Demystifying SOC 1 (Part I): What Exactly Is SOC 1, and Why Should CPAs Care?

Key Takeaways

• SOC 1 reports focus on controls relevant to financial reporting.
• Accounting and SOX teams are responsible for reviewing and relying on SOC 1 reports.
• Most medium to large and publicly traded companies require SOC 1 from in-scope service organizations.
• External auditors routinely request SOC 1 reports during financial audits.
• A strong SOC 1 reduces manual testing and audit friction.
  
  

What Is SOC 1? A Straightforward Definition

A SOC 1 report is an independent assurance report issued by certified public accountants that evaluates a service organization’s controls relevant to user entities' internal controls over financial reporting.

In plain terms:

A SOC 1 report shows whether a vendor has the right controls in place around the systems or processes it runs that affect a company's financial statements.

It applies specifically to systems and services that impact the financial reporting process.

When Does SOC 1 Apply?

SOC 1 is relevant when a service organization operates systems or performs services that could affect a company’s financial statements.

Common examples include:

• Payroll processors
• Billing platforms
• Loan servicers
• Financial data platforms
• Accounting software used in the month-end close
  
  

If the output of a system affects financial reporting, financial statement auditors will likely require a SOC 1 report.

For accounting teams, this means identifying third-party systems that support financial processes and obtaining SOC 1 reports from those providers as part of their audit process. 

In practice, once a system becomes part of the financial reporting workflow, auditors will expect assurance that the vendor's controls can be relied upon.

Why Do CPAs and Accounting Teams Care About SOC 1?

Accounting teams are responsible for internal control over financial reporting. That responsibility does not stop at the company’s firewall.

If a third-party service organization impacts financial reporting, accountants must:

• Obtain the SOC 1 report
• Review the control objectives
• Evaluate the design and operating effectiveness of controls
• Identify any control gaps
• Ensure compliance with Complementary User Entity Controls

External auditors will often request evidence that these steps were performed.

If the service organization lacks a SOC 1 report, the burden shifts back to the accounting team. That can mean expanded audit scope, additional manual testing, and increased compliance costs.

What Does a SOC 1 Report Actually Cover?

A SOC 1 audit evaluates whether certain controls are:

• Properly designed
• Operating effectively
• Providing reasonable assurance over financial reporting
  
  

The report typically includes:

• Management’s assertion about the control environment
• A description of the system and services provided
• Control objectives and the controls designed to achieve them
• Testing performed by the auditor
• Results of that testing

Within both SOC 1 and SOC 2, the organization must also choose a SOC type. Note that the SOC type (Type 1 vs Type 2) is different from the SOC category (SOC 1 vs SOC 2) - confused enough yet?

Type 1 (Point-in-Time)

SOC Type 1 reports evaluate design effectiveness at a specific point in time.

Type 2 (Over Time)

Evaluates both design and operating effectiveness over a period, usually six to twelve months.

Type 2 SOC reports are generally more valuable to accounting teams and financial statement auditors. FloQast has completed both SOC Type 1 and SOC Type 2 examinations. 

SOC 1 and Internal Control Over Financial Reporting

SOC 1 directly supports compliance with internal control over financial reporting under SOX, typically using the COSO framework.

It connects third-party systems to the broader control environment.

For example:

• If a payroll processor calculates wages incorrectly, financial statements could be misstated.
• If a billing system miscalculates revenue, it affects reported income.
• If system access controls fail, unauthorized changes could impact financial data.

SOC 1 provides independent assurance that appropriate controls exist to address these risks.

How SOC 1 Impacts the Audit Process

During a financial audit, external auditors often ask:

• Which service organizations are in scope?
• Do you have their SOC 1 reports?
• Did management review them?
• Were any exceptions identified?
• Are you compliant with the required user entity controls?

Failure to provide adequate SOC 1 documentation can result in:

• Expanded substantive testing
• Additional audit procedures
• Higher audit fees
• Delays in reporting
• Control deficiencies
  

A well-structured SOC 1 report, on the other hand, reduces audit friction and strengthens the organization’s ability to demonstrate oversight of third-party financial reporting controls.

SOC 1 vs. SOC 2: Key Differences

While SOC 2 focuses on security and availability, SOC 1 is specifically tied to financial reporting.

SOC 1 answers the question:

Can companies rely on this system for financial reporting?

SOC 2 answers the question:

Is this system secure and protected?

Both are important, but SOC 1 is uniquely tied to accounting and financial reporting responsibilities, therefore more important for CPAs and accounting teams to understand.

Why the Quality of a SOC 1 Report Matters

Accounting teams are responsible for reviewing SOC 1 reports, which might feel like a formality at times, but probably warrants more attention than you realized. Not all SOC 1 reports provide the same level of assurance, yet they can have a significant impact on your audit risk.

If certain controls are missing from a SOC 1 report, then your accounting team takes on full responsibility for those areas and may need to perform additional testing beyond what you’d anticipated.

A strong SOC 1 report shifts testing responsibility to the service organization’s auditors across some key areas, providing support for your accounting team and lessening your testing and audit burden. A weak one SOC 1 report might be adding to your accounting team’s burden without them realizing it.

In Part II of this series, we will break down what makes a SOC 1 report strong versus weak, and how accounting teams can evaluate quality effectively.

Why SOC 1 Is Actually Kind of a Big Deal for Accounting Teams

SOC 1 is a cornerstone of financial reporting assurance in an increasingly outsourced, cloud-based environment.

If your organization relies on third-party systems for financial data, SOC 1 reporting is essential to maintaining accurate financial statements, supporting audits, and protecting stakeholders—as well as your own accounting team.

Understanding SOC 1 empowers accounting teams to reduce risk, streamline audits, and confidently manage the systems that underpin financial reporting.