Understanding and Defining SOC 1 Control Objectives

System and Organization Controls 1, better known as SOC 1, is a type of audit report designed to provide an assessment of the internal control systems employed by a service organization. These controls are specifically related to the organization’s services that are likely to be relevant to their clients’ (user entities’) financial reporting.

Developed by the American Institute of Certified Public Accountants (AICPA), a SOC 1 audit is performed under the SSAE 18 (Statement on Standards for Attestation Engagements No. 18) guidelines. The objective of the audit is to instill confidence in the user entities and their auditors about the service organization’s control environment, particularly focusing on the design and operating effectiveness of these controls.

There are two (2) types of SOC 1 reports:

• SOC 1 Type I: This report assesses the design of the service organization’s controls at a specific point in time. In other words, it evaluates whether the controls are suitably designed to achieve their specified control objectives.
• SOC 1 Type II: This report goes a step further. Not only does it assess the design of the controls, but it also evaluates the operating effectiveness of these controls over a specified period, typically no less than six months.

The main focus of a SOC 1 audit is on controls that are likely to impact the user entities’ internal control over financial reporting (ICFR). This audit plays a critical role in the user entities’ financial audit process, as it provides valuable information that the user entities’ auditors can use in planning and executing their financial audits.

System and Organization Controls (SOC) 1 control objectives are the specific goals that are intended to be met by a service organization’s internal control system. These objectives provide a clear statement of the desired result or purpose and should be specific to allow for the measurement of the organization’s performance in achieving the objective. The objectives should be designed to provide reasonable assurance that the services provided by your organization do not negatively impact your clients’ financial reporting. They are usually defined in relation to the five components of internal control outlined by the COSO Framework: control environment, risk assessment, control activities, information and communication, and monitoring activities.

Control objectives are fundamental to the SOC 1 audit process and form the basis for the auditors’ examination. They relate to the services that a service organization provides to user entities, which are likely to be relevant to the user entities’ internal control over financial reporting.

In the context of SOC 1 reports, these control objectives often pertain to transaction processing, data integrity, validity, confidentiality, privacy, and other aspects that could impact the user entities’ financial reporting.

Defining and designing your SOC 1 control objectives is a fundamental step in preparing for a SOC 1 audit. These objectives need to be created in a way that addresses the potential risks that your organization’s services could pose to your clients’ financial reporting. Here are some steps to guide you through the process:

1. Understand Your Services: The first step in defining your SOC 1 control objectives is to thoroughly understand the services your organization provides that are likely to impact your clients’ financial reporting. This understanding should encompass the processes, technologies, and responsibilities involved in these services.

2. Conduct a Risk Assessment: Identify and assess the potential risks that your services could pose to your clients’ financial reporting. This could include operational risks, compliance risks, or financial risks. It’s crucial to understand what could go wrong and how that could impact your clients’ financial reports.

3. Define Your Control Objectives: Based on your understanding of your services and the associated risks, you can define your control objectives. These objectives should be clear, concise, and measurable. They should represent what you intend to achieve with your internal controls in terms of mitigating the identified risks. An effective control objective is one that can be measured. This means that there should be clear criteria to determine whether the objective has been achieved. This could be a percentage, a number, a yes/no outcome, or any other quantifiable measure. For instance, a measurable control objective could be, “Reduce the number of access control violations by 50% over the next 6 months.

4. Design Controls to Meet the Objectives: Next, you need to design and implement controls that will help you achieve your control objectives. The controls should be tailored to mitigate the risks you’ve identified. For instance, if one of your control objectives is to ensure data accuracy, you could implement a control that requires data to be reviewed and approved by a second party before it is entered into a system.

5. Document Your Control Objectives and Controls: Documentation is key in a SOC 1 audit. You should document your control objectives and the corresponding controls in a clear and detailed manner. This documentation should describe what each control is, how it works, when it is performed, and who is responsible for it.

6. Monitor and Review: Once your control objectives and controls have been defined, designed, and implemented, it’s important to continuously monitor and review them. This will help you ensure that they remain effective and relevant as your organization and the external environment evolve.

By defining and designing your SOC 1 control objectives carefully and thoughtfully, you can enhance your organization’s internal control environment, reduce the risk of errors or fraud in your clients’ financial reporting, and increase the likelihood of a successful SOC 1 audit.

Designing controls to meet your control objectives is a critical step in achieving compliance with standards such as SOC 1. Each control you design should align with a specific control objective and should effectively mitigate the associated risk. Here’s how you can design your controls:

1. Identify Control Activities: Once you’ve defined your control objectives, the next step is to identify the appropriate control activities that will help achieve those objectives. Control activities may include approvals, authorizations, verifications, reconciliations, review of operating performance, security of assets, and segregation of duties.

2. Consider the Nature of Your Services and Operations: The controls you design should be tailored to the specific nature of your services and operations. For instance, if your services involve significant manual processes, you might need to design manual controls. Conversely, if your services are highly automated, you will need to design automated controls.

3. Align Controls with Risks: The controls should align with the risks they are designed to mitigate. For instance, if there’s a risk of unauthorized access to your systems, you might design controls around user access management such as strong password policies, multi-factor authentication, and periodic user access reviews.

