an examination of the conformance of bank internal auditors with internal auditing standars

INTRODUCTION Internal auditing professional practice standards were recently developed by the Professional Standards and Responsibilities Committee of The Institute of In- ternal Auditor

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Johnston, James Grover

AN EXAMINATION OF THE CONFORMANCE OF BANK INTERNAL AUDITORS WITH INTERNAL AUDITING STANDARDS

University of Missouri - Columbia PH.D 1982

University

Microfilms

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The undersigned, appointed by the Dean of the Graduate Faculty, have examined a thesis entitled

AN EXAMINATION OF THE CONFORMANCE OF BANK INTERNAL AUDITORS WITH INTERNAL AUDITING STANDARDS presented by James G Johnston

a candidate for the degree of Ph.D in Accountancy

and hereby certify that in their opinion it is worthy of

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I wish to express appreciation to Dr Joseph A Silvoso for the guidance he provided throughout my doctoral program and for his advise and comments during the completion cf this project Also, I wish to thank Dr Ralph £ Skelly for serving as a reader of this dissertation, and Dr James E Holstein for his helpful comments, especially in

Chapters VII and VIII Special thanks must also be expressed to Mr Harold J Smolinski of Louisiana Tech University for his constant encouragement

My greatest appreciation is to my wife, Karolyn, who endured these years of study with patience and love, and to my daughters, Teri and Dana, who never complained about the

sacrifices that were asked of them

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TABLE OF CONTENTS ACKNOWLEDGMENTS a ° « * * s ° « * e + + ° * LIST OF TABLES e s ° * * e * * « « * ° s s « Chapter T It Hài INTRODUCTION aớẲỬẲỬ.ớ.,Ặ.ẶóẶÏ76(./ an 5 ° Research Question `

Contribution of the Study Review of the Literature : Research Setting ‹ Hypotheses + + « « > ` Methods of Analysis ‘ Expected Results ` Organization of Xemainder of Study - © © © # @ 4 eô â â &â â # os e+ 2 *# © _ 2 2» a» © @ © ° + e ° * » 2 * © ©» @© @ a @

HISTORICAL PERSPECTIVE OF INTERNAL AUDITING: EARLY TWENTIETH CENTURY (1900-1940)

Early Twentieth Century (1900-1940) Environment ` ¬ Changing Technology Management System Financing and Reporting Internal Auditing Bank Internal Auditing Summary of Early Years © © & © * 2 © @ » 5 + * @ #8 s »° © © @ @& - â ôâ 8 28 @ = 2 @â â â &â ô4 â eo 8 â â 8 8 © @ o e = 2 8

HISTORICAL PERSPECTIVE OF INTERNAL AUDITING:

THE WAR YEARS (1941-1955) ° * 8 « 8 6 eo * + * The War Years (1941-1955) Environment rr War Production and Firm Size * « Management Structure Manpower « « « 6 2 ôâ ô Internal Auditing

Bank Internal Auditing

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Vv

The Recent Years (1956-Present) Environment 2 ôâ 6 © «© «© © © « « «

The Computer var

Diversification and Foreign Expansion Government Regulation Internal Auditing ôâ 2 «+ ee s Bank Internal Auditing Summary of the Recent Years Historical Perspective: Conclusion

THE DEVELOPMENT OF AUDITING STANDARDS:

(1900-1955) ‹ a a ° ° s * ° e e +

Need for Standards , ‹

Early Twentieth Century (1900- -1940) Early Standards for Independent

Accountants

Internal Auditing - Prior to "1940 The War Years ae ee Establishment of Standards by Independent Accountants Term "Generally Accepted Auditing Standards” 2 6 2 2 2 se ee Disagreement between Committee and Commission ‹ soe Distinction between Standards and Procedures «2 oo Opposition co Establishment £ Standards cee ee es Lack of Participation Delay Caused by War , The Tentative Outline Adoption by Membership The Fourth Reporting Standar Some Misunderstandings › Applicability of Statements on Auditing Procedure Enforcement of Standards Public Accounting Auditing Standards in Summary Bank Auditor's Contributions } + * * e * + e * * « d * *

