. Use of antiquated accounting systems 

5. Weak or non-existent data security,

6. No backup of the accounting data.

As a result of these problems, Mr. Benson realized that the company’s internal accounts were materially out of balance. To “correct” the problem, he made a variety of fraudulent journal entries to inventory accounts, leading to a material overstatement in ending inventory. The entries improperly recorded consigned inventory as inventory that DGSE owned. Benson then provided these fraudulent inventory records to the company’s auditor, asserting that DGSE owned the inventory. He also signed a management representation letter, stating that management was unaware of any fraud, that the company held title to all the assets that it asserted that it owned, and that all consigned inventory was excluded from the ending inventory balances. Of course, Benson knew that these assertions were entirely false. 

a. What is consignment inventory? Describe important features of consignment inventory from the perspectives of both the consignor and the consignee. 

b. Why might a company that is a jewelry retailer be particularly susceptible to fraud relating to consigned inventory? 

c. What types of substantive procedures should an auditor employ to determine whether a client actually owns the inventory on its books and in its possession?