To: Gord McFarland

From: CPA, External Auditor

Re: CompuHealth Inc. (CHI) Audit Planning Memo

Risk at the Overall Financial Statement Level (OFSL): This is the assessment of the risk of
material misstatement at the overall Financial Statement level which is assessed as high. The
reasons are as follow:

The audit is a first-time audit in the past 10 years, which will involve a significant amount
of time and work
o Although an external firm was engaged to provide a report for CHI with less
assurance than auditing, it is still considered to have potential risk of
undiscovered financial misstatement due to lack of audit competence
o the Financial Statements may contain errors that impact many accounts in many
years, therefore it will need time to be fixed and corrected
The misplace of working papers for various acquisitions will expect to be re-valued in
next month
o This will delay the regular audit process
o This will affect the historical cost and fair value for each acquisition under
generally accepted accounting principles (GAAP)
They may have several going concern issues:
o The cash account is negative, which may due to various reasons but it indicates
an insufficient cash flow or wrong accounting payable. Although their revenue
doubled in 2009, they have a net loss in the Financial Statement. The bank might
be concerned on whether to call the loan if the cash account keeps negative for
too long or the financial status become unhealthy
o Since they are planning to go public next fall, their accounting policy is
mandatory to change to IFRS. This major change of accounting policy would
create a huge impact on CHIs Financial Statements. It also requires lots of
changes to the accounts, which may create a risk of misstatement.
o The amount of the investment in R&D is huge, whether it is worth investing need
to be properly evaluated. Especially in technology industry in general, the rapid
growth of the technological development and innovation increases the
investment risk
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 The board of directors in CHI are all lifelong friends of Helen, therefore there is a
potential risk of being bias and having a conflict of interest. For example, when making a
business decision, they agree with each other because dont want to hurt friends feeling.
Helen may use this relationship to manipulate any business decision that board of
directors makes since they are active in the operations of CHI too
The bank is using CHI monthly consolidated Financial Statements as the covenant, thus
there is a high degree of reliance.
o CHI havent sent out their Consolidated Financial Statements since March
o The bank could cancel their loan anytime since this covenant is being breached
o So far, the bank didnt have any movement
Overall Inherent Risk:
o Due to the rapid technological developments, CHIs inventory has a high inherent
risk of being obsolete quickly (There is already a large amount of inventory in the
Financial Statement)
o The general level of economic growth is an external factor that affects all
businesses. CHIs primary focus is in healthcare and educational markets, which
is relatively limited compares to other economic scale and growth
o There is a risk in computerized accounting system that threaten the companys
financial information, such as:
the virus entry into the system intentionally or unintentionally through the
network
system crash due to the softwares limited capacity or lack of
maintenance
Overall Control Risk:
o Less than competent personnel on accounting and financial reporting
Lack of formal job descriptions or training given to employees that create
poor performance and poor morale in accounting department
None of the accounting staff have a professional accounting designation
even though they have significant experience in accounting
Less reliable of the accounting department since the quality is not
standardized in way a CPA will do nor to follow the CPA code of conducts
o Unknown quality of accounting knowledge from the communized accounting
system controller when he/she was providing oversight to the accounting
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 department. Thus, it might create a low confidence level of using new
computerized software the employees so that to create high risk of misstatement
There is a risk in computerized accounting system that threaten the
companys financial information, such as:
human errors that damage the files
the unauthorized access to financial information for other use
o Lack of tracking system on the evidence of approvals or authorizations for
payments, reimbursements or transactions
Increase the risk of omissions, errors and frauds, yet it is hard to trace
back or prove since there is no evidence
o Management structure is poorly designed therefore will lead to a poor
performance, low productivity and higher chance to make errors and mistakes
No regular monitoring or review of financial results to budget
No formal job descriptions
Board members get involved in day-to-day operations and undermine
management authority
Overall fraud risk:
o Simple or zero control on transactions is attractive for theft and fraud
o Due to the owner-managed business environment and lack of appropriate
professional skills on accounting, finance and business management, there is a
high fraud risk in CHI top management without being noticed or identified by any
employees or CEO

Materiality: A smaller percentage should be used because of the high degree of reliance on
the Financial Statements:

The CEO is excited about the prospect of going public, which will use the Financial
Statements to the public to attract investors. The CEO will want the Financial Statements
looks appealing. Therefore, there will be an increased reliance on the financial
statements as well
The bank will use the Financial Statements as a covenant to see whether CHI has
sufficient cash flows to repay the loan. The bank will also use the Financial Statements
to evaluate whether they will call the loan or sign the full loan agreement

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 Materiality should be based on revenue or Gross Margin since the potential investor will
make his/her investment decision on the revenue growth of the company

Client Acceptance: To reconsider whether to continue performing the audit to this client, MC
should not only consider the above OFSL list but also the following items:

1. The Financial Statement of 2010 is not ready yet, lack the required Financial statement,
and any previous auditing reference would further increase the audit work and time
2. Integrity in the company may be questionable
a. Former CFO has committed fraud, is there any other undiscovered activity of
fraud?
b. The stakeholders are friends; although this does not violate the Independence
Rules of Professional Conduct, it has the potential conflict of interest
c. Family members are hired for positions but whether they are qualified is unknown
and need to be evaluated
3. Since the CEO wants the company to go public, she will intend to make the Financial
Statements look attractive to the investors. This may create ethical issues
4. There may have several going concern issues at CHI as follow:
a. The negative cash account that indicates insufficient cash flows or wrong
accounting payable, and they have a net loss in the Financial Statement. A
concern is raised on whether CHI can continue pay outing their loan and keep
their financial health in the future
b. If to go public in next fall, there will be a major change in accounting policy to
IFRS, which may create a risk of error and misstatement
c. The rapid growth of the technological development and innovation increases the
unstableness and the investment risk

Audit approach: Based on the analysis above we conclude that the overall control risk is
assessed as overall ineffective and high for the assertion. If these items could not be resolved
satisfactorily, I recommend that we stop this engagement before the official audit engagement
date with CHI. However, this memo is still prepared under the assumption of continuing the
auditing process since we already accepted CHI as a client. In this case, a Substantive
Approach would be more appropriate due to CHIs weak internal control and poor
representation and performance of the Financial Statements. More detailed procedures will be
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