Blog  Difference between SOC 2 Type 1 and Type 2

When it comes to keeping your organization’s data secure and compliant, understanding SOC reports is a must. SOC 1 and SOC 2 might sound like technical jargon, but they’re actually quite important for financial reporting and data protection. 

SOC 1 reports zero in on internal controls related to financial reporting. Meanwhile, SOC 2 reports cover a broader spectrum, focusing on security, availability, processing integrity, confidentiality, and privacy—making them crucial for service organizations, especially those offering tech and cloud services. 

Let’s examine these reports’ main points and the reasons your business should care about them. 

Understanding SOC Reports 

To navigate the world of compliance and data security, it’s essential to grasp the purpose and types of SOC reports.

1. Purpose of SOC Reports

SOC reports are governed by the American Institute of Certified Public Accountants (AICPA) and are aimed at ensuring that organizations maintain robust internal controls. Here’s why they matter: 

• • Auditing Processes: They examine the efficiency and effectiveness of an organization’s internal controls. 
  • Compliance: Help organizations comply with industry standards and regulations. 
  • Trust Building: Offer reassurance to clients and stakeholders about the reliability and integrity of their service providers. 

 2. Types of SOC Reports

There are three main types of SOC reports, each serving unique purposes: 

SOC 1 

• • Focus: Internal controls over financial reporting (ICFR). 
  • Purpose: Ensure accurate financial reporting by the service organization. 
  • Primary Audience: Service organization’s management, user entities, and auditors of the user entity’s financial statements. 

SOC 2 

• • Focus: Controls relevant to security, availability, processing integrity, confidentiality, and privacy. 
  • Purpose: Address a broader range of internal controls and processes related to managing and safeguarding data. 
  • Primary Audience: Stakeholders concerned with data management, including security and privacy. 

SOC 3 

• • Focus: Similar to SOC 2 but intended for a more general audience. 
  • Purpose: Provide a high-level overview of the service organization’s controls without the detailed information found in SOC 2. 
  • Primary Audience: General public, including potential clients and other stakeholders. 

Understanding these types of SOC reports can help your organization choose the right one to meet compliance requirements and build trust with your clients and stakeholders. 

For more on our SOC compliance services, Click Here

SOC 1 Report in Detail 

SOC 1 reports are crucial for organizations whose services directly impact the financial statements of their clients. Let’s break down what SOC 1 reports entail, the standards they follow, and where they are ideally used.

1. Definition and Purpose

A SOC 1 report focuses on evaluating the internal controls over financial reporting (ICFR) of a service organization. The main objective is to ensure that these controls are designed and operating effectively to accurately process financial data. This type of report reassures clients and stakeholders that the financial information managed by the service provider is reliable.

2. SSAE 18 Standards (Update from SSAE 16)

SOC 1 reports adhere to SSAE 18 standards, which replaced the older SSAE 16 standards. This change simplified and converged attestation standards related to SOC 1 audits. Additionally, the SSAE 18 also expanded to cover more types of attestation reports (including SOC 2), whereas SSAE 16 was limited to only SOC 1 reports.

3. Type 1 vs Type 2 Reports

SOC 1 reports come in two types: 

• • Type 1 Report: Evaluates the design of controls at a specific point in time. It provides an overview of the system and whether the controls are suitably designed to meet control objectives. 
  • Type 2 Report: Assesses not only the design but also the operational effectiveness of controls over a period (usually six months to a year). This type of report gives a more comprehensive view of how well the controls function in practice. 

4. Ideal Use Cases for SOC 1

SOC 1 audits are particularly important for service organizations that have a direct impact on their clients’ financial reporting. Examples include: 

• • Payroll Processing Companies: Handle sensitive employee financial information and calculations critical to financial reporting. 
  • Loan Servicing Companies: Manage payment processing, interest calculations, and other financial activities impacting the financial health of borrowers. 
  • Benefits Administrators: Oversee retirement accounts, health insurance claims, and other benefits with financial implications. 
  • SaaS Providers with Financial Impact: Offer platforms used for financial transactions or reporting, necessitating checks to ensure the integrity of processed financial data. 

SOC 2 Report in Detail 

SOC 2 reports are essential for service organizations that store, process, or handle customer data, especially when demonstrating a commitment to data security and compliance is critical. Let’s explore the details of SOC 2 reports, including their purpose, criteria, types, and ideal use cases.

1. Definition and Purpose

A SOC 2 report is designed to evaluate an organization’s controls related to security, availability, processing integrity, confidentiality, and privacy. Unlike SOC 1, which focuses on financial reporting, SOC 2 addresses a broader scope of data management and protection. The purpose of SOC 2 is to provide assurance to stakeholders that the service organization has implemented effective controls to safeguard data.

2. Five Trust Service Criteria

SOC 2 reports are based on five trust service criteria, which form the foundation for evaluating the effectiveness of an organization’s controls: 

Security. Information and systems are protected against unauthorized access, unauthorized disclosure of information, and damage to systems that could compromise the availability, integrity, confidentiality, and privacy of information or systems and affect the entity’s ability to achieve its objectives.    

