Introduction to ACH Processing

PROCESSING YOUR FUNDS AT THE SPEED OF LIGHT

This is an inside look at electronic payment processing through the Automated Clearing House network and is for educational purposes only. There is no warranty, expressed or implied in connection with making this information available. Electronic Funds Corporation is in no way liable nor responsible for omissions or errors, herein

The Automated Clearing House (ACH) is an electronic payment network used by individuals, businesses, financial institutions and government organizations. Electronic ACH payments provide better cash management capabilities and lower costs than traditional paper payments. The nationwide network exchanges funds and information throughout the 50 states as well as the U.S. territories and Canada with participation by over 98% of the nation’s financial institutions, including thousands of savings banks and credit unions. Efforts are underway for the development of a worldwide ACH Network -the Worldwide Automated Transaction Clearing House (W.A.T.C.H).

The ACH network allows funds to be electronically debited or credited to a company’s or individual’s deposit account. Currently these deposit accounts include checking and savings accounts. As of September 15, 2000, ACH credit transactions may be directed to loan accounts and ACH debit and credit transactions to financial institution general ledger accounts. ACH transactions carry basic entry details such as the individual name (except Point-of-Purchase transactions), financial institution routing number, account number, amount and effective date for the transaction. Additional payment information may be sent in expanded record formats called addenda records. The addenda may include payment-related information such as invoice number or shipping advice.

How Does ACH work?

1. A company/individual (Receiver) authorizes a company/individual (Originator) to initiate a transaction to their financial institution account.

2. The Originator prepares information about the transactions that are to be automated for its customers or employees and passes it along to an Originating Depository Financial Institution (ODFI).

3. The ODFI collects ACH transactions from participating companies, consolidates the information and presents it to the ACH Operator. (The ODFI may retain entries for its own account holders)

4. ACH Operator processes transaction files from submitting ODFIs and distributes it to Receiving Depository Financial Institutions (RDFls).

5. The RDFI receives entries for its customer accounts and posts entries on the settlement date. Transactions are also reported on account statements

ACH Participants and Definitions

RCK: Refers to Returned Check and represents the electronic check process for electronic re-presentment of paper NSF checks – Electronic Check Re-presentment.

Recurring Payment Authorization: An individual or company authorizes the periodic debit of their account for the same period and amount.

Return Reason Codes: Or R Codes are rejections of original ACH entries by the RDFI.

RDFI: The Receiving Depository financial Institution, the financial institution that receives an ACH transaction for a holder of an account.

Return Entry: The return of an original entry that either could not be posted or was not able to be identified by the RDFI – closed account, NSF, wrong account number, etc.

Standard Entry Class Code (SEC): Three character code, such as Prearranged Payments or Deposits (PPD), used in an ACH header record to indicate the ACH format being used and to identify entries for proper application of rules.

TEL: Telephone Initiated Entry

Telephone-Initiated Entry: (TEL) is an entry initiated through a telephone authorization for a onetime debit for collection of funds for payment of goods and services. A TEL is valid only when there is an existing relationship between the parties or if no existing relationship, the consumer initiates the telephone call.

Transaction Code: Two-digit code that indicates whether an entry is a debit or credit to a checking, savings, loan or financial institution general ledger account.

Truncation: In ACH it normally refers to stopping or truncating a paper check as in POS or lockbox check truncation and turning that paper check into an electronic item.

How ACH Funds are Settled

Settlement is the actual transfer of funds for ACH entries between financial institutions provided by the Federal Reserve Bank. The net debit and credit positions of financial institutions are calculated and posted to the reserve accounts of financial institutions (or to the account of their correspondent).

The timing of settlement is based upon the effective entry date indicated on the ACH file and the time of its delivery to the ACH Operator. ACH debits may be delivered to the ACH Operator no earlier than one banking day prior to the settlement date. ACH credits may be delivered no earlier than two banking days prior to the settlement date.

When the ACH Operator processes an ACH file, the effective entry date is read and entries are settled according to that date. If the ACH Operator cannot settle on the effective entry date due to untimely file delivery, a stale date, weekend, or holiday, the ACH Operator will apply a settlement date of the next business day

What is the legal Framework for ACH?

