What Is a SOC 1 Report and Who Needs One?

These days, many businesses use third-party providers to manage important financial processes, such as payroll, accounting, billing, and financial data management. While often necessary and beneficial, this outsourcing introduces potential risks to financial reporting accuracy and integrity. 

To mitigate these risks, businesses must ensure their service providers have robust internal controls in place. This is where SOC 1 (System and Organization Controls 1) reports come into play, serving as a vital tool for assessing and validating these controls.

What Is A SOC 1 Report?

A SOC 1 report focuses on internal controls related to financial reporting. Unlike SOC 2 reports, which 

cover trust services criteria, SOC 1 specifically examines how a service organization’s systems can affect their clients’ financial statements. 

SOC 1 reports require a collaborative approach between the SOC auditor and the service organization, leading to the creation of tailored control objective statements. The framework for SOC 1 is less prescriptive than SOC 2, allowing for more flexibility in defining control objectives.

SOC 1 vs. SOC 2: Key Differences

While both SOC 1 and SOC 2 reports assess internal controls, they differ in several important ways:

1. Focus: SOC 1 centers on financial reporting controls, while SOC 2 addresses trust services criteria such as security, availability, processing integrity, confidentiality, and privacy.
2. Framework: SOC 1 is less prescriptive, allowing for more customized control objectives.
3. Audience: SOC 1 reports are typically read by financial auditors and those involved in financial reporting, while SOC 2 reports have a broader audience, including potential clients and security professionals.
4. Expertise required: SOC 1 audits demand a stronger background in financial auditing.

Many organizations find they need both SOC 1 and SOC 2 reports, often obtaining them in quick succession to provide comprehensive assurance to their clients.

Who Needs a SOC 1 Report?

SOC 1 reports are typically required by companies that provide services that influence their clients’ financial reporting. For example:

• Payroll and accounting services
• Lawyers and bankruptcy firms handling financial statements
• Companies that provide insurance related services
• Accounts receivable cloud-based services
• Banking related services
• Fixed asset trackers
• Software providers that manage financial data

In short, organizations that serve public clients or whose services directly affect their clients’ financial statements are prime candidates for SOC 1 reports. If your company processes, stores, or transmits financial data that appears on your clients’ financial statements, you likely need one. 

Key Characteristics of SOC 1 Reports

SOC 1 reports have several defining features:

1. Financial focus: These reports primarily address internal controls related to financial reporting.
2. Customized objectives: They feature control objectives tailored to the service organization’s specific offerings and processes.
3. Business-centric approach: There’s a strong emphasis on understanding the client’s business model and products to ensure relevant controls are evaluated.
4. Flexibility within structure: The SOC 1 framework provides a structured approach while allowing for adaptability to accurately represent an organization’s unique processes and controls.
5. Comprehensive coverage: Typically, one universal SOC 1 report is produced per service type, offering a holistic view of the organization’s controls.
6. Auditor collaboration: The process requires close cooperation between the auditor and the client to develop appropriate control objective statements.
7. Similarity to SOC 2: While distinct, SOC 1 reports share similarities with the processing integrity aspect of SOC 2 reports, but within their own framework.

This customized approach allows for a more accurate representation of a service organization’s controls and processes. The development of control objectives in SOC 1 reports is often described as more of an art than a science, requiring a deep understanding of the business and its operations.

Types of SOC 1 Reports

SOC 1 reports come in two types. Type 1 is a point-in-time assessment of the organization’s internal controls, as they exist at that moment. Type 2, meanwhile, evaluates the effectiveness of internal controls over an extended time, typically six months to a year.

Type 1 reports aim to evaluate the design and implementation of internal controls, and whether they are tailored for their environment. As such, Type 1 reports may be helpful at the time when new internal controls are established. Later, a company will typically pursue a Type 2 report to show the effectiveness of their controls over a period of time. 

The SOC 1 Audit Process

The SOC 1 audit process is a collaborative effort between the auditor and the service organization. It requires a solid understanding of financial auditing principles and the organization’s specific business model. 

Key steps in the process include:

1. Developing control objectives and statements: The auditor and client work together to define specific goals for internal controls related to financial reporting. These statements guide the audit and must be tailored to the organization’s unique processes.
2. Assessing internal controls: A thorough examination of the organization’s processes that impact financial reporting.
3. Testing the effectiveness of these controls: Evaluating how well the controls function in practice.
4. Documenting findings and preparing the report: Compiling all information into a comprehensive report.

Unlike some “SOC in a box” solutions that focus primarily on IT controls, a thorough SOC 1 audit requires in-depth financial analysis from an auditor that understands the nuances of financial processes. As such, it’s important to select an audit partner with the required fluency.

The Importance of Choosing the Right Auditor

Selecting the right auditor for your SOC 1 report is crucial for ensuring its accuracy and value. When evaluating potential auditors, look for:

• Extensive experience in financial auditing
• Deep understanding of your industry and business model
• Ability to provide tailored, thorough assessments
• Commitment to collaboration in developing control objectives

An experienced auditor will work closely with you to ensure your SOC 1 report accurately reflects your organization’s processes and provides valuable assurance to your clients. This partnership is essential for developing meaningful control objectives and conducting a comprehensive assessment. 

Companies requesting SOC 1 reports are often more discerning than those seeking SOC 2 reports. They require specific assurances about financial controls, reflecting the critical nature of financial reporting in their operations. This heightened scrutiny makes it even more important to choose an auditor with the right expertise and approach.

Smith + Howard: Your SOC 1 Audit Partners 

SOC 1 reports provide assurance about the controls affecting financial reporting. Understanding the purpose and scope of these reports helps organizations prepare for the audit process more effectively. 
When considering a SOC 1 audit, partnering with an experienced auditor can ensure a thorough and valuable assessment of your financial controls. Smith + Howard’s experienced SOC reporting professionals have the financial and industry-specific fluency to help you navigate a successful SOC 1 audit. Contact us today to get started.