Understanding SOC 1 vs. SOC 2 Reports: Choosing the Right Compliance Framework for Your Organization
In today's interconnected business landscape, organizations must demonstrate their ability to safeguard sensitive information and ensure the reliability of their internal systems.
Two prominent compliance frameworks, SOC 1 and SOC 2, are vital in validating control effectiveness and providing assurance to stakeholders.
This article will clarify the differences between SOC 1 and SOC 2 reports and guide organizations in determining which report best aligns with their needs.
SOC 1: An Overview
A SOC 1 (System and Organization Controls 1) report is a type of audit report that evaluates the internal controls of a service organization. These reports are conducted in accordance with the Statement on Standards for Attestation Engagements (SSAE) No. 18, which is issued by the American Institute of Certified Public Accountants (AICPA).
The purpose of a SOC 1 report is to offer confidence to users that the service organization has effective internal controls to ensure the accuracy and completeness of their financial reporting. The service organization’s clients typically request SOC 1 reports, as they want to ensure that their financial information is accurate and secure.
Who Does a SOC 1 Report Serve?
The primary audience for a SOC 1 report is the service organization’s clients. These clients may include financial institutions, insurance companies, or any other organization that relies on the service organization for financial reporting.
In addition to clients, other stakeholders may also be interested in a service organization’s SOC 1 report. These stakeholders may include regulators, auditors, or potential investors.
Types of SOC 1 Reports
While there are many differences between SOC 1 and SOC 2, both have two types of audit: Type I and Type II.
A SOC 1 Type I report evaluates the design of the service organization’s internal controls as of a specific date. This report validates that the controls are suitably designed to achieve the intended control objectives.
A SOC 1 Type II report evaluates the design and operating effectiveness of the service organization’s internal controls over a period of time (usually six months to a year). This report assures that the controls are designed and operate effectively to achieve the intended control objectives.
SOC 2 Reports: An Overview
A SOC 2 (System and Organization Controls 2) report is a type of audit report that evaluates the internal controls of a service organization related to security, availability, processing integrity, confidentiality, and privacy. These reports are conducted in accordance with the Trust Services Criteria (TSC), which is issued by the American Institute of Certified Public Accountants (AICPA).
The purpose of a SOC 2 report is to assure users that the service organization has adequate internal controls in place to ensure the security, availability, processing integrity, confidentiality, and privacy of their data. The service organization’s clients typically request SOC 2 reports, as they want to ensure that their data is secure and protected.
READ MORE: The History of SOC 2 Compliance
Who Does a SOC 2 Report Serve?
One of the main differences between SOC 1 and SOC 2 is the primary audience. SOC 2 reports are for the service organization’s clients. These clients may include technology companies, healthcare organizations, or any other organization that relies on the service organization for data processing or storage.
In addition to clients, other stakeholders may also be interested in a service organization’s SOC 2 report.
Types of SOC 2 Reports
Two types of SOC 2 reports are Type I and Type II.
SOC 2 Type I
This report evaluates the design of the service organization’s internal controls at a point in time. It assures that those controls are suitably designed to achieve TSC.
SOC 2, Type II
This report evaluates the design and operating effectiveness of the service organization’s internal controls over a period of time (usually six months to a year). It assures that the controls are suitably designed and operating effectively to achieve the intended control objectives related to TSC.
READ MORE: SOC 2 Frequency: What You Should Know
3 Main Differences Between SOC 1 and SOC 2 Reports
When evaluating a service organization's internal controls, SOC 1 and SOC 2 are two of the most common audit reports.
While both reports serve the purpose of assuring clients and stakeholders, SOC 1 and SOC 2 reports have several key differences.
Reporting standards
Scope of the audit
The nature of the controls being evaluated
By understanding these differences, organizations can choose the appropriate report based on their specific needs and ensure that their clients and stakeholders have the necessary level of assurance.
1. Reporting Standards for SOC 1 and SOC 2
SOC 1 reports adhere to the rigorous SSAE 18 standards to maintain consistency and quality. These standards provide a framework for evaluating internal controls over financial reporting and require an auditor's attestation.
SOC 2 reports, however, follow the Trust Services Criteria, consisting of five categories encompassing a broader range of control objectives. These criteria address risks and guide for assessing controls relevant to non-financial reporting areas.
2. Scopes of SOC 1 and SOC 2 Audits
The scope of SOC 1 audits centers around the controls related to financial reporting processes. This includes evaluating controls such as revenue recognition, financial statement preparation, and billing.
SOC 2 audits have a broader scope covering data protection controls, system availability, logical access, change management, etc. SOC 2 reports provide valuable insights into an organization's ability to secure its systems and protect customer data.
3. The nature of the controls being evaluated
One of the biggest differences between SOC 1 and SOC 2 is the controls necessary for a successful audit. Both are essential for clients and stakeholders of service organizations.
In a SOC 1 report, the controls being evaluated are related to the financial reporting of the service organization. The report assesses the effectiveness of the controls in place to ensure the accuracy and reliability of the financial statements of the service organization. This is important for clients of the service organization that rely on their financial statements for their financial reporting and decision-making.
On the other hand, a SOC 2 report evaluates the controls related to TSC criteria to ensure that the service organization's systems are secure, available, and processing data with integrity and confidentiality.
Determining Your Requirements: SOC 1, SOC 2, or Both?
Determining which report you need, SOC 1 or SOC 2, depends on the nature of your business and the services you provide.
