What Is a SOC 1 Report for Financial Reporting?

A SOC 1 report is an audit document designed to provide transparency into the internal controls of service organizations. These reports are relevant for businesses that outsource functions impacting their financial reporting, such as payroll processing or data hosting. The report serves as an independent assessment, offering insights into how a service organization manages its control environment. A SOC 1 report helps user entities, the clients of the service organization, and their auditors gain confidence in the integrity of financial data processed by third parties.

Understanding SOC 1 Reports

A SOC 1 report specifically addresses internal controls over financial reporting (ICFR) at a service organization. This means the report focuses on controls that could affect a user entity’s financial statements. A “service organization” refers to a company that provides services to other companies, where those services impact the client’s financial reporting, such as a payroll service provider or a cloud provider storing financial data.

These reports provide assurance to user entities and their auditors regarding the controls at the service organization. When a company outsources a function, the controls related to that function effectively become part of the user entity’s overall control environment for financial reporting. The independent audit helps user entities understand and assess the risks associated with relying on outsourced services.

The American Institute of Certified Public Accountants (AICPA) governs these reports under Statement on Standards for Attestation Engagements (SSAE 18). This framework ensures consistency and reliability. While other SOC reports like SOC 2 or SOC 3 exist, they focus on different aspects such as security, availability, or processing integrity, whereas SOC 1 reports maintain a singular focus on controls relevant to financial reporting.

Types of SOC 1 Reports

SOC 1 reports come in two types: Type 1 and Type 2, each offering a different level of assurance. The primary difference lies in the time period covered and whether the operating effectiveness of controls is tested.

A Type 1 report provides a snapshot of the service organization’s controls at a specific point in time. This report includes a description of the service organization’s system and an auditor’s opinion on the fairness of management’s description and the suitability of the design of the controls to achieve the stated control objectives. A Type 1 report does not include testing of the operating effectiveness of these controls. It confirms that the controls are designed appropriately at a given moment.

In contrast, a Type 2 report offers a more comprehensive evaluation, describing the service organization’s controls over a specified period. This report includes everything found in a Type 1 report, but it also features the auditor’s opinion on the operating effectiveness of the controls throughout that period. The auditor performs tests of controls to determine if they consistently operated as intended. A Type 2 report provides a higher level of assurance because it confirms not only the design but also the sustained operation of the controls.

The Report’s Contents

A SOC 1 report follows a structured format, providing information about the service organization’s control environment.

The Auditor’s Opinion presents the independent auditor’s formal conclusion regarding the fairness of the service organization’s description of its system and the suitability of the design and/or operating effectiveness of its controls. An unqualified opinion signifies that the controls are designed properly and, for Type 2 reports, operated effectively.

Management’s Assertion is a formal statement from the service organization’s management. Management asserts that their description of the system is fairly presented and that the controls were suitably designed to achieve the control objectives. For a Type 2 report, management also asserts that the controls operated effectively throughout the specified period.

The Description of the Service Organization’s System provides a narrative explanation of the services offered, the system used to deliver those services, and the relevant internal controls. This section details the processes, policies, procedures, and personnel involved in the outsourced activities. It also identifies the period the description relates to and lists the control objectives.

Control Objectives and Related Control Activities outline the goals the service organization aims to achieve through its internal controls. This section details the control activities, which are the procedures and policies implemented to meet those objectives.

A SOC 1 report may include Other Information, such as Complementary User Entity Controls (CUECs) and Complementary Subservice Organization Controls (CSOCs). CUECs are controls that the user entity is expected to implement. CSOCs relate to controls at other subservice organizations that the primary service organization uses.

Using the SOC 1 Report

User entities and their auditors benefit from SOC 1 reports in managing risks associated with outsourced services and fulfilling audit responsibilities. The report helps understand and evaluate the control environment of a third-party service provider.

For user entities, the SOC 1 report helps understand internal controls relevant to their financial reporting performed by their service provider. It allows them to assess and mitigate potential risks related to outsourcing key financial processes, such as payroll or payment processing. This understanding helps user entities maintain their own robust internal control environment.

For user entity auditors, the SOC 1 report is an important tool in planning and performing financial statement audits. Auditors rely on the report to gain an understanding of the service organization’s controls, which reduces the need for them to directly audit the service organization’s operations. This reliance streamlines the audit process and helps auditors determine their own audit procedures.

The report also plays a role in the risk assessment process for financial statement audits. User entity auditors can identify potential control deficiencies at the service organization that might impact the user entity’s financial statements. This allows them to adjust their audit strategy to address any identified risks. The independent assessment supports the user entity’s financial reporting accuracy and helps meet regulatory compliance requirements.