Security refers to the protection of    

1. i. information during its collection or creation, use, processing, transmission, and storage, and  
2. systems that use electronic information to process, transmit, transfer, and store information to enable the entity to meet its objectives. Controls over security prevent or detect the breakdown and circumvention of segregation of duties, system failure, incorrect processing, theft or other unauthorized removal of information or system resources, misuse of software, and improper access to or use of, alteration, destruction, or disclosure of information.  

Availability. Information and systems are available for operation and use to meet the entity’s objectives.   

Processing Integrity. System processing is complete, valid, accurate, timely, and authorized to meet the entity’s objectives.   

Confidentiality. Information designated as confidential is protected to meet the entity’s objectives. Confidentiality addresses the entity’s ability to protect information designated as confidential from its collection or creation through its final disposition and removal from the entity’s control in accordance with management’s objectives.   

Privacy. Personal information is collected, used, retained, disclosed, and disposed of to meet the entity’s objectives. ​​

3. Type 1 vs Type 2 Reports

SOC 2 reports come in two types: 

• Type 1 Report: Evaluates the design and implementation of controls at a specific point in time. It provides a snapshot of the control environment and whether the controls are suitably designed to meet the Trust Service Criteria. 
• Type 2 Report: Assesses not only the design but also the operational effectiveness of controls over a period (usually six months to a year). This type of report offers a comprehensive view of how well the controls function in practice and whether they consistently meet the Trust Services Criteria.

4. Ideal Use Cases for SOC 2

SOC 2 audits are relevant for a broad range of service organizations that handle customer data and need to demonstrate their commitment to data security and compliance. Ideal use cases include: 

• • Cloud Computing Services: These providers store and process vast amounts of data, making robust controls over data security, availability, and privacy essential. 
  • SaaS Providers (Non-Financial Impact): SaaS platforms that handle customer data (but do not impact financial reporting) require stringent controls to ensure data security and privacy. 
  • Data Centers: Facilities that host critical infrastructure and data for multiple businesses must assure clients of their physical and environmental controls to maintain operational integrity and security.
  • Managed IT Services: Companies offering IT management services need to ensure the confidentiality, integrity, and availability of the systems and data they manage to maintain trust and reliability. 

Talk to our experts today!

Choosing Between SOC 1 and SOC 2 

Selecting the appropriate SOC report—SOC 1 or SOC 2—depends on various factors related to your business needs, industry requirements, and the specific services you provide. Here’s a guide to help you make an informed decision.

1. Factors to Consider

When deciding between SOC 1 and SOC 2, consider the following factors: 

Nature of Services Provided: 

• SOC 1: Ideal if your services directly impact your clients’ financial reporting (e.g., payroll processing, loan servicing). 
• SOC 2: Suitable if your services involve storing, processing, or managing customer data with a focus on security and compliance (e.g., cloud services, SaaS platforms). 

Regulatory and Compliance Requirements: 

• SOC 1: May be required if your industry has strict regulations around financial reporting and integrity. 
• SOC 2: while not directly replacing GDPR, HIPAA or CCPA, it can contribute to data protection practices and align with these regulations when implemented effectively. SOC 2 and these regulations serve different purposes, but together they enhance data security and privacy. 

Client and Stakeholder Expectations: 

• SOC 1: Clients concerned with the accuracy of financial transactions and reporting will look for SOC 1 compliance. 
• SOC 2: Clients and stakeholders who prioritize data security, privacy, and availability will value SOC 2 reports. 

2. Decision-Making Guide for Businesses

To determine whether SOC 1 or SOC 2 is the right choice for your organization, follow this decision-making guide: 

Evaluate Your Services: 

Do your services have a direct impact on your clients’ financial statements? 

Yes: Consider SOC 1. 

No: Move to the next question. 

Assess Data Management Practices: 

Do you handle, store, or process sensitive customer data that requires robust security, availability, and privacy controls? 

Yes: Consider SOC 2. 

No: SOC 1 might still be relevant if any financial reporting elements are involved. 

Identify Regulatory Requirements: 

Are there industry standards or regulatory requirements specific to financial reporting or data protection that you must comply with? 

• Financial Reporting Regulations: SOC 1. 
• Data Protection Regulations: SOC 2. 

Understand Client Needs: 

What do your clients and stakeholders expect in terms of assurance and compliance? 

• Financial Accuracy and Integrity: SOC 1. 
• Data Security and Privacy: SOC 2. 

Consider Long-Term Goals:

Which report aligns better with your strategic goals and market positioning? 

• If aiming to establish credibility in financial reporting, opt for SOC 1. 
• If prioritizing data security and compliance, go for SOC 2. 

By carefully considering these factors, your organization can choose the most appropriate SOC report to meet compliance needs, build client trust, and support business objectives. 