Internal Auditing Standards Progress

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VI THE DEVELOPMENT OF AUDITING STANDARDS: (1956-PRESENT) ôâ wo «

Changes in the Standard Setting Process for Independent Accountants

Statement on Standards for

Accounting and Review Services Statement on Responsibilities

in Tax Practice

Statement on Standards for Management Advisory Services Bank Internal Auditing Standards * * Internal Auditing Standards The 1957 Revision The 1971 Revision The 1976 Revision Establishing Internal Auditin Standards The Adoption of the Standards Summary 6 + 1 8 © # ew VII THE RESEARCH METHOD * * 5 ô * â # & @ *

Banks Included in Survey Population Banks Included in Sample Response Rates «+ « Non-Response Bias Questionnaire ee we Scoring 2 2 2» es e « + Weighting of Responses Data Analysis 1 + Summary 1 6 6 8 oe + @ â @ #8 ô@ - Â ôâ @ 9 u ô # 8 & # â e â © @© 2 @

VIIEI INTERNAL BANK AUDITORS COMPLIANCE

WITH THE STANDARDS - > +

Conformance Versus Size of Bank

Conformance Versus Size of Audit SCaf£, Conformance Versus Number of Certified

Personnel « « » « + « » Federal Versus State Charter

Membership in Federal Reserve System Overall Compliance Weakest Areas for "Professional Proficiency" w °ằ w s ^ˆ ˆ s9 * =a ¢ © » 8 @ @# 8 °

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19 11, 12 13 15 16 LIST OF TABLES Changes in the Environment and Impact on Internal Auditing (1900-1940) - Changes in the Environment and Impact on Internal Auditing (1941-1955) 6 » e « « Changes in the Environment and Impact on

Internal Auditing (1956-Present) + Correlation of Public Accounting Standards

to Internal Auditing Standards + Stratification of Banks Included in Study Response Rates for Each Stratum «s+ s+ se s

Responses to Questionnaire + « + se es

Test for Nonresponse BiaS 2 6 2 6 2 ee ew

Question Numbers on Questionnaires Related

to General Adreas and Specific Standards Questionnaire Scoring 6 2 6 se ee ew ee es

Correlation of Bank Rank and Scores Achieved on Questionnaire «2 6 6 ee ne we es

Achieved Score by Strata 2 6 ôâ â ô © 1 1 9

Correlation of Number of Personnel on Audit

Staffs and Scoves Achieved on Questionnaire Correlation of Number of Personnel Holding

Professional Certification and Scores Achieved on Questionnaire 6 « vo +

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18 19 20 21 22 23

Membership Status in the Federal Reserve

System Versus Scores Achieved +

Percent of Maximum Scores Achieved by Banks

Percent of Scores Acnieved in General Areas

by Banks 2 2 6 ew ee te ee

Disciplines not Represented on Audit Staffs

Activities Receiving Little Consideration

Scores Achieved by Banks Based Upon Membership of the Director of Internal Auditing in The

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CHAPTER I INTRODUCTION

Internal auditing professional practice standards were recently developed by the Professional Standards and Responsibilities Committee of The Institute of In- ternal Auditors While standards for the practice of public accounting have existed for many years ,* the stan~ dards for internal auditing developed by the Institute's Committee marked the initial effort to develop standards

for measuring and evaluating operations of an internal audit department of business and non-business enterprises The standards for internal auditing address the areas of

independence, professional proficiency, scope of work, performance of audit work, and the management of the in- ternal audit department

Research Question

This study addresses the following research question:

How well do internal auditors of banks presently conform to internal auditing professional practice standards?

