Appendix C: Item Processing
Item processing operations play a critical role in an institution's ability to receive, record, and process customer transactions in an accurate, reliable, and timely manner. The item processing function converts data into an electronic format the institution's systems can capture and use in an automated environment. It is a function institutions can do internally or outsource, in a centralized or decentralized manner. This appendix reviews key item processing elements and controls.
Item processing systems convert data from source documents, including checks and customer transaction tickets, to formats that can be processed electronically. Three common methods of capturing source document data for information systems are:
- Item Magnetic Ink Character Recognition (MICR) Capture - MICR encoded documents are pre-encoded to industry standards with account number and other transaction information, except for the dollar amounts. The item processing phase encodes (prints) a dollar amount on items.
- Optical Character Recognition - Optical character recognition (OCR) reads data that is printed or typed with a special type font. Handwriting recognition systems are similar and can remove the need for a special type font.
- Direct Item Entry - Direct item entry involves manually entering data into systems. In these systems, users enter data from source documents directly into application files or onto magnetic media for subsequent capture and processing. Data sources can include teller terminals, ATMs, POS terminals, PCs, and items that are not MICR-encoded.
MICR-encoded documents are generally pre-encoded with transit number, account number and other transaction information, except for the dollar amounts. The dollar amount is typically encoded during the proof phase of item processing. The MICR encoding area at the bottom of a check, deposit slip, loan payment coupon and other transaction documents meet national standards accepted by all financial institutions using data processing equipment.
MICR-encoded items can be machine-read and processed with little or no human intervention. Large blocks or trays of MICR-encoded documents can be passed through a high-speed reader/sorter where the MICR information on the checks and transaction tickets is captured by the computer for processing. Alternatively a multi-pocket proof machine can be used to encode and capture for computer processing. Multi-pocket proof machines and reader/sorters are described in more detail later in this Appendix. At the end of the workday, batch totals of the items captured by the reader/sorter or multi-pocket proof machine are balanced and reconciled to the appropriate applications (deposit accounting system, loan accounting system, general ledger, etc.) and balanced to the proof batch totals.
At some point in item processing an image of both the front and back of each item is captured. Images may be captured by the multi-pocket proof machine, the high-speed reader/sorter or other equipment designed specifically for the purpose of image capture such as a microfilmer.
ITEM PROCESSING OVERVIEW
From an enterprise-wide perspective, management's main responsibility is to ensure data integrity, reliability, and accuracy with proper control procedures throughout all phases of transaction processing. Whether the item processing controls are manual or automated, they should cover transaction initiation, data entry, and computer processing. Management should update the control environment for new item processing technologies (e.g., truncation, electronic presentment and return). The board and management are responsible for adequate business continuity planning. They should also ensure the institution meets GLBA privacy and security requirements.
Technology advances continue moving the data capture point closer to the transaction initiator (i.e., customer). This trend changes item processing characteristics from a labor intensive process to a technology operations process. For example, on-line bill payment using ACH eliminates traditional item processing and emphasizes automated electronic capture techniques. The IT Handbook's "Retail Payment Systems Booklet" describes retail payment instruments; clearing and settlement processes; and risk management.
There are several different types of processing:
- Batch - In batch processing, various institution departments accumulate and process debits and credits through the proof and capture methods. Items are converted to electronic format through a reader/sorter or multi-pocket proof machine. Batch processing creates electronic batch files that are forwarded to the computer throughout the day, or at a minimum at the end of the day for creating a transaction file of the current day's activities. A new master file is created by updating the prior day's master file with the current day's transaction file.
- Real Time Data Entry - Unlike batch processing, this system permits the instantaneous updating of the master files or programs. An institution maintains a daily transaction file as back-up and a form of control. Thrift institutions and credit unions use real time systems most frequently.
- Memo Post - This system allows an institution to update information on transactions throughout the day, but still uses a batch system for actual posting. With this system institutions post transactions to a copy of the master file either individually or in batches, as deemed appropriate throughout the day, thus allowing a more accurate reflection of transactions and account balances. At the end of the day the memo-post file is deleted and actual posting occurs through normal batch processing.
Proof operations capture the transaction data in an electronic format for subsequent processing. Institutions proof work in batches as a control mechanism. Proof machines typically have built-in balancing features used during the encoding phase. The typical single pocket proof/reader/sorter operations workflow includes:
- The teller and departmental work is bundled in batches with a ticket showing the dollar total of all the items in the batch. Some financial institutions define batch processing based on a certain number of items rather than a specific time of day.
- Proof operators process the transactions. The item-processing center MICR encodes, proves, and balances the teller and departmental work before receipt by operations for batch processing.
- Proof operators consolidate batches into blocks and prepare block tickets for the total of all batches in the block.