The Audit Process 

For SOC 1 Audit: 

• • Defining Control Objectives: Identify the control objectives crucial for financial reporting and operations related to your services. This involves understanding what needs to be controlled and why. 
  • Identifying Relevant Controls: Determine and document the specific controls that support your defined objectives. Ensure these controls are effective at mitigating related risks. 
  • Engaging a Qualified CPA Firm: Choose a CPA firm with expertise in SOC 1 audits. A firm like TrustNet can guide you through the audit process and ensure compliance with AICPA standards. 
  • Implementing Remediation Measures: Address any gaps or weaknesses in your controls before the audit. This step is critical to meet the required standards for financial reporting integrity.

For SOC 2 Audit: 

• • Defining Control Objectives: Focus on the Trust Services Criteria applicable to your services—security, availability, processing integrity, confidentiality, and privacy. 
  • Identifying Relevant Controls: Map out controls that address the chosen Trust Services Criteria. This includes detailing how your organization safeguards and manages data. 
  • Engaging a Qualified CPA Firm: Select a firm seasoned in SOC 2 audits like TrustNet to ensure your controls meet the rigorous requirements of the Trust Services Criteria. 
  • Implementing Necessary Remediation Measures: Similar to SOC 1 preparation, remediate any control deficiencies to align with SOC 2 standards, focusing on data protection and privacy. 

What to Expect During the Audit 

• • Initial Assessment: The audit begins with an initial assessment where the auditors understand your organization’s control environment and scope of the audit.
  • Documentation Review: Auditors will review the documentation of your control processes. This includes policies, procedures, and records that demonstrate how controls are implemented. 
  • Control Testing: For Type 1 reports, auditors evaluate the design of controls at a specific point in time. For Type 2 reports, they assess the operational effectiveness of controls over a period (usually six months to a year). 
  • Interviews and Observations: Auditors may conduct interviews with key personnel and observe processes in action to verify that controls are functioning as documented.
  • Feedback and Remediation: Throughout the audit, auditors may provide feedback on areas of improvement. Addressing these points promptly can help ensure a smooth audit process. 

Interpreting Audit Results 

Unqualified vs. Qualified Opinions: 

• • Unqualified Opinion: This is the best outcome, indicating that the auditor found no significant issues with the design and operating effectiveness of the controls. It means that the controls are appropriately designed and are functioning effectively. 
  • Qualified Opinion: Indicates that the auditor found some deficiencies in the design or operating effectiveness of controls. These deficiencies need to be addressed to meet the required standards. A qualified opinion doesn’t mean a failure but highlights areas needing improvement. 

Benefits of SOC Compliance 

Achieving SOC compliance provides several key advantages for organizations:

1. Enhanced Credibility and Trust

SOC compliance shows adherence to high standards of control and security, boosting credibility with clients and stakeholders and building trust through demonstrated commitment to data protection.

2. Competitive Advantage

Compliance differentiates your organization from competitors by signaling robust data security practices, making you a more appealing choice for potential clients, especially in security-sensitive industries.

3. Risk Management and Security Improvement

The compliance process identifies and mitigates risks, strengthening internal controls and reducing the likelihood of data breaches and financial misstatements, leading to a more secure and resilient operation. 

Recent Developments and Trends in SOC Reporting 

SOC reporting continues to evolve, influenced by technological advancements and regulatory requirements. 

The need for SOC reports has grown as cloud computing and digital transformation have become more prevalent. SOC 2 is especially important since cloud-based service companies need to show that they have strong security and compliance protocols in place.  This pattern highlights the necessity of ongoing control monitoring and upgrading in order to protect data in ever-changing digital settings.  

Also, SOC reports are becoming more and more interwoven with other regulatory frameworks, such as HIPAA and GDPR. These days, businesses look for SOC audits that satisfy a variety of legal criteria, expediting compliance procedures and offering clients total assurance. This integration improves overall compliance efficiency by guaranteeing that controls not only satisfy SOC criteria but also comply with more extensive legal and regulatory requirements. 

The Critical Role of SOC Reports in Modern Business 

Building trust, boosting credibility, and giving an advantage over competitors are all made possible via SOC reports. They support businesses in efficiently managing risks and ensuring that strict control requirements are met, protecting sensitive data, and upholding operational integrity. 

Additional Resources

For further information and to deepen your understanding of SOC reports, explore the following resources:

A. Links to AICPA Guidelines

AICPA SOC Overview: Comprehensive information about SOC reports, including guidelines and standards.

SOC 1 Report Guide: Detailed guidance on SOC 1 reports and their applications.

SOC 2 Report Guide: In-depth insights into SOC 2 reports and the Trust Services Criteria.

B. FAQs About SOC Reports

What is a SOC report?

A SOC report is an audit report that evaluates the controls at a service organization, focusing on financial reporting (SOC 1) or data security and privacy (SOC 2).

Who needs a SOC report?

Organizations providing services that impact clients’ financial statements or handle sensitive customer data typically need SOC reports to demonstrate control effectiveness and compliance.

How often should a SOC audit be conducted?

SOC audits are generally conducted annually to ensure ongoing compliance and to address any changes in control environments or regulatory requirements.

What is the difference between Type 1 and Type 2 SOC reports?

Type 1: Evaluates the design of controls at a specific point in time.

Type 2: Assesses both the design and operating effectiveness of controls over a period (usually six months to a year).