Welcome » IT Booklets » Operations » 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:
MICR ENCODING
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:
PROOF OPERATIONS
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:
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:
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:
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.
BATCH PROCESSING
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.
REJECTED ITEMS
The operations area should maintain a list of rejected items and send them to reconcilement clerks. This hard copy listing should contain the following:
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).
OPERATING CONTROLS
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.
TRANSACTION CONTROLS
Important internal control considerations include the following:
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:
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:
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.
HOLDOVERS
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.
BALANCING RECONCILEMENT
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:
MANAGEMENT REPORTS
Management should identify reports that facilitate item processing management. Management performance monitoring and control reports can include the following:
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.