- Proof operators process trays of block work through high-speed reader/sorters and the computer to capture the item information and transaction tickets. The reader/sorter sorts the items and transaction tickets into different pockets based on the type of item it is.
- At the end of the workday, operations staff review financial and item capture report totals to ensure they balance and reconcile.
- All unprocessed items are returned to the originating branch or department for research and correction. Until corrected, return items are charged to a temporary control account (e.g., unposted debit/credit account, suspense items, etc.). Once the return item is corrected the temporary control entries are reversed and the item is posted to the proper customer or detail account. If systems automatically post to the general ledger, manual entry to control accounts should be restricted.
- When proof operations are complete, the transaction information in batches is transmitted directly or indirectly through magnetic media (i.e. disk or tape) to the computer for processing.
With multi-pocket proof machines, the steps may vary because multi-pocket proof machines encode, read, and sort, combining many of the steps required in single pocket proof operations into a more streamlined and simplified process.
Some institutions set up regional proof centers to reduce operating costs. These centers operate similarly to the proof department of a single branch, but perform the proof operation for many offices.
In small branches and departments lacking proof equipment, tellers or other branch personnel may develop batch control totals on transactions by running adding machine dollar totals. An independent person should review the batch totals and prepare control totals for all batches on a transmittal form. One method of establishing control in item capture is to limit the size of each batch of entries for data processing to no more than 150-300 items. For auditing purposes, small batches are easier to handle and reconcile.
PROOF MACHINES AND BATCH PROCESSING
Three basic machines are used in the proof area: the single pocket proof, the multi-pocket proof machine and the reader/sorter. Many aspects of the proof function are the same, regardless of which type of proof machine is used.
SINGLE POCKET PROOF MACHINES
Using a single-pocket proof machine, proof operators encode the dollar amount (at minimum) and put credit and debit items into one pocket. The register locks in credit entries and then subtracts debit entries or vice versa. The user cannot enter additional credits until the preceding credits and debits net to zero. This method proves each transaction as well as creates an overall debit and credit total. The single-pocket machine also typically prints information about the institution related to "bank of first deposit" requirements described in Regulation CC. Some key features of a single pocket proof machine include the following:
- The machine has a ten key keyboard;
- Function keys permit the operator to enter information such as account number, ABA transit number, transaction code, dollar amount, etc.;
- A master tape lists the information encoded on the item and any other information entered through the keyboard;
- The machine may have a small screen that displays the MICR encoding and special messages;
- The machine may have a programmable capability that defines the functions to be performed and the sequence in which they are performed;
- The machine contains a single pocket to receive processed items. Items are stacked in the sequence they are processed in;
- The machine endorses each item as it is processed; and
- The machine has a zero-balance capability that enables the operator to know each individual transaction is in balance. Debits must equal credits, and therefore net to zero. If it is not in balance, the machine locks until corrections bring the transaction into balance.
High-speed document handlers or reader/sorters are used in conjunction with the single pocket proof machine. Some characteristics of a high-speed document handler include the following:
- The MICR read-head reads the MICR-encoded items and sorts items into predefined pocket;
- The machine may operate on-line with a computer when it is part of the item processing operation. In some operations the reader/sort may produce a file that is dumped or saved to disk or tape and then transferred to the computer for processing;
- The reader/sorter can be used to sort checks into account number sequence (fine sort);
- The machine has on-line data-capture capability under computer program control;
- The machine's feed rate ranges from 600 to 2400 documents per minute;
- The number of pockets items that are sorted into may range from 6 to 36 depending on vendor and model;
- An ink-jet sprayer or stamp prints the document identification number on the reverse side of the document;
- The machine may have a high-speed microfilm unit;
- The machine may have a high-speed endorsement capability; and
- A rack above the document handler pockets stores processed items as pockets fill up.
Upon receipt at item processing operations, personnel prepare the branch or department work for processing on high-speed MICR reader/sorter equipment. Each batch of debits and credits should contain a batch header or adding machine tape listing indicating the total dollar amount of the items included in the batch.
Usually, a clerk encodes a batch number on a batch header card or creates a batch header and assembles the batches into blocks of items. A header card is included with each block that contains a block number and the total dollar amount of all batches in the block. Using a standardized form to record the batch number and corresponding batch total is an effective control over batches of work. Additional data integrity processing controls include using hash totals, block and record counts, and cross footing balancing.
The reader/sorter, which is a high speed document handler, reads the MICR encoded information on documents and captures it in a form the computer will be able to understand and process. The reader/sorter also sorts the documents into groups based on the type of document.
