When organizations outsource functions like data hosting, payroll processing, or software services, they need assurance that the vendor is managing those responsibilities properly. A System and Organization Controls (SOC) report details a service organization’s internal controls. These reports address the risks created when a company entrusts sensitive operations to a third-party vendor. They provide confidence that established processes are operating effectively to protect the user entity’s interests. Understanding the different types of SOC reports is important for navigating modern business relationships and regulatory expectations.
Defining the Acronym and Governing Body
The acronym SOC stands for System and Organization Controls. This suite of reports is designed to help service organizations build trust with their clients. These reporting standards are established and governed by the American Institute of Certified Public Accountants (AICPA). The reports are performed by independent Certified Public Accountants (CPAs) or CPA firms, ensuring the examination of controls is conducted by an objective third party following a standardized professional framework.
Why Are SOC Reports Necessary?
Modern businesses frequently rely on external vendors for functions that affect their operations, necessitating formal vendor risk management and due diligence. SOC reports provide the necessary transparency for a client, known as the user entity, to evaluate the risks associated with outsourcing these services. For service organizations, having a report streamlines the audit process by providing one comprehensive document instead of responding to countless individual client questionnaires.
The documentation also plays a large role in regulatory compliance, particularly for publicly traded companies or those in highly regulated industries. The reports demonstrate that a service organization has formalized, independently verified controls in place. They transfer assurance from the service provider back to the user entity, satisfying governance requirements.
The Core Difference Between SOC 1 and SOC 2 Reports
The two most frequently encountered SOC reports, SOC 1 and SOC 2, address fundamentally different organizational concerns, dictating their respective audiences and content. The SOC 1 report focuses exclusively on controls relevant to a user entity’s Internal Controls over Financial Reporting (ICFR). This means the report is primarily concerned with how the service organization’s operations might impact the client’s financial statements.
In contrast, the SOC 2 report is centered on the security, availability, and integrity of the service organization’s systems and the confidentiality or privacy of the data processed. SOC 2 provides assurance over how the service organization protects the client’s information technology environment and data. This foundational difference directs the entire scope of the audit.
Understanding SOC 1 Reports
A SOC 1 report is formalized under the Statement on Standards for Attestation Engagements (SSAE) No. 18, the AICPA standard for examining service organization controls. The scope is narrow, focusing only on controls that could impact the user entity’s financial reporting, such as those related to payroll processing or investment management services. The primary audience for this technical report is the user entity’s financial statement auditors, who use the information to assess risk and plan their audit procedures.
The report helps the client’s auditors understand how the service organization’s controls affect the numbers appearing on the client’s general ledger. It provides details on the service organization’s control objectives and the specific controls designed to meet them.
Understanding SOC 2 Reports and the Trust Services Criteria
The SOC 2 report is designed for technology and cloud service providers, focusing on non-financial controls related to data handling and system reliability. Its audience includes current and prospective clients, business partners, and regulatory bodies concerned with data protection practices. The report is structured around the Trust Services Criteria (TSC), which are principles guiding the design and operation of controls related to information security. The Security criteria, often called the Common Criteria, are mandatory for every SOC 2 examination.
Security
Security controls manage the protection of information and systems from unauthorized access, disclosure, and damage. This includes controls like network firewalls, intrusion detection, and access controls to protect against logical and physical threats.
Availability
The Availability criteria address whether the system is accessible for operation and use as agreed upon with the user entity. This involves controls related to network performance monitoring, disaster recovery planning, and system backup procedures.
Processing Integrity
Processing Integrity relates to whether system processing is complete, accurate, timely, and authorized. Controls in this area focus on quality assurance procedures, error detection, and data validation during transactions.
Confidentiality
Confidentiality addresses the service organization’s ability to protect information designated as confidential from unauthorized disclosure. This is typically achieved through encryption during transmission and storage, along with strict access controls.
Privacy
The Privacy criteria pertain to the service organization’s use and collection of personal information in conformity with its privacy notice and established principles. This criterion specifically addresses the personally identifiable information (PII) of data subjects, distinct from the broader Confidentiality criteria.
The Difference Between Type 1 and Type 2 Reports
A distinction that applies to both SOC 1 and SOC 2 reports is the inclusion of either a Type 1 or a Type 2 designation, which defines the period covered by the auditor’s examination. A Type 1 report describes the service organization’s system and the suitability of the design of its controls at a specific point in time. The auditor confirms the controls are appropriately designed and implemented, but does not test whether they actually worked over time.
In contrast, the Type 2 report reports on the operating effectiveness of those controls over a period of time, typically six to twelve months. For a Type 2 report, the auditor confirms the control design and performs detailed testing to verify that the controls consistently functioned as intended throughout the period. Because the Type 2 report includes evidence of sustained control operation, it is the preferred report by regulators, sophisticated clients, and user entity auditors.
Understanding SOC 3 Reports
The SOC 3 report serves as a public-facing, general-use summary derived from the detailed SOC 2 Type 2 examination. Unlike the SOC 2 report, which is restricted to user entities and their auditors under a non-disclosure agreement, the SOC 3 is intended for broad distribution and can be posted on a service organization’s website. It covers the same criteria as the SOC 2, but it omits the detailed description of the controls and the specific results of the auditor’s testing. This summary format makes the SOC 3 report an effective marketing and assurance tool for organizations demonstrating their commitment to robust security practices.