In studying this question, the investigation will attempt to identify (1) standards with which internal

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which internal bank auditors are not presently in con- formance, but for which future conformance appears feas-~- ible; (3) standards with which internal bank auditors may not be able to conform; (4) standards which may have been omitted from the list of standards proposed by the Committee; (5) attributes of banks whick may lead to or detract from the internal bank auditors’ conformance tc the standards; and (6) courses of action which internal bank auditors may pursue in order to achieve conformance with standards identified during the study as having a

low degree of acceptance

Contribution of the Study

Identification of the issues addressed above will provide evidence either supporting or refuting the ability of bank internal auditors to comply with the standards in an operational manner Potential benefits from the study are as follows:

1 Identification of areas where a low degree of conformance to the standards exists will provide information as to where efforts to achieve greater conformance should be con- centrated,

2, Recognition that conformance with one or more of the standards is not practical

or feasibie will indicate that consider- ation should, perhaps, be given to revis- ing one or more of the standards

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3

&, Identification of attributes which may Lead to or detract from conformance to the standards will allow a bank auditor to assess his own environment and deter- mine whether favorable attributes are present or may be added, or whether un-

favorable attributes are present or may be deleted

5, Development of comparative data will al- low a bank auditor to have a basis for the comparison of his conformance to the standards with other bank auditors’ con- formance to the standards

6, Identification of courses of action to achieve greater conformance to any of the standards identified as having a low degree of conformance will provide internal auditors a route to follow in order to move toward a greater degree of conformance in the future

Review of the Literature

A review of the literature revealed no studies directed toward determining conformance by individuals within a profession to newly developed standards of that

profession The study is, therefore, unique in that it

is ^n attempt to determine existing conformance to newly established standards of a profession

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performed.“ However, no studies were found which were directed toward examining the internal auditors in re- lation to the broad range of concepts encompassed by the recently adopted standards

Research Setting

Internal auditors of banks have been selected fov this study for several reasons First, the banking in- dustry is composed of thousands of entities, all of which perform similar functions By limiting the study to one industry, the variability which certainly exists between different industries can be minimized Secondly, the bank- ing industry offers a significantly diverse range of organ- izational sizes and structures to allow an analysis to be made of the effect of certain of the attributes related

to size and structure and still be of a manageable dimen~ sion Thirdly, the author's experiences and interests are strongly rooted in and directed toward the banking industry

Banks included in this study were those listed in a directory of the largest banks in the United States as hav- ing deposits in excess of $100 million as of December 31,

1976 The threshold of $100 million was based on the

author's experience that banks with deposits of under $100 million would not be of sufficient size to have a viable

internal audit department Discussions with internal audi- tors employed in the banking industry confirmed that depos-

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5

expect an internal audit department to exist Of the ap- proximately 14,000 banks in the United States, there were just under 1,000 which had deposits of sufficient size to be included in this study The results of this study, however, still may prove useful to the banks of a lesser

size as they grow to a point where the establishment of an internal audit department becomes feasible

Hypotheses

To explore the research question stated earlier, several hypotheses are identified The primary hypothe- sis to be tested by this study is:

H.1l.: Internal bank auditors are in con- formance with the standards for the professional practice of internal auditing

In addition to the primary hypothesis implied by the research question, several secondary factors which may affect the auditor's conformance to the standards will also be investigated These factors center around the organi-

zational attributes which may contribute to the confor- mance or nonconformance with the standards These secon- dary hypotheses are:

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H.3.: The size of the internal audit depart- ment in terms of number of profession- al staff directly affects the confor- mance of internal bank auditors to the

standards for the professional prac- tice of internal auditing

H,é,: The number of professional staff hold- ing certification in an accounting discipline directiy affects the con- formance of internal bank auditors to the standards for che profession- al practice of internal auditing

H.5.: The nature of the bank's charter (state or national) directly affects the con- formance of internal bank auditors to the standards for the professional practice of internal auditing

H.6.: The membership status of the bank in the Federal Reserve System directly affects the conformance of internal bank auditors to the standards for

the proressional practice of inter- nal auditing

Methods of Analysis

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7

A random sample of banks was selected from a di-

rectory of the largest 4,571 banks in the U s,° The

questionnaire was addressed to the Director of Internal Auditing at each selected bank Efforts were made to a- chieve as high a response rate as possible through sub- sequent mailings to those who did not reply to the initial request

