Tello Enterprises (Tello) is a large importer of goods from China. Tello deals with thousands of suppliers in China and sells the goods to discount stores in Australia. The discount stores include some of the major department store retailers, franchise ‘Lo-Cost’ chains and independent newsagencies and variety stores. The focus of the business is on cheap, mass-produced items that sell from less than a dollar up to around $50. Both Tello and the discount retailers operate on a business model of high volumes and low margins.

The discount stores sell for cash or on credit card only, but Tello trades on credit. In the past, Tello tried to protect its cash flow by requiring a security deposit from the smaller retailers and refusing to advance credit until a satisfactory credit check was performed on each retailer. In addition, terms of payment were seven days, which meant that the retailer had to pay almost immediately the goods were received. Tello has faced increasingly stiff competition over the last two years. Some of the Chinese suppliers are negotiating better deals with Tello’s competitors, and retailers are also starting to use more than one importer. In an effort to retain business, Tello’s management has decided to relax credit terms for retailers. Six months ago, the terms of payment were renegotiated with all larger retailers and some smaller retailers from 7 days to 30 days. In addition, security deposits are no longer required from smaller retailers, although credit checks are still performed.

Required

(a) Explain the potential impact of the change in credit terms on the accounts and the associated risk of material misstatement.

(b) What changes to the audit program for debtors would you recommend this year given the change in credit terms?

(c) How would you select a sample of Tello’s debtors for debtors’ confirmation letters?