What Is SOC 1 Certification and Who Needs a Report?

A SOC 1 report provides an independent assessment of a service organization’s internal controls relevant to its customers’ financial reporting. This evaluation ensures controls are designed and operate effectively, offering assurance for businesses relying on outsourced services.

Understanding SOC 1 Certification

SOC 1, or System and Organization Controls 1, addresses internal control over financial reporting (ICFR) at a service organization. The American Institute of Certified Public Accountants (AICPA) developed this standard under their Statements on Standards for Attestation Engagements (SSAE) 18. A SOC 1 report’s primary purpose is to assure user entities (clients) and their auditors about the effectiveness of controls impacting the user entity’s financial statements.

A service organization refers to entities providing services that impact other businesses’ financial operations or data. Examples include payroll processors, data centers, cloud service providers handling financial data, and claims administrators. The report details how the service organization’s controls are designed to meet specific, tailored control objectives. This connection between the service organization’s controls and client financial reporting is central to the SOC 1 framework.

The report evaluates whether the service organization’s internal processes and IT controls are sufficient to ensure accurate and reliable financial data processing. It covers business process controls and general IT controls, such as logical access and change management. An independent CPA firm specializing in IT security and business process controls performs the audit. This external validation helps user entities and their auditors assess risks from outsourcing financial functions.

Who Benefits from SOC 1 Reports

SOC 1 reports primarily benefit service organizations, user entities, and their auditors. For service organizations, obtaining a SOC 1 report demonstrates a commitment to robust internal controls over financial reporting. This commitment builds client trust, serving as a competitive differentiator. It also helps service organizations meet client demands and potential regulatory requirements, such as the Sarbanes-Oxley Act (SOX).

User entities and their financial statement auditors utilize the SOC 1 report to understand controls relevant to their financial data. When a business outsources functions like payroll or data hosting that impact its financial statements, it needs assurance about the integrity of those outsourced processes. The report helps user entities assess the risks associated with delegating these functions to a third party.

The user entity’s auditors rely on the SOC 1 report to evaluate the effectiveness of the service organization’s controls as part of their own financial statement audits. This reduces the need for the user entity’s auditor to independently audit the service organization’s controls, streamlining the audit process. The report is intended for user entities and their auditors, and is not for public disclosure.

Distinguishing SOC 1 Report Types

Understanding the two primary SOC 1 report types, Type 1 and Type 2, is key to grasping the assurance they provide. A Type 1 SOC 1 report offers a snapshot of the service organization’s system and the suitability of its controls’ design at a specific point in time. It assesses whether controls are designed to achieve stated objectives and have been implemented, confirming they are in place on a particular date.

In contrast, a Type 2 SOC 1 report provides a more comprehensive evaluation, describing the service organization’s system and assessing both the design suitability and operating effectiveness of its controls over a specified period (typically six to twelve months). It includes auditor testing to determine if controls operated effectively throughout the review period, verifying consistent function as intended over time.

The key differences lie in their scope and assurance level. A Type 1 report is a point-in-time assessment focused on design and implementation. A Type 2 report covers a period and includes testing of controls’ operating effectiveness, offering a higher level of assurance by confirming consistent application and effectiveness over an extended duration. Many organizations start with a Type 1 report, then transition to a Type 2 in subsequent periods.

Key Elements of a SOC 1 Report

A SOC 1 report typically follows a structured format, providing a detailed overview of the service organization’s control environment.

The Independent Service Auditor’s Report contains the auditor’s opinion. This opinion states whether the service organization’s system description is fairly presented and if controls are suitably designed and, for a Type 2 report, operating effectively. The auditor’s opinion can be unqualified (no material issues), qualified, adverse, or a disclaimer.

Management’s Assertion is a formal statement by the service organization’s management. In this assertion, management affirms the accuracy of their system’s description and the effectiveness of their controls.

The report includes a Description of the Service Organization’s System. This section provides detailed information about services offered, the system used, and internal controls implemented.

For Type 2 reports, Control Activities and Tests of Controls details specific controls tested by the auditor and presents the results. This section provides evidence of controls’ operating effectiveness over the specified period.

SOC 1 reports may also contain Other Information, such as details on complementary user entity controls, which are controls the user organization is expected to have in place.