MULTI-POCKET PROOF MACHINES
Multi-pocket proof machines encode and sort items and may be used in place of the single-pocket proof machine and reader/sorter. When operating a multi-pocket proof machine, the operator should encode the item, determine if it is a debit or credit and classify the transaction by type (on-us check, foreign check, cash-in or cash-out, general ledger, etc.). Each pocket creates a record for the dollar amount of each credit and debit sorted to it. Periodically, operators take each pocket's entries and sum-totals entries run to that pocket. Multi-pocket proof machines capture information in an electronic format, eliminating the need to run items through the reader/sorter. Electronic batch files may be forwarded to the mainframe throughout the day or held to the end of the day to complete the transaction processing.
- A multi-pocket proof machine has all the features and functions of a single pocket proof machine, but with the following additional features:
- The multi-pocket machine sorts items to multiple pockets, based on the type of item and disposition;
- The machine captures, records, and transmits data to the computer or onto magnetic media as items are processed;
- The machine has an ink jet sprayer or stamp that prints the document identification number on the reverse side of the document;
- The machine may have a high speed microfilm unit; and
- It can be used to sort checks into account number sequence (fine sort).
Throughout the day, as the computer receives batches, it accumulates dollar totals for posting to the respective general ledger accounts. At the end of the day, after all batches have been received, the computer operator will proceed with processing the transaction. Processing involves posting all debits and credits to the specific accounts and developing new account balances. Rejected items are typically held overnight in general ledger suspense accounts and are resubmitted with the next day's work. At some point in item processing a picture of both the front and back of each item is captured. This may be done several ways. A stand-alone microfilmer, or a multi-pocket proof machine or reader/sorter with a microfilmer attached to it or other equipment designed specifically for the purpose of image capture may be used.
The operations area should maintain a list of rejected items and send them to reconcilement clerks. This hard copy listing should contain the following:
- A batch number;
- A block number;
- An item capture number (each item is sequentially numbered on some systems for tracing purposes);
- An account number;
- The dollar amount of each item;
- Batch and block dollar control totals; and
- Out of balance dollar amounts.
The departments submitting work should list total dollar amounts on a transmittal form for all batches submitted. The transmittal form provides total batch debits and credits for each pocket. This control feature creates an audit trail to reconcile the general ledger and gives personnel dollar totals to balance the item processing capture runs. User departments and the proof areas should develop control totals since these amounts form the basis for all internal accounting controls (i.e., subsequent run-to-run totals and final output records).
Item processing controls are important because item processing involves source data, large dollar total amounts, and high volume activities. Item processing control weaknesses can lead to losses from unintentional errors, fraud, and poor business continuity planning. Institutions should recognize the risks and incorporate item processing technologies that result in improved efficiencies, better BCP, and reduced fraud losses. Management should address item processing controls during data capture, balancing, and reconcilement.
Important internal control considerations include the following:
- Segregation of duties;
- Appropriate oversight of transaction input, processing, and output functions;
- Well-defined standards for overnight control of dollar totals for rejects and holdover items;
- Appropriate reconcilement and balancing of work returned from processing to the previously established control totals;
- Expeditious clearing of exception items (exceptions are contrary to effective control and create potential risk to the financial institution); and
- Review exception reports by operations officers and supervisors.
Management should ensure segregation of duties to reduce potential fraud losses. Item processing automation and reduction in staff increases the importance of segregation of duties because critical functions are concentrated in fewer hands. Typically, departments achieve segregation of duties by ensuring an individual is not responsible for any two of the following:
- Input preparation and operating data input equipment;
- Operating computer equipment;
- Operating sorting equipment;
- Approving rejects for re-entry; and
- Reconciling output.
DIRECT ITEM ENTRY - CONTROLS
Direct item entry systems need enhanced controls to ensure data integrity because items are manually input for capture and processing without going through proof. Prompt input error notification can significantly reduce item rejects. The risk of fraud or error increases when operators convert data from source documents to electronic. Direct item entry software programs and system software can provide a high degree of error control by using the following techniques:
- Character/field count - A check of character and field count totals for comparison against original data entry totals.
- Checks for completeness - Ensuring users fill all entry fields using programmed checks.
- Check digits - The system performs an algorithmic operation on numeric fields and the results validate the account numbers.
- Dollar and item count totals - A necessary tool to balance dollar and non-dollar transactions to established control totals.
- Dual-field entry - When the same input appears twice, processes check to ensure both fields match.
- Reasonableness checks - Programmed comparisons of data entered to predetermined absolute values or relative limits of reasonableness.
- Sequence checks - Processes check key record fields for proper data entry sequence.
- Truncation fields - An automatic provision that provides round off or truncation rules for fields that exceed maximum length.
- Verification check - Systems query the user to validate the input data.