The data from the returned questionnaires were ana~ lyzed to determine whether factors such as the size of the bank (measured by deposits), the size of the audit depart- ment (measured by number of personnel), the number of audi-

tors on the staff holding a professional accounting certi- fication, the nature of the bank's charter (national or state), and membership status in the Federal Reserve System influence the ability of an internal audit department to comply with the internal auditing professional practice standards Statistical tests such as chi-square tests for difference in probabilities were used in the analysis of

the data

Expected Results

The expected results of this study are that the find- ings will indicate that internal bank auditors are general- ly not in conformance with the new standards for the pro- fessional practice of internal auditing Also, it is ex-

pected that the size of the bank, the size of the audit de-

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au-the Federal Reserve System will be found to have a direct relationship with the auditor’s conformance to the stan-

dards

Organization of Remainder of Study

A historical perspective of internal auditing is

presented in Chapters [I, III, and IV Chapter II contains

a review of the Early Twentieth Century (1900-1940) ;

Chapter LII, the War Years (1941-1955); and Chapter IV, the Recent Years (1956-Present) In each chapter, the

changes which occurred in the business environment within each period are discussed, along with the impact these changes had on internal auditing in general and on bank internal auditing in particular

The development of internal auditing standards is the subject of Chapters V and VI Chapter V contains a review of the developments during the period 1900-1955 and Chap-

ter VI continues for the period 1956-Present The need for standards is discussed and the process through which stan- dards were developed for the public accounting profession and the internal auditing profession are compared and contrasted

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Finally, a summarization of the study and the conclu- sions whi-h may be drawn are presented in Chapter Ix

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CHAPTER I END NOTES

lgtandards for the Professional Practice of Internal

Auditing, (Altamonte Springs, The Institute of Internal

Auditors: 1978)

2auditing standards in the United States date to 1917 See Statements on Auditing Standards No l,

(New York, ALCPA: 1973) for a historical review of the development of auditing standards for the public account- ing profession in the United States

SLarry E Rittenberg and Gordon 8 Davis, ''The Roles of Internal and External Auditors in Auditing EDP

Systems," The Journal of Accountancy 126 (December, 1977): pp 51-58,

4pobert L Grinaker and Kamal E Said, "Scope and Intensity of Audit Work Performed by Internal Auditors," Unpublished Working Paper, University of Houston, 1977

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CHAPTER IT

HISTORICAL PERSPECTIVE OF INTERNAL AUDITING: EARLY TWENTIETH CENTURY (1900-1940)

The purpose of this chapter and the following two chapters is to provide a historical perspective of the de- velopment of the field of internal auditing The primary objective of these chapters is to identify the conditions that led to the development of the Standards for the

Professional Practice of Internal Auditing In Chapter V,

the process through which the standards were developed will

be examined

Three separate historical periods will be reviewed The three periods are the Early Twentieth Century

(1900-1940), the War Years (1941-1955), and Recent Years (1956-Present) These periods are discussed in this

chapter, Chapter III, and Chapter IV, respectively Within each period, the general environment in which business was conducted is examined; the scope of the internal audit furne-

tion and the role of the internal auditor are discussed;

and, the development of internal bank auditing is analyzed Early Twentieth Century (1900-1940)

An analysis of the development of internal auditing during the period 1900-1940 is presented in this section

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The break at 1940 has been selected because the formation of The Institute of Internal Auditors (IIA) in 1941 is

generally recognized as the first stage of the evolvement of modern internal auditing.!

Environment

A business firm does not operate in a vacuum, but rather must function as a component of the society and culture within which it exists Likewise, the function of any component of a firm, such as an internal audit depart- ment, is dependent upon the overall climate and environment within which the firm operates Before an analysis of the development of the internal audit function can be

understood, first it will be necessary to review the environment in which businesses operated

The first forty years of the twentieth century brought many chagges to the development of business in the United

States While Cochran's American Business in the Twentieth

Century provided an insight into those changes, this study

will address only several of the more significant elements which have Led to the development of the internal audit

funetion within business entities The elements to be reviewed are the development of new technology and its

