You are an external auditor of a large private company, BunnyCute. BunnyCute manufactures a high volume of reasonably priced pants and shirts for young people. Based on your investigations, you’ve found the following information;

BunnyCute has suffered an increasing level of bad debts and slow payers in recent years, mostly as a result of small pants and shirt shops becoming insolvent. The company has also lost several overseas customers because of a requirement for them to pay advancement. Management wishes to expand the overseas market and has decided that overseas customers will in future be allowed credit terms.

The company has a trade receivables ledger that is material to the financial statements containing four different categories of account. The categories of account, and the risks associated with them, are as follows:

(i)  Small retail pants and shirt shops. These accounts represent nearly two thirds of the accounts on the ledger by number, and one third of the receivables by value. Some of these customers pay promptly, others are very slow;

(ii)  Mail order companies who sell the company’s pants and shirts. There have been a number of large new accounts in this category, although there is no history of bad debts in this category. Receivables listed under (ii) to (iv) are roughly evenly split by both value and number. All receivables are dealt with by the same managers and staff and the same internal controls are applied to each category of receivables.

(iii)  Chains of discount pants and shirt shops that buy their inventory centrally. These accounts are mostly well-established ‘high street’ chains. Again, some of these accounts are large and overdue; and

(iv)  Large retail pants & shirts shops (including a number of overseas accounts) that sell a wide range of shoes. Some of these accounts are large and overdue;

Receivables listed under (ii) to (iv) are roughly evenly split by both value and number. All receivables are dealt with by the same managers and staff and the same internal controls are applied to each category of receivables. Therefore, you do not consider that using the same managers and staffs, and the same controls, is the best method of managing the receivables ledger.

Your supervisor has asked you to classify the risks associated with the receivables ledger in order to manage trade receivables account as a whole more efficiently. You have been asked to help classify accounts as high, medium or low risk.

1.Classify the risks relating to the four categories of trade receivables as high, medium or low and explain your reason of the classification.

2.Describe the internal controls that you would recommend to BunnyCute to manage the risks associated with the receivables ledger under the headings:

All customers.

Slow paying customers.

Larger account.

International customers.