Understanding the Key Variations in Service Organization Controls: SOC 1 versus SOC 2
Organizations depend more and more on outside service providers to manage important facets of their operations in the linked corporate environment of today. This dependence has created a rising need for confidence on the integrity, availability, and security of the systems of these service providers. Service Organization Control (SOC) 1 and SOC 2 reports are two fundamental systems addressing these issues. Although both are meant to provide insightful analysis of the controls of a service company, they have different uses and appeal to various groups. This paper attempts to investigate the main variations between SOC 1 and SOC 2 reports, thereby enabling companies and stakeholders to decide which kind of report best fits their situation.
SOC 1: Emphasizing Financial Reporting
Originally titled “Reports on Controls at a Service Organization Relevant to User Entities’s Internal Control over Financial Reporting,” SOC 1 mostly addresses how the controls of a service organization affect its customers’ financial statements. These reports are intended for service companies whose outsourced operations impact the financial reporting of their user companies.
The main audience for SOC 1 reports consists in:
User entities—that is, service organization clients—have
Users entity Auditors
Management of the company with services
Two forms exist for SOC 1 reports:
Type I: explains the systems of the service organization and evaluates if the control descriptions fairly reflect and adequately constructed to reach the designated control goals at a given moment.
Type II comprises all information in a Type I report along with an evaluation of the controls’ operational performance over a designated period—typically six to twelve months.
Usually, important topics addressed in a SOC 1 report consist of:
Control atmosphere
Methodologies of risk assessment
Information systems and correspondence
Control efforts
Watching events
SOC 1 reports center on internal controls over financial reporting (ICFR). This implies that the controls under analysis directly affect the dependability and correctness of financial accounts. For instance, a payroll processing business would require a SOC 1 report to show that its controls guarantee the computation and reporting of employee salaries, thus impacting its customers’ financial statements.
SOC 2: Trust Service Standards
Unlike SOC 1, SOC 2 reports on security, availability, processing integrity, confidentiality, and privacy of a service organization’s controls pertinent to systems used to handle user data. Based on the AICPA’s Trust Services Criteria, these reports are meant for a wider spectrum of service companies handling private customer data but may not immediately influence financial reporting.
The main audience for SOC 2 reports consists in:
Organization of the service company
Potential clients
Business collaborators
Authorities
Like SOC 1, SOC 2 reports also arrive in Type I and Type II variations:
Type I: Details the systems of the service organization and evaluates if the controls are appropriately built to satisfy the relevant Trust Services Criteria at a given moment in time.
Type II comprises everything in a Type I report along with an evaluation of the controls’ operational performance over a designated time.
A SOC 2 report’s Trust Services Criteria address:
Security: The system is kept both physically and logically free of illegal access.
Availability: As pledged or agreed upon, the system is operational and usable.
System processing is full, valid, accurate, timely, approved.
Information identified as confidential is safeguarded as agreed upon or promised.
Personal information is gathered, utilized, stored, shared, and disposed of in line with the terms of the entity’s privacy statement and with standards defined in Generally Accepted Privacy Principles (GAPP).
With security the sole necessary requirement, a service organization may decide to include any mix of these standards in its SOC 2 report.
Important Variances
Goal and Emphasize:
SOC 1: Works on controls pertinent to financial reporting.
SOC 2 covers security, availability, processing integrity, confidentiality, and privacy related measures.
Audiance:
SOC 1: Designed mostly for auditors of user entities.
Designed for a more general readership including regulators and potential customers, SOC 2
Criteria:
SOC 1: Based on financial statements of user entities and control goals particular to the service company.
SOC 2: Derived from Trust Services Criteria of the AICPA.
Versatility:
SOC 1: The control goals are catered to the particular services provided and their effect on financial reporting.
SOC 2: Service firms may decide which extra Trust Services Criteria to include even while security is required.
Legal Requirements:
SOC 1: Usually needed to follow laws like Sarbanes-Oxley Act (SOX).
Often used to show adherence to industry standards and data security rules is SOC 2.
Transmission of Reports:
SOC 1: Usually limited to the auditors, user entities, and service organizations.
Often used as a marketing tool to show the organization’s dedication to security and privacy, SOC 2 may be more generally shared.
Selecting SOC 1 or SOC 2
Pursuing a SOC 1 or SOC 2 report will rely on a number of considerations:
Nature of Services: A SOC 1 report is probably required if the operations of the service company directly affect the financial statements of its customers. SOC 2 is better fit for companies managing sensitive data without immediate financial reporting consequences.
Client Needs: As part of their vendor management systems, certain customers may especially ask for or demand either a SOC 1 or SOC 2 report.
Certain sectors or laws may need certain kinds of assurance reports.
SOC 2 reports may be effective marketing tools that show to prospective customers a dedication to security and privacy, therefore strengthening their competitiveness.
Organizations should decide which facets of their operations and controls should be looked at and documented on.
Service companies sometimes may need both SOC 1 and SOC 2 reports to satisfy various stakeholders needs.
In conclusion
Although their structure and goal of providing assurance are somewhat similar, SOC 1 and SOC 2 fulfill different demands in the corporate environment. For companies which directly influence their customers’ financial statements, SOC 1 reports on the effect of the controls of a service organization on financial reporting, therefore they are absolutely important. For a variety of service providers managing sensitive data, SOC 2 reports—on security, availability, processing integrity, confidentiality, and privacy—address a more general set of issues and are thus beneficial.
Service companies that want to choose one of these two kinds of reports best fits their customer demands and business strategy must first understand their variances. User entities and other stakeholders equally need to understand these differences when choosing possible service providers or determining if their controls are sufficient.
SOC reports will probably become more important as the corporate scene changes and data security and privacy become more and more of relevance. Companies that aggressively seek and maintain suitable SOC reports show their dedication to openness, security, and dependability, thereby building confidence among their partners and customers.