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13 Changing Technology

Cochran noted that many of the changes can be traced to the development of the gasoline engine and to the har- nessing of electricity.4 The gasoline engine led to the

production of automobiles and trucks which in turn began to remold transportation and Living arrangements The use of electricity for communication, power and lighting became common during this period.4 Chandler, in his writings on big business in America since the year 1815, also Listed the internal combustion engine and the coming of electricity as

the major technological changes occurring from 1910 to

1920.9

Prior to the development of electric motors and auto- mobiles, the trend of business in the United States was

toward bigness Several factors contributed to this trend Steam power could only be produced by big engines close to furnaces and boilers, and could not be transmitted over long distances.® Factories thus tended toward bigness in order to effectively use the steam power

A second factor which led toward bigness of industry was the lack of mobility of the population Craf noted that agricultural mechanization during the last half of the nine-

teenth century had reduced the percent of farm labor to total Labor from 63.7 percent in 1850 to 37.5 percent in

1900.7 Colm stated that as industrialization created

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came from all parts of the world to offer their labor to this new country.8 Thus, both migration of farm workers and foreign immigration led to concentration of populations in urban areas The readily available labor force combined with the necessity of using steam power both were factors in

the trend toward bigness

The advent of the gasoline engine and further develop- ments in the use of electricity counteracted this trend

toward bigness The gasoline engine with the subsequent refinement of the automobile led to a mobility of che popu~ lation as well as changes in the distribution system for manufactured goods Robertson and Walton noted that until

the end of World War I, railroads were the dominant means of transportation.? They also stated that since 1920, trucks and busses have taken business away from the railroads and that the railroad had reached its maturity about 1920 via

nearly every type of test.!0

The advent of electricity also decreased the need for bigness Cochran observed that no longer was there a need

for Large steam generating plants to be near manufacturing facilities.!} The electricity provided by a remote central generator was also infinitely divisible and could travel hundreds of miles over power transmission lines Factories no longer needed to be large to be efficient

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15

appear, the management systems needed to control operations

would also change Since the railroad industry had already been faced with the problems of controlling widespread operations, a logical view for other industries to take would be to examine that structure and adopt it where

possible

The next section presents a review of the progression

of the management system as developed by the railroad

industry into the management structure of other industries

Management Svstem

The managerial system was also changing during the

early twentieth century Cochran observed that the mana-

gerial system for large businesses had grown up with the railroads and public utilities and had moved into manufac~ turing Late in the nineteenth century when the increasing cost of mechanized equipment began requiring the public sale of securities.!4 He also indicated that the eventual spread

of the managerial system to finance, trade and service may

be seen partly as a consequence of demands made upon these sectors by large-scale industry and transportation l3

Chandler noted that the railroads were the innovators in the basic methods of communication and control essential to the operation of the modern corporation.!4 He also

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perceptive, energetic, or imaginative than others, but

rather that they were the first to face the challenge.!5 The challenge to which Chandler referred occurred during the last half of the eighteenth century as the nation's railway system grew quickly and transcontinental Lines were layed The railroads were the first industry in

the United States to require massive initial construction

costs as well as large annual operating outlays, and also had to make many and varied technically difficult

decisions.!® In addition to the financial apsects of

operating a railroad, the far-flung geographic range of the company and the many varied activities and facilities which it encompassed required the development of a system of operational controls which had not been necessary in any U S industry prior to that time

The Baltimore and Ohio Railroad Company, the oldest of the trunk Lines, was the first to systematize its opera-

tions Chandler stated that one of the railroad's major

innovations was the departmentalizing of the firm's opera-~ tions into two general categories of railroad operations, and collection and disbursement of the revenue.!? Within each of these categories, further subdivisions were made Chandler stated that this was probably one of the first functionally departmentalized, administrative structures for

an American business enterprise,!8 and further noted that

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17

of the Baltimore and Ohio) and Thompson (Chief Engineer) who both were well known among the best civil engineers of their day, and who had both played important roles in the actual construction of the line.!9

