INFORMATION FOR THE REPORT WAS GATHERED DURING SITE VISITS AND MEETINGS FROM AUGUST 1976 TO MARCH 1977. RESULTS INDICATED THAT THE NAVY NEEDS TO STRENGTHEN ITS INTERNAL AUDIT TO KEEP TOP MANAGEMENT BETTER INFORMED ON HOW OPERATIONS ARE CONDUCTED AND HOW RECOMMENDATIONS FOR IMPROVEMENTS ARE CARRIED OUT. THE INTERNAL AUDIT FUNCTION IS NOT PLACED HIGH ENOUGH IN NAVY'S ORGANIZATION TO GRANT AUDITORS MAXIMUM INDEPENDENCE IN CONDUCTING AND REPORTING ON AUDIT WORK. CURRENT ORGANIZATIONAL STRUCTURE IS INCONSISTENT WITH THE COMPTROLLER GENERAL'S AUDIT STANDARDS WHICH ADVOCATE THAT THE AUDIT FUNCTION BE PLACED AT THE HIGHEST PRACTICAL LEVEL IN THE ORGANIZATION. ALTHOUGH DEFENSE DEPARTMENT POLICY REQUIRES ALL NONMILITARY POSITIONS TO BE FILLED BY CIVILIANS, THE AUDIT SERVICE IS HEADED BY A MILITARY OFFICER AND EMPLOYS 34 OTHER MILITARY OFFICERS. DUE TO MASSIVE WORKLOAD AND USE OF AUDIT RESOURCES ON INAPPROPRIATE WORK, THE AUDIT SERVICE HAS A LARGE AUDIT BACKLOG. THE FOLLOWUP SYSTEM IS INADEQUATE. IT IS RECOMMENDED THAT THE AUDIT SERVICE BE RELOCATED DIRECTLY UNDER THE SECRETARY OR UNDERSECRETARY OF THE NAVY. FURTHERMORE, ALL POSITIONS SHOULD BE FILLED BY PROFESSIONALLY QUALIFIED CIVILIANS, AND THE SERVICE'S ABILITY TO HANDLE ITS WORKLOAD SHOULD BE IMPROVED. THE AUDIT FOLLOWUP FUNCTIONS MUST BE STRENGTHENED. FINALLY, CONGRESS SHOULD AMEND THE 1947 NATIONAL SECURITY ACT TO PLACE THE INTERNAL AUDIT FUNCTIONS OF THE THREE MILITARY DEPARTMENTS UNDER THE SECRETARY OR UNDERSECRETARY OF DEFENSE. TABLES ARE INCLUDED. FOR RELATED MATERIALS PRESENTED TO THE SENATE HEARING ON INSPECTOR GENERAL LEGISLATION, SEE NCJ-67353-67356 AND 67358. (CFW)