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E&Y Global Audit Methodology and Supplemental Audit

Guidance
Global Supplemental Audit Manual
Chapter 5 – Illustrative Substantive
Procedures for Specific Account Balances
5.19 (S) Commitments

5.19 (S) Commitments

1 Introduction
The illustrative procedures for auditing commitments are principally performed
in connection with other phases of the audit. Many of the sections on account
balances in this chapter include illustrative procedures aimed at identifying
commitments. Accordingly, we remain alert for commitments throughout the
audit, and perform few additional procedures aimed solely at identifying
commitments.

Commitments are obligations for future performance by the parties to an

agreement. Examples of commitments include:
l Orders for future delivery of raw materials and other inventories;
l Agreements to buy or sell financial instruments;
l Agreements to purchase other assets, particularly property, plant and
equipment;
l Unconditional purchase obligations, typically associated with project
financing arrangements (e.g., take-or-pay contracts or through-put
contracts)
l Agreements to pay future rentals under non-cancelable operating leases.
(Finance/Capital leases are commitments too, but they are recorded.)

The principal objectives in auditing commitments are to determine whether:

l All commitments reflected in the financial statements, including notes,
exist (Existence assertion);
l All commitments have been reflected in the financial statements,
including notes, to the required extent (Completeness assertion);
l Commitments have been included in the financial statements, including
notes, at the appropriate amounts (Valuation assertion);
l All commitments are obligations of the entity for future performance
(Rights and Obligations assertion);
l Commitments are properly classified, described, and disclosed in the
financial statements, including notes, in accordance with the applicable
financial reporting framework (Presentation and Disclosure assertion).

2 Inherent Risk Factors

S08 Make Combined Risk Assessments of the EY Global Audit Methodology (“EY

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GAM”) provides information on our inherent risk assessments. The following

items are examples of inherent risk factors that may increase the inherent risk
for this account or disclosure. When the opposite situations exist, that would
decrease inherent risk for the account or disclosure.

Nature of the item

l Significant commitments exist;
l Our prior audit experience indicates that there frequently have been
situations where commitments were not recorded and/or disclosed;
l Various types of commitments have been entered into by the entity;
l Significant judgment is used in estimating the outcomes and effects of
commitments;
l The results of our planning analytics do not coincide with our
expectations;
l Complex or unusual transactions occurred at or near the end of the
period.

Nature of the business/industry

l Numerous commitments exist.

Organization of the Entity

l Legal and/or accounting personnel have a lower level of competence or
experience.

3 Primary Substantive Procedures applicable to

Commitments
EY GAM S11 Design Substantive Audit Procedures requires that we perform
Primary Substantive Procedures (“PSPs”) on all audit engagements for all
significant accounts, regardless of the combined risk assessments.

PSPs describe the nature of the procedures to be performed. As part of the

development of our audit plan, we also include the timing and extent of the
PSPs.

PSPs on their own will not necessarily provide all of the audit evidence we need
on a particular assertion for a significant account. Therefore, the audit plan also
includes other substantive procedures we believe are necessary to appropriately
respond to our combined risk assessment. Other general procedures are set out
in Appendix 1 Additional Illustrative Substantive Procedures for Notes Payable.

The PSP for Commitments is set out in EY GAM S11_Exhibit 1 Appendix A:

Primary Substantive Procedures (PSP) by Account. This PSP is discussed further
below.

3.1 PSP S6: Inquiry for Completeness of Significant

Commitments

PSP S6: Inquire of management for complete listing of significant

commitments, e.g., purchase or sale contracts, fixed-priced or long-term
agreements, service guarantees, insurance policies and determine whether or

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not disclosures need to be made.

The objectives of our procedures are to identify commitments and evaluate the
appropriateness of the entity’s accounting and/or disclosure with respect to
them. Typically, disclosure of the existence and the amount of material
commitments is all that is required. However, we are alert for commitments that
may need to be accounted for in the financial statements. For example, if the
entity is committed to purchase inventory that is expected to be sold at a loss,
the loss may need to be recognized under the applicable financial reporting
framework in the period in which it becomes evident.