4. Design Preventive and Detective Controls: Controls can be preventive (designed to prevent an unwanted event) or detective (designed to detect an unwanted event after it has occurred). Both types of controls are important. For instance, you might implement a control to prevent unauthorized access (preventive), and also a control to detect any unauthorized access attempts (detective).

5. Consider Efficiency: When designing your controls, also consider the efficiency of the control operation. Aim to design controls that are effective but also efficient in terms of time, resources, and cost.

6. Document Your Controls: Once you’ve designed your controls, you should document them. The documentation should clearly describe each control, its purpose, how it operates, when it operates, who is responsible for it, and how it helps achieve the related control objective.

7. Test Your Controls: After designing and implementing your controls, test them to ensure they are operating as expected and effectively mitigating the identified risks. Any issues identified should be remediated promptly.

Designing controls is not a one-time process but requires continuous monitoring and adjustment as the organization’s environment, systems, and processes change over time. Regularly reviewing and updating your controls can help ensure they remain effective and relevant, thereby enhancing your organization’s overall control environment.

When we talk about controls in the context of a SOC 1 report, we’re referring to two major types: Information Technology General Controls (ITGCs) and controls over business processes.

ITGCs represent the foundation of the IT control structure. They help ensure the reliability of data generated by IT systems and support the assertion that systems operate as intended and that output is reliable. ITGCs typically include controls over the Data Center, Network, Systems Development, Access to Programs and Data, and Program Changes.

In the context of a SOC 1 audit, ITGCs are crucial because they directly influence the reliability and security of the systems that process and manage financial data. For example, if user access controls are weak, there’s an increased risk that unauthorized individuals could access, manipulate, or delete financial data. Likewise, if change management controls are insufficient, untested or unauthorized changes could lead to system errors or downtime, potentially impacting financial data and reporting.

Controls over business processes refer to the procedures and activities designed to prevent or detect errors in the business operations that could impact a client’s financial reporting. These controls are typically manual procedures, but they may also be automated in certain scenarios.

In the context of a SOC 1 audit, these controls are important because they help ensure that the service organization’s operations are carried out correctly, accurately, and consistently, thus preventing errors or irregularities that could affect the user entities’ financial statements. For example, if the service organization provides payroll processing services, controls might be implemented to ensure that payroll calculations are accurate, that changes to payroll data are authorized and documented, and that payroll disbursements are correctly recorded in the financial system.
In essence, both ITGCs and business process controls are highly relevant to SOC 1 as they provide assurance to the user entities (clients) and their auditors that the service organization has effective controls in place to protect the integrity, completeness, and accuracy of the financial data it handles, thereby supporting accurate financial reporting.

A SOC 1 report can also include other relevant controls depending on the services the organization provides. For instance, the report may include controls over data governance, compliance processes, human resources processes, and vendor management, among others, if they are relevant to the services provided by the organization. It’s important to note that SOC 1 reports should only include controls that are likely to be relevant to the user entities’ internal control over financial reporting (ICFR). Other controls that do not impact the user entities’ financial reporting are typically not included in SOC 1 reports but may be included in other types of SOC reports (e.g., SOC 2 or SOC 3 reports), which have a broader scope.

To provide you with an idea of what control objectives might look like, here are a few examples with explanations on the risks addressed:

1. Control Objective – Accuracy of Data Processing: Ensure that all transactions are accurately processed in the system. This objective is designed to mitigate the risk of errors in data processing, which could lead to inaccuracies in the clients’ financial reports.
2. Control Objective – Access Controls: Implement controls to prevent unauthorized access to financial data. The objective is to mitigate risks associated with unauthorized access or manipulation of financial data.
3. Control Objective – System Modifications: Ensure that all system modifications are authorized, tested, and approved before implementation. This objective addresses the risk of system disruptions or errors due to unauthorized or improperly tested system modifications.
4. Control Objective – Incident Response: Establish procedures to respond effectively to IT incidents. This objective helps to mitigate the risk of prolonged system downtime or data loss due to IT incidents, which could impact the client’s financial reporting.
5. Control Objective – Backup and Recovery: Ensure regular backups of financial data and establish effective data recovery procedures. This objective is designed to mitigate the risk of data loss, which could impact the availability and integrity of financial data for reporting.
6. Control Objective – Segregation of Duties: Implement appropriate segregation of duties within financial processes. This objective addresses the risk of fraud or error due to inappropriate segregation of duties.
7. Control Objective – Compliance with Regulatory Requirements: Ensure compliance with relevant regulatory requirements pertaining to financial reporting. This objective mitigates the risk of non-compliance, which could lead to financial penalties or reputational damage for the clients.

SOC 1 control objectives play an essential role in assuring stakeholders of a service organization’s internal controls over financial reporting. They provide a comprehensive evaluation of the design and operating effectiveness of these controls, which is crucial for service organizations serving user entities. Understanding and defining these objectives require a strategic approach that aligns with the company’s overall risk management and compliance strategy. Implementing these controls demands expertise, as well as ongoing monitoring and assessment. It’s also important to remember that while SOC 1 controls are a powerful tool for risk mitigation and trust building, they should be part of a broader control environment that prioritizes security, accuracy, and transparency.

Please reach out if you would like to learn more about how Audit Peak can assist you with your SOC 1 compliance or for a free consultation. WE WILL TAKE YOU TO THE PEAK.