A client uses a third-party service organization to process its payroll. The auditor has obtained a Service Organization Control (SOC) 1 Type 2 report that covers the period under audit. The report indicates that the service organization's controls were suitably designed and operating effectively. Which of the following is the most appropriate action for the auditor to take regarding the client's payroll controls?
- APerform extensive tests of controls at the client level related to payroll processing.
- BRequest a SOC 2 report from the service organization to assess the effectiveness of its controls.
- CDisclaim an opinion on the client's financial statements due to reliance on a third party.
- DRely on the SOC 1 Type 2 report to reduce the scope of substantive payroll testing.
Show answer & explanationAnswer & explanation
Correct answer: D. Rely on the SOC 1 Type 2 report to reduce the scope of substantive payroll testing.
A SOC 1 Type 2 report provides assurance about the design and operating effectiveness of controls at the service organization relevant to user entities' financial reporting. If the report covers the period under audit and indicates effective controls, the user auditor can generally rely on it to reduce the scope of substantive testing for the payroll process, assuming the report adequately addresses the client's risks and the auditor determines it is appropriate to rely on the service auditor's work.
Why the other options are wrong
- A. Extensive tests of controls at the client level would be redundant if the SOC 1 Type 2 report provides sufficient assurance about the service organization's controls and the client's complementary controls are also effective.
- B. A SOC 2 report focuses on controls related to security, availability, processing integrity, confidentiality, and privacy, not directly on controls relevant to the user entity's financial reporting (which is the purpose of a SOC 1 report).
- C. Disclaiming an opinion is inappropriate. A SOC 1 Type 2 report is a standard audit tool for relying on service organizations' controls and does not necessitate a disclaimer.
Reliance on SOC 1 Type 2 Report
A Service Organization Control (SOC) 1 Type 2 report provides a user auditor with evidence about the design and operating effectiveness of controls at a service organization relevant to the user entity's financial reporting. When the report is favorable and covers the audit period, the user auditor can often reduce the extent of their own testing of controls and substantive procedures related to the outsourced function.
- SOC 1 reports focus on controls relevant to financial reporting.
- Type 2 reports cover both design suitability and operating effectiveness over a period of time.
- User auditors must evaluate the report's adequacy, coverage, and the service auditor's competence.
- Reliance on a favorable SOC 1 Type 2 report can reduce, but not eliminate, the need for user entity-level control testing or substantive procedures.
Memory trick: A GOOD SOC 1 Type 2 means LESS work for YOU.