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When businesses outsource services like payroll processing, IT management, or data storage, they’re also entrusting another organization with important information and operations. But how can they be confident that their service provider has the appropriate controls in place to manage those responsibilities?

That’s where System and Organization Controls (SOC) examinations come in.

SOC examinations provide independent assurance over a service organization’s internal controls, helping customers, business partners, and auditors evaluate the risks associated with outsourced services. Two of the most common reports are SOC 1 and SOC 2.

Although both examine internal controls, they serve different purposes. Understanding the difference between SOC 1 vs SOC 2 is an important first step in determining which examination your business may need.

What Is a SOC Examination?

A SOC examination is an independent assessment of a service organization’s systems, processes, and internal controls, performed by a qualified CPA firm in accordance with applicable professional standards.

The resulting SOC report provides information about the organization’s control environment and helps customers and other stakeholders evaluate whether the controls relevant to their needs are appropriately designed and, depending on the report type, operating effectively.

SOC examinations are particularly common among businesses that provide outsourced services, including payroll processors, Professional Employer Organizations (PEOs), technology companies, and financial service providers.

There are several types of SOC reports, but SOC 1 and SOC 2 are distinguished primarily by the types of controls they examine.

What Is the Difference Between SOC 1 and SOC 2?

The primary difference between SOC 1 and SOC 2 examinations is their focus.

SOC 1 examines controls relevant to a customer’s financial reporting, while SOC 2 examines controls related to system security, availability, processing integrity, confidentiality, and privacy.

In other words, SOC 1 helps customers understand whether an outsourced service could affect the reliability of their financial reporting. SOC 2 helps customers understand how a service provider manages risks related to its systems and information.

SOC 1 vs SOC 2 Comparison Matrix

Neither report is inherently better or more comprehensive than the other. The appropriate examination depends on the services your business provides, the risks those services present, and the information your customers need.

Difference between Type 1 and Type 2 SOC Report

Another aspect of SOC examinations is the report type, Type 1 and Type 2, which is not to be confused with SOC 1 and SOC 2. A SOC 1 report can be in both type 1 or type 2, as can a SOC 2. Depending on the report type, a SOC report evaluates the design of specified controls and, for a Type II report, their operating effectiveness over a defined period. A Type I report evaluates control design as of a specific date.

What Is a SOC 1 Examination?

A SOC 1 examination evaluates controls at a service organization that are relevant to its customers’ internal control over financial reporting (ICFR).

This is particularly important when businesses outsource functions that directly affect their financial records, transactions, or financial statements.

For example, consider a company that outsources payroll to a third-party provider. The company relies on that provider to process payroll information accurately and completely. Errors or weaknesses in the provider’s controls could affect the company’s payroll expenses, liabilities, and financial reporting. Now consider if it  was a major publicly traded company with mass amounts of employees or data. They may require SOC Examinations of all their vendors to ensure their data isn’t being mishandled.

A SOC 1 examination helps the customer and its financial statement auditors evaluate controls relevant to those risks.

Who Needs a SOC 1 Report?

SOC 1 examinations are commonly relevant for organizations providing services such as:

• • Payroll processing: Companies that calculate wages, process payroll, and manage payroll-related transactions.
  • Professional Employer Organizations (PEOs): Organizations providing outsourced payroll, employee benefits, and HR administration.
  • Financial services: Organizations processing financial transactions or maintaining information that affects customers’ financial statements.
  • Outsourced accounting services: Providers performing accounting functions that customers rely on for financial reporting.

A SOC 1 report may also be requested by a customer’s external auditor when the customer’s financial statements depend on transactions or processes handled by a service organization.

Importantly, SOC 1 is not a general examination of a company’s financial statements. It examines the specific controls at a service organization that are relevant to its customers’ financial reporting.

What Is a SOC 2 Examination?

A SOC 2 examination evaluates a service organization’s controls against the American Institute of Certified Public Accountants (AICPA) Trust Services Criteria.

While SOC 1 focuses on financial reporting, SOC 2 addresses risks associated with information systems and the services they support.

SOC 2 examinations are especially relevant for businesses that store, process, transmit, or otherwise have access to sensitive customer information.

For example, a cloud-based software provider may handle confidential customer records and maintain systems that customers rely on every day. A SOC 2 examination can help demonstrate how the provider’s controls address risks such as unauthorized access, system interruptions, or improper handling of confidential information.

What Are the Five SOC 2 Trust Services Criteria?