Participants in the ACH network must abide by the ACH Rules published by the NACHA. The ACH Rules define the required methods, procedures and record specifications for the processing of commercial ACH transactions.

Federal Regulation E places additional obligations on the RDFI and defines consumer rights regarding all electronic payments. The Uniform Commercial Code Article 4A (UCC-4A) places requirements upon ODFls originating wholesale credit (corporate) transactions as well as the RDFls that receive such entries. Federal Government payments must also conform with certain Codes of Federal Regulation commonly referenced in The Green Book.

Rules Affecting Originators

1. Prior to the origination of an ACH transaction an Originator must:

  •  Enter into an agreement with the ODFI.
  •  Obtain authorization from the Receiver. (For consumer debits the authorization must be in writing and a copy of the authorization must be provided to the consumer. For corporate entries, the authorization may take the form of a written agreement. )
  • Maintain the authorization up to 2 years beyond the life of a transaction.
  • Send a non-dollar test entry called a pre-notification (optional).

2. The Originator must notify a consumer 10 days in advance of a change in the amount or 7 days in advance of a change in the posting date of an ACH debit

3. The Originator cannot recall valid transactions after they reach the ACH Operator. Allowances are made, however, for the reversal of erroneous transactions.

4. Transaction file records must conform to ACH format specifications.

5. Originators must not reinitiate payments that have been returned as unauthorized or are incorrect until the problem is solved; they may, however, reinitiate a transaction if the original entry was returned for insufficient or uncollected funds.

Rules Affecting ODFIs

1. Prior to the origination of entries subject to UCC-4A (wholesale credits), the ODFI must make certain disclosures regarding Transaction Settlement, Security Procedures, Choice of State Law and Provisional Payment.

2. The ODFI also makes the following warranties that

  • Originated entries are in accordance with a valid authorization.
  • Entries are timely; that each debit entry is for a valid payment.
  • Entries comply with the Rules.
  • The Originator has complied with PIN Management Security standards if applicable (such as for debit card transactions).
  • Transaction information complies with the Rules
  • Reclamation entry information is accurate, complete and timely.

(ODFI warranties and liabilities apply to entries originated directly or through the use of a sending point to the ACH Operator.)

Rules Affecting RDFIs

1. An RDFI may request a copy of an authorization from the Originator but is not required to keep authorizations on file.

2. RDFIs must verify the account number on the pre-notifications they receive and must either return invalid pre-notification entries or send notifications of change to the ODFI which detail necessary corrections.

3. RDFI may rely solely upon the account number for purposes of posting to a Receiver’s account.

4 An RDFI must make funds available for consumer credit entries no later than the date of settlement. If entries are available by 5:00 p.m. on the day prior to settlement, funds must be made available at the opening of business on the settlement date.

5. An RDFI may not post a debit entry to a Receiver’s account prior to the settlement date.

6. An RDFI must initiate any returned entries in accordance with procedures and deadlines provided by the ACH Rules.

Rules Affecting Originators

1. Prior to the origination of an ACH transaction an Originator must:

  •  Enter into an agreement with the ODFI.
  •  Obtain authorization from the Receiver. (For consumer debits the authorization must be in writing and a copy of the authorization must be provided to the consumer. For corporate entries, the authorization may take the form of a written agreement. )
  • Maintain the authorization up to 2 years beyond the life of a transaction.
  • Send a non-dollar test entry called a pre-notification (optional).

2. The Originator must notify a consumer 10 days in advance of a change in the amount or 7 days in advance of a change in the posting date of an ACH debit

3. The Originator cannot recall valid transactions after they reach the ACH Operator. Allowances are made, however, for the reversal of erroneous transactions.

4. Transaction file records must conform to ACH format specifications.

5. Originators must not reinitiate payments that have been returned as unauthorized or are incorrect until the problem is solved; they may, however, reinitiate a transaction if the original entry was returned for insufficient or uncollected funds.

Rules Affecting ODFIs

1. Prior to the origination of entries subject to UCC-4A (wholesale credits), the ODFI must make certain disclosures regarding Transaction Settlement, Security Procedures, Choice of State Law and