In today's fast-paced, digital-first world, businesses increasingly rely on technology and outsourced services to meet their operational needs. But this reliance on third-party service providers creates a need for greater transparency and accountability.

That's where SOC 1 comes in.

SOC 1 is a widely recognized and standardized framework for evaluating the effectiveness of a service provider's internal controls. In this post, we'll discuss what SOC 1 is, why it's important, who needs it, the different types of SOC 1 reports, the benefits of getting a SOC 1, how to become SOC 1 compliant, and more.

What is SOC 1?

SOC 1, which stands for System and Organization Controls 1, is a type of report issued by an independent auditor to evaluate a service organization's internal controls related to financial reporting.

The report is based on the SSAE 18 standard in accordance with the American Institute of Certified Public Accountants' (AICPA) Service Organization Control (SOC) reporting framework. In May 2017, SSAE 18 replaced the previous SSAE 16 and SAS 70 auditing standards that had been in use for about 25 years.

The SOC 1 report evaluates the effectiveness of an organization's controls in achieving specific control objectives established by the organization and is typically based on the COSO (Committee of Sponsoring Organizations) framework, which is widely used in the accounting and auditing profession. The report also includes a description of the organization's system as well as the tests performed by the auditor to evaluate the controls.

Why is SOC 1 important?

SOC 1 reports are important because they provide assurance to service organization clients and their auditors that the organization has adequate controls in place to mitigate the risk of errors or fraud that could impact financial reporting. This assurance is critical because many service organizations operate in highly regulated industries where compliance with industry standards is necessary to maintain client relationships and win new business.

SOC 1 reports can also help organizations improve their internal controls by identifying weaknesses or deficiencies in their systems. By addressing these issues, businesses can reduce the risk of fraud or errors and improve their overall operations.

Who needs SOC 1?

SOC 1 reports are commonly used by organizations that provide services that could impact their clients' financial reporting, such as payroll processing, data center hosting, payment processing, or other outsourced services that are critical to their clients' financial operations. SOC 1 reports are often requested by clients as part of their vendor due diligence process, and in some cases, they may be required by industry regulators or other governing bodies.

The different types of SOC 1 reports

There are two types of SOC 1 reports: SOC 1 Type 1 and SOC 1 Type 2. Each type of report provides a different level of assurance to service organization clients and their auditors that the organization has adequate controls in place. Let’s take a look at all three types of reports now.

SOC 1 Type 1

A SOC 1 Type 1 report evaluates the design effectiveness of the company's controls at a specific point in time, with the auditor testing said controls to ensure they’re designed effectively to achieve the control objectives. This type of report is useful for clients who want to understand the design of an organization's controls but may not require evidence of their operating effectiveness. SOC 1 Type 1 reports are typically conducted during the initial year of an engagement or after significant changes to an organization's control environment.

SOC 1 Type 2

A SOC 1 Type 2 report provides an auditor's opinion on the design and operating effectiveness of the organization's controls over a period of time, which is typically six to 12 months. This means that in addition to testing the controls to ensure they’re designed effectively, the auditor also ensures they’re operating as intended to achieve the control objectives. This makes SOC 1 Type 2 reports useful for clients who require assurance that the controls have been effective over a period of time. This type of report is typically conducted after the initial year of an engagement or after significant changes to an organization's control environment.

Benefits of getting a SOC 1 report

Getting a SOC 1 report can provide a number of benefits to service organizations and their clients, including:

Risk mitigation

Conducting a SOC 1 audit can help companies identify gaps in their controls and improve their risk mitigation and management processes. This can help prevent potential issues from arising and reduce the risk of financial loss or reputational damage.

Trust building 

A SOC 1 report provides assurance to clients that the business has a commitment to strong internal controls in order to mitigate the risk of errors or fraud that could impact their financial reporting. This can increase client confidence in the organization's ability to protect their sensitive information and make them more likely to continue a working relationship.

Increased revenue

Having a SOC 1 report can provide a competitive advantage for service organizations and ensure regulatory compliance — thereby avoiding potential financial penalties — all of which can make it easier to land new clients and ultimately increase revenue.

How to become SOC 1 compliant

Becoming SOC 1 compliant can be a complex process, but following these steps can help simplify it:

1. Gather documentation

The first step in becoming SOC 1 compliant is to gather documentation related to your organization's internal controls, including policies, procedures, training materials, and other documentation. From there, you’ll need to identify which controls are relevant to financial reporting and ensure that they’re all properly documented.

2. Complete audit

Once you’ve gathered your documentation, you’ll need to engage a qualified auditor to perform a SOC 1 audit. The auditor will review your documentation and perform testing to ensure that your controls are operating effectively and meeting specific control objectives. This may involve interviews with key personnel, walkthroughs of your processes, and other testing procedures depending on what type of SOC 1 report you need.

3. Get report

After completing the audit, the auditor will issue a SOC 1 report that provides an opinion on the effectiveness of your controls. The type of report you’ll need will depend on your specific business needs and the requirements of your clients.