If your organization offers services directly related to financial reporting, such as payroll processing or accounting services, then a SOC 1 report is likely the appropriate choice. This report assures clients that the internal controls related to financial reporting are effective and reliable.
On the other hand, if your organization provides services that are not directly related to financial reporting but involve handling sensitive data, such as healthcare or technology services, then a SOC 2 report is likely the appropriate choice. This report assures clients that the internal controls related to their data's security, availability, processing integrity, confidentiality, and privacy are effective and reliable.
It's important to note that determining which report is needed is ultimately up to the client or stakeholder requesting the information. They will need to evaluate the nature of the services provided by the service organization and determine which report will provide the necessary level of assurance.
In some cases, clients may request both SOC 1 and SOC 2 reports to ensure they have a comprehensive understanding of the internal controls. This may be particularly relevant for service organizations that provide both financial reporting and non-financial services.
Examples of organizations that may need a SOC 2 report:
Cloud service providers:
Organizations that offer cloud computing services, including infrastructure-as-a-service (IaaS), platform-as-a-service (PaaS), or software-as-a-service (SaaS) models, often require a SOC 2 report. This report assures clients that appropriate security controls are in place to protect their data.
Data centers:
Companies operating or providing colocation services may need a SOC 2 report. It demonstrates that they have implemented adequate security, availability, processing integrity, confidentiality, and privacy controls.
Software-as-a-service (SaaS) providers:
SaaS companies that handle sensitive customer data, such as personal information or financial records, can benefit from obtaining a SOC 2 report. It verifies that its information security controls meet industry standards and customer expectations.
READ MORE: Why SOC 2 Auditing is Essential for SaaS Businesses
Examples of organizations that may need a SOC 1 report:
Third-party service providers:
Companies that offer payroll processing, HR administration, or financial transaction processing for other organizations might require a SOC 1 report. This report assesses the effectiveness of their internal controls over financial reporting, which is crucial for their client's financial audits.
Pension plan administrators:
Organizations responsible for managing pension plans may need a SOC 1 report. This report demonstrates that they have appropriate controls to ensure the accuracy, completeness, and confidentiality of financial information related to pension plans.
Trust companies:
Financial institutions, such as trust companies, that manage assets on behalf of clients might require a SOC 1 report. It assures its clients that internal controls are in place to protect the assets and maintain accurate financial records.
Examples of organizations that may need both SOC 2 and SOC 1 reports:
Data center and managed services provider:
Companies that offer data center and managed services, such as IT infrastructure management or network security, may require both SOC 2 and SOC 1 reports. The SOC 2 report covers the security controls for their services, while the SOC 1 report assesses their controls related to financial reporting.
Cloud-based financial software provider:
Organizations that offer cloud-based financial software, which handles financial transactions and customer data, may need SOC 2 and SOC 1 reports. The SOC 2 report ensures the security and privacy of customer data, while the SOC 1 report addresses the controls over financial reporting within the software.
Outsourced payroll and HR services provider:
Companies that offer outsourced payroll and HR services, including handling financial transactions and managing sensitive employee data, might require both SOC 2 and SOC 1 reports. The SOC 2 report verifies the security and privacy controls for customer data, while the SOC 1 report assesses controls related to financial reporting for payroll processing.
Who Should You Hire When Considering a SOC 1 or SOC 2 Audit and Report?
When seeking SOC 1 and SOC 2 assessments, audits, reports, and certification, partnering with a reputable third-party CPA firm is crucial. These firms possess the necessary expertise and experience to conduct thorough evaluations of a service organization's internal controls, assuring clients and stakeholders.
Why Third-Party CPA Firms for SOC 1 and SOC 2 Assessments and Certification Are Crucial for Compliance
Due to the differences between SOC 1 and SOC 2, engaging a qualified third-party CPA firm is essential for assessments, audits, reports, and certification.
These firms specialize in auditing services for businesses of all sizes, bringing integrity, efficiency, and flexibility to their auditing processes. They help clients demonstrate compliance with governance, risk management, and compliance (GRC) requirements.
The professionals in these firms have extensive experience in the GRC field and are committed to delivering a seamless engagement experience. Each client is assigned a dedicated auditor and a Customer Success team to ensure personalized and prompt service.
Clients can expect to receive their final report within 4 to 6 weeks from the start of the audit. These reports address the controls pertinent to the security, availability, and processing integrity of user systems. Additionally, they align with an organization's regulatory compliance needs, such as HIPAA Security and Breach Notification Rules.
These firms also offer readiness assessments for organizations seeking certification to the ISO/IEC 27001 standard.
By collaborating with a qualified third-party CPA firm, service organizations can fulfill internal control requirements and provide the necessary assurance to clients and stakeholders.
Understanding the differences between SOC 1 and SOC 2 reports is crucial for organizations seeking to establish control over their internal systems and processes. While SOC 1 reports attest to financial controls, SOC 2 reports address a wider range of control objectives, including security, availability, processing integrity, confidentiality, and privacy.
By selecting the appropriate compliance framework, businesses can meet the specific reporting requirements of their industry and provide confidence to clients, partners, and regulators.
It is important for organizations to engage with a qualified risk advisory professional CPA firm to determine the most suitable report for their needs.
By partnering with risk assessment and compliance experts, businesses can navigate the complexities of SOC reporting and develop a comprehensive strategy to demonstrate control effectiveness and instill trust in their operations.