Earlier in this section, it was noted that Cochran stated the managerial system for Large businesses in the United States grew up with the railroads and public utili-

ties and then moved into manufacturing and later co finance,

trade, and service.29 As the railroad management system was designed by engineers, the management system of manufac-

turing concerns of the early twentieth century also ‘sok on an engineering touch Wren has written that engineers

designed the equipment, supervised its installation, advised on its utilization, and provided the major source of

assistance in solving management problems 21

The period from the turn of the century until the early 1930's is the era of Scientific Management 22 Taylor is often referred to as the “Father of Scientific

Management" ,23 but the names of Barth, Gantt, Gilbreth, Cooke, and Emerson are all associated with the spreading of the gospel of efficiency in America.24 The common thread among all these names is their engineering or technical backgrounds

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theories espoused by the proponents of scientific manage- ment A basic premise of scientific management as defined by Taylor is task management whereby time studies are per- formed and standards established.29 The need for accurate data in such a system is obvious and the integration of this data into the accounting system would soon come about

Wren observed that eras in management thought typi-

cally blend into one another ,26 and that eras in management

thought never begin and end neatly in any particular year Thurston stated that the cyclical span from the initial recognition of the importance of a new area of management

thought to its final wide acceptance is approximately 25 years.¢/ Though the work of Taylor and his disciples began in the early 1900's, it was not until the World War II era

(1940) that the techniques of scientific management became accepted by production managers

The next widely accepted era of management thought also began during the period 1900-1940 While Taylor was concerned mainly with the production function, men like Fayol and Weber were examining firms from an organization aspect Perhaps some of this shift in orientation o£

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19

Fayol's thoughts stressed planning and organization and emphasized education for management rather than teca- nical training 28 George observed that Fayol and Taylor were working on the same problems, but from different perspectives: Taylor from the shop up and Fayol from the board of directors down.29

Weber's writings focused on the bureaucracy, or

authoritative form of control Wren stated that many of his concepts were analogous to Taylor's For example, both sought technical competence in leaders who would lead by virtue of fact and not whim Both believed in division of

Labor in which authority and responsibility were clearly

defined, and organizational members were selected on the

basis of technical qualifications 30 As with Fayol, Weber was examining the organization as a whole while Taylor is

linked primarily to the production function

Wren noted that while Weber's writings occurred during the first 20 years of this century, they were largely unrec- ognized until the 1940's and 1950's.3! This notation is in agreement with Thurston's observation that there is a con- siderable lag between the initial recognition of a new man- agement thought era and its general acceptance

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take on many of the aspects of the scientific management

era Toward the end of this period (1900-1940), the manage~

ment systems began to lean toward the principles advocated by the emerging administrative theory concepts

While the size and geographic spread of business was changing, and the management structure and system were adjusting to these changes, the financial aspects of busi- ness were also undergoing revisions

The next section reviews the changes occurring in the early twentieth century with respect to the means used to finance business and the public reporting of corporate

information

Financing and Reporting

The capital markets and financial reporting practices were also undergoing change during the early twentieth cen-

tury Dawkins noted that as late as 1900 the amount of financial information presented to stockholders by the man- agers of most publicly owned American manufacturing cor- porations was meager, invaribly colored by the point of view of the corporations, and frequently unreliable.32 He also remarked that the practices of manufacturing concerns was in contrast to the reporting practices of public utilities,

insurance companies, banks and railroads whose activities

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21

Dawkins noted gradual improvement in the level and frequency of financial disclosure after 1900 He attributed the improvement to four factors First, a gradual recogni- tion by managers of their public responsibility Second, increasing criticism of menagement accounting and reporting practices by influential groups and individuals outside of

the management class Third, a direct involvement by federal government regulation, such as the Securities Acts

of 1933 and 1934 Fourth, the recognition by the accounting

profession, and acceptance by the business community, of some common accounting and reporting standards 34

While the factors recognized by Dawkins may all be relevant to the improvement in financial reporting, the underlying cause must rest in the manner in which firms acquired capital Prior to 1900, the railroads were a major

consumer of new capital, but as Robertson and Walton noted,

the Form of security was generally a mortgage bond, and

later, preferred stock.39

Chandler had also noted that the railroads’ needs for capital led to the development of new financial instruments such as preferred stock and mortgage, income, and conver-

tible bonds, and also led to the centralization and institu-

tionalization of the American investment market in New York City 36 He stated that because the railroads intimately