SOC 2 examinations use five categories known as the AICPA Trust Services Criteria. Security is included in every SOC 2 examination, while the remaining categories are included when applicable to the organization’s systems, services, and commitments.

1. Security (Required)

Evaluates controls designed to protect systems and information against unauthorized access, unauthorized disclosure, and other security risks. Examples include access management, monitoring, risk assessment, and incident response procedures.

2. Availability

Evaluates whether systems are available for operation and use in accordance with the organization’s commitments. Relevant controls may include disaster recovery planning, system monitoring, and incident management.

3. Processing Integrity

Examines whether system processing is complete, valid, accurate, timely, and authorized. This may be particularly relevant for organizations performing automated transactions, data processing, or analytics.

4. Confidentiality

Evaluates controls designed to protect information designated as confidential, such as proprietary business information, financial records, or customer data. Examples include encryption, restricted access, and secure information disposal.

5. Privacy

Addresses how personal information is collected, used, retained, disclosed, and disposed of in accordance with applicable privacy commitments and criteria.

Not every SOC 2 report covers all five categories. The examination’s scope is determined by the organization’s operations, risks, and relevant customer requirements.

Who Needs a SOC 2 Report?

SOC 2 examinations are commonly pursued by organizations such as:

• • Software-as-a-Service (SaaS) providers
  • Cloud hosting and data storage companies
  • IT service providers and managed service providers
  • Data processing and analytics companies
  • Businesses managing sensitive customer information
  • Other technology-enabled or outsourced service providers

For these organizations, SOC 2 reports can be particularly valuable during vendor evaluations, contract negotiations, and customer security reviews.

SOC 1 vs SOC 2: Can a Company Need Both?

Yes. SOC 1 and SOC 2 are not mutually exclusive, and some businesses may benefit from obtaining both reports.

Consider a Professional Employer Organization (PEO) that manages payroll processing and employee information for multiple client companies.

Because the PEO processes payroll transactions that may affect its clients’ financial statements, a SOC 1 examination could help customers and their auditors evaluate relevant financial reporting controls.

At the same time, the PEO maintains sensitive employee information, potentially including personal identification details, compensation records, and benefits data. A SOC 2 examination could address controls related to protecting that information and maintaining secure, reliable systems.

The need for one or both examinations depends on the organization’s activities and its customers’ requirements.

Preparing for a SOC Examination

Whether your company needs SOC 1, SOC 2, or both, preparation is an important part of the process.

Before beginning an examination, organizations should understand which systems and processes will be included, identify responsible personnel, and establish documentation supporting the controls being evaluated.

Common preparation activities include reviewing:

• • Policies and procedures governing relevant business processes and systems.
  • Access management, change management, and risk management controls, where applicable.
  • Documentation demonstrating that controls have been performed.
  • Management oversight and responsibility for key controls.
  • Processes for identifying, documenting, and addressing control deficiencies.

For a quick understanding of your SOC readiness, take this assessment to determine your strengths and areas for improvement: Free SOC Readiness Assessment

SOC 1 and SOC 2 Examinations with CKH Group

Understanding the difference between SOC 1 and SOC 2 is only the first step. The next is determining the appropriate scope of your examination and whether your organization is ready.

CKH Group provides SOC 1 and SOC 2 examinations and readiness services for organizations seeking independent assurance over their internal controls.

Our assurance professionals work with businesses across a range of industries, including technology providers, Professional Employer Organizations (PEOs), payroll processors, and other outsourced service organizations. Our CKH Michigan team is exceptionally well versed in PEOs and their needs relative to audit and SOC examination services.

For businesses preparing for their first examination, CKH can assist with a SOC readiness assessment to evaluate existing controls and identify potential gaps. For organizations with established SOC reporting programs, our team also supports recurring examinations.

Not sure whether your business needs SOC 1 or SOC 2? Learn more about CKH Group’s SOC Examinations and Readiness Services, take our SOC readiness assessment, or contact our team to discuss your organization’s needs.

The information provided is for general educational and informational purposes only and does not constitute financial, legal, or tax advice. The tax rules and regulations are complex and subject to change. Before taking any form of action, you should consult your own tax, legal, and accounting advisors who understand your particular situation. CKH Group will not be held liable for any harm/errors/claims arising any tax, legal, or financial consequences you may incur. Whilst every effort has been taken to ensure the accuracy of the contents, we will not be held accountable for any changes that are beyond our control.