We also consider the possibility that an entity may have entered into
agreements to buy or sell financial instruments, commodities, or foreign
currencies at a future date because the potential gains and losses from such
agreements can be material. These agreements may be in the form of futures,
forwards, options, or standby commitments. Refer to section 5.18 (S)
Derivatives and Hedging Transactions in this manual for guidance.

4 General Procedures
Refer to Appendix 1 Additional Illustrative Procedures to Consider for
Commitments Regardless of Risk Assessmentfor examples of general procedures
that we may wish to perform.

5 Documentation
Documentation includes, but is not limited to, identification of the following:
l The nature, timing and extent of procedures performed (generally the
audit plan or reference to it) and conclusions reached with respect to the
procedures performed, together with a statement of overall conclusions
with respect to commitments;
l A description of the policies and procedures used by management for
identifying, evaluating and accounting for commitments;
l A description of the problems encountered and bases of resolution; and
l To the extent appropriate, the following:
¡ Descriptions of the various commitments of which we are aware;

¡ Evaluation of the need to account for and/or disclose the

commitments in the financial statements or notes;
¡ Memoranda of discussions regarding commitments with officers
and employees of the entity;
¡ Letters received from counsel; and
¡ Management representation letters.

Because most of the audit procedures that are intended to identify

commitments are performed in other phases of the audit, the results of those
procedures may be recorded at various points throughout the workpapers.
Duplication in section S of information available elsewhere in the workpapers is
not intended but, to facilitate review, summary memoranda concerning
commitments documented in other sections may be included here with
appropriate cross-references.

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Appendix 1 – Additional Illustrative Procedures to

Consider for Commitments Regardless of Risk
Assessment
This appendix sets out illustrative procedures for auditing commitments.

General Procedures

Inquire of and discuss with management the entity’s policies and procedures
for identifying, evaluating, and accounting for commitments.

Compare commitments disclosed in the financial statements with those

proposed disclosed in the prior year, and inquire as to changes in the nature of
commitments.

Review the results of audit procedures performed for other accounts.

Read the minutes of corporate meetings (e.g., shareholders and those charged
with governance, such as board of directors or relevant committees of the
board) held during the period being audited and through to the date of the
auditors’ report.

Read significant contracts, loan agreements, leases, service guarantees,

insurance policies (or note the lack of insurance), and other applicable
documents.

Determine, through inquiry and review of sales and/or lease agreements,

policies in effect with respect to returns, repurchases, and future allowances
applicable to sales or leases.

Determine, through inquiry and review of minutes, contracts/agreements, and

bank confirmations, accounting and operating policies in effect with respect to
interest rate and foreign currency futures/hedges.

Examine returned standard bank confirmation forms and any other returned
confirmations of bank credit arrangements for letters of credit, and
compensating balance arrangements.

Inquire as to material commitments to:

l Complete sales contracts at a loss or that cannot be fulfilled;
l Repurchase assets previously sold;
l Purchase quantities in excess of requirements or at prices in excess of
prevailing market prices;
l Construct or acquire property, plant, equipment, investments,
intangibles, or other non-current assets.

Review cost and progress estimation procedures for long-term projects.

Obtain estimates of pension plan vested benefits and unfunded past service
cost.

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Obtain management’s representation regarding commitments as part of the

financial statement representation letter.

Evaluate the principal assumptions underlying management’s estimates of the

outcomes and effects of commitments.

Inquire of management and of the entity’s financial institutions (specifically the

assigned lending officers), orally or by supplementing bank confirmation
requests, about guarantees (including oral guarantees) of the debt of others.

Review adequacy of disclosure/recognition in the financial statements in

respect of these commitments.

Go To Document ID: GSAM 5.19

Last Modified Date:06 Jun 2008

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