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voters demanded and obtained a new type of government regu- Lation of private corporate enterprise The impact of regu- lation on business will be discussed later in this chapter

Colm observed that prior to the United States involve- ment in World War I much of the new capital had to be

attracted from abroad.3’ However, Crof stated that exten-

sive sales of bonds to the American public during World War I familiarized a large segment of the population with

the operation of the security markets.98 After the war, more and more people began to buy stocks and bonds, a prac-

tice which was aided by an age of easy credit.39 With this

amergence of the small investor, it could be argued that

there would be greater demands for improved reporting prac~- tices Previts and Merino argued, however, that there is Little evidence that small investors considered financial reporting and independent audits important 40

While deficient financial reporting may have existed in the 1920's, no one has argued that this was the cause of the stock market crash of 1929 and the following Great

Depression, although Carey noted that loose accounting prac- tices had contributed to the debacie.4! One result of the depression was government regulation of many aspects of business Schnitzer lists many of the areas where govern- ment controls were effected.4% The Robinson-Patman Act

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23

National Labor Relations Act enhanced the bargaining power of labor unions; and, the Walsh-Healey and Fair Labor Standards Act provided legislation for the regulation of hours, wages, and working conditions, to only mention a few

of the efforts of Congress to control business.43 However,

the Legislation of the 1930's which had a profound effect on the accounting profession was the passage of the Securities Act of 1933 and the Securities Exchange Act (1934)

The Securities Act of 1933 provided for filing of

detailed information, including audited financial state- ments, with the Federal Trade Commission before new securi-

ties could be offered for sale to the public in interstate commerce or through che mail.44 The Securities Exchange Act created the Securities Exchange Commission and required periodic reporting of detailed information, again including

audited financial statements, of all securities listed on

national security exchanges 45 Previts and Merino reported that the passage of these acts marked the beginning of a social consciousness with respect to financial reporting in

the U $46

The next part of this chapter relates the factors discussed thus far to the development of the internal audit

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Internal Auditing

Sawyer has stated that while internal auditing has its roots in antiquity, modern internal auditing has had pain- fully slow growth 47 He viewed the turning point to be 1941, the year of the founding of The Institute of Internal Auditors “®

The preceding parts of this chapter have provided a review of the general environment in which business was being conducted during the early years of the twentieth century Technological changes were occurring which were affecting the size and geographical dispersion of busi- nesses Management systems were changing to meet the

challanges the technological changes wrought The means by

which capital was raised, and the external reporting

requirements underwent revision All of these changes helped bring into being the beginnings of an internal audit

function as we know it today

As the corporate form of organization emerged, manage- ment of an entity moved from owners to hired professionals

As Brown has noted, the ownres in absentia became concerned

over the proper protection and growth of their capital

investment,^2 However, the professional managers also needed a means of assuring themselves that controls were in place and operating Previous parts of this chapter have

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25

internal auditing also Sawyer reported that the railroads were among the first to adopt far-flung internal auditing programs since executives needed assurances that station Masters across the country were handling receipts

properly 29 Lambert and Thurston concurred with this view They also noted that the railroads were probably among the

first to recognize the need for internal auditing in order to control their widely scattered activities.>!

While the public accounting profession was making a foothold in the American business community during the period 1900-1940, little was heard of internal auditing

The Institute of Internal Auditors (formed in 1941) reported

in a 1953 brochure that "internal auditing is a business function which was comparatively unheard of before 1940.92 Sawyer reported that in the early part of the twentieth cen-

tury internal auditors were usually employed in the

accounting department where they checked routine financial activities 93

Cunningham confirmed Sawyer's comments Speaking in 1947, Cunningham stated that internal auditing of the "past" was More in the nature of a clerical or policing function and did not require much more ability than a superior skill in mathematics and a keen suspicious nature 24

Another indication of the lack of identification of internal auditing as a field prior to 1940 can be found by