Modern Industries, Inc. employs a corporate auditing department with a professional staff of 16 auditors. The director of the auditing department is a retired FBI agent who worked for five years with a public accounting firm before joining the FBI. The director makes it a practice of hiring only CPAs who have experience in financial auditing with public accounting firms. The director of auditing reports directly to the president of Modern Industries, who established the department in 1978 in order to guard against violations of the Foreign Corrupt Practices Act.

The president has given the director of auditing explicit instructions to accomplish two objectives for the department: (1) guard against irregularities in the financial internal control of the company and (2) assist the external auditors in order to decrease the company's fees to the firm's public accountants.

The audit director has consistently maintained that in order to do his job correctly, the department must restrict itself to testing the financial record-keeping system's compliance with formally established internal control procedures, standards, and policies. He maintains that it is operational management's job to evaluate the controls and to design and implement them. He says that the company might want to hire the CPA firm's management services staff to design a financial internal control system for the company.

The director of internal auditing runs what he calls a "tight ship." The male auditors are expected to wear only dark suits with white shirts and dark, conservative ties. The women are instructed to wear equally conservative suits with skirts. Each auditor attends an annual conference on fraud detection, and on the walls of every office in the department is an 8 " by 10" photograph of what the director calls the department mascot - Hector, a large Doberman pinscher. Every auditor is issued a thick notebook and is instructed to carry it in the inside pocket of his or her suit jacket. When anything suspicious is observed in the financial operations of the firm, the auditor is required to write down the observation in the notebook and, later, to enter it in a departmental log. These observed irregularities are checked by a team of two auditors within a maximum of ten days. Regular audits are conducted on a random basis to enhance the surprise factor. All of the auditing reports are delivered directly to the president of the company, who reviews them with the director of internal auditing. Recommendations for changes are made by the president through the operational chain of command, so that the supervisors within the departments where the changes are to take place will be the ones to institute them. The director of auditing recommended this plan of implementing changes in order to preserve the company auditors' objectivity and independence of operations.

Required:

a. Evaluate the internal auditing function in Modern Industries, Inc. based upon the principles contained in this chapter. Explain your evaluations.

b. What changes, if any, would you make in the function? Explain what you would hope to accomplish with each recommended change.