PROOF AND CAPTURE SORT CODES
Like mainframes, proof and capture machines require some programming to ensure items are properly handled. These are commonly referred to as proof and capture sort codes. These codes ensure the physical items are sorted to the appropriate pocket on the reader/sorter or multi-pocket proof machine. Items miscoded and thus sorted to the wrong pocket can affect balancing. These codes need to be backed up and included in disaster recovery procedures as they would need to be transferred to any new machine if the machines at the institution are unworkable or inaccessible. Additionally, it is important the institution use proper change control procedures, as described in the IT Handbook's "Development and Acquisition Booklet", when code changes are required.
Holdover transactions occur when an institution is unable to process the volume of items, usually checks, within the date received. This may occur when a customer brings in a large volume of checks to be credited to his or her account before the close of business, and the institution does not have time to process all the items. If this is allowed, the deposit ticket is processed on the date received with an offsetting debit posted to a holdover account. The actual offsetting items (checks) are secured for processing the next day. The next day the checks are processed (debits) with the credit going to the holdover account to zero out the debit there. If this occurs on a regular basis, an institution should have an agreement with the customer spelling out the conditions, especially if the transaction is out of balance with the deposit slip, when the checks are processed the following day. If this occurs on an infrequent basis, the institution should instruct the customer that the deposit will be posted the following day and not allow a holdover to occur. Of note, holdovers should only be performed for customers with good credit relationships. If examiners see this occur during an examination, they should ensure the items held over are processed the next day, that the holdover account is regularly balanced, and no balances are maintained in the holdover account for more then one business day.
BALANCING AND RECONCILEMENT
The balancing and reconcilement process ensures captured item data is accurate and reliable. These are also critical phases in item processing to identify exceptions and potential losses caused by damaged items, input error, and fraud.
Reconcilement clerks balance each batch of debits and credits to the batch capture reports using a reconcilement form. The reconcilement clerk collects rejected entries (i.e., items not captured) as he or she balances each batch. Additionally, the item processing systems generate rejected entry reports with each item's dollar amount. The department that handles a rejected item researches, corrects, and then resubmits each item with the normal processing work. The reconcilement clerks complete final balancing processes and return unprocessed items to the user department for additional research and correction.
Personnel should segregate or identify all rejected, unread, unposted, and uncaptured items. The review clerk either corrects the item for resubmission and posting or returns it to the user area for disposition. The department manager or supervisor should review all reject re-entry items to ensure proper correction. This control environment prevents unprocessed items from reappearing for extended periods.
OCRR AND CONTROLS
Reader/sorter operators or other personnel have an opportunity to repair rejected items before they get to a reconcilement clerk. Most reader/sorters will allow for on-line correction, repair, and re-entry (OCRR) of unreadable or missing items from the MICR line. A list of the rejected items is presented on a CRT screen. The operator can then provide the missing or inaccurate information. After repairing a batch, the operator should forward the data for supervisory review prior to resubmission. Most software limits correction to the problem fields, but some do not. Management should require audit logs that identify the operator name, time of entry, and a list of repairs to mitigate error or fraud.
GENERAL LEDGER RECONCILEMENT AND FINAL REVIEW
The general ledger reconcilement process involves reconciling final daily item processing entry totals to the respective general ledger control account. Personnel should make adjustments for missing entries, extra entries, and rejected or non-posted items. Key controls aspects include the following:
- Reconciling transactions against source documents;
- Reviewing the transaction reconcilement form for accuracy;
- Completing an additional reconcilement form for balancing the trial balance and other report totals to the general ledger;
- Maintaining adequate suspense account, rejected, and holdover item control processes;
- Reviewing exception reports (e.g., overdraft, large item, stop/hold, uncollected funds, kiting suspects);
- Comparing larger dollar items to the daily posting journal and signature card;
- Returning forged, dishonored, or otherwise invalid items within time limits specified by the Uniform Commercial Code, clearing house associations, and federal rules and regulations; and
- Auditing to ensure the control environment remains effective and appropriate.
Management should identify reports that facilitate item processing management. Management performance monitoring and control reports can include the following:
- Item processing volumes;
- Item processing systems capacity;
- Processing efficiencies (e.g., items per hour, items per employee);
- Courtesy Amount Recognition/Legal Amount Recognition (CAR/LAR) rejection rates;
- CAR/LAR false acceptance rates (i.e., processed items subsequently returned due to errors missed using automated solutions);
- Error rates;
- Reject volumes; and
- Exception reports
BUSINESS CONTINUITY PLANNING
Item processing business continuity planning should consider item handling from the transaction initiation point through final general ledger reconciliation. Item processing often involves moving and handling large amounts of information. Consequently, if a disruption or disaster occurs, management may have a difficult task restoring items in process. Management should assess the risk involved in each item processing area and develop appropriate continuity plans. Senior management should understand the risks involved in areas where the institution does not have or cannot create reference copies to recreate transactions.
Appendix B: Glossary
Appendix D: Advanced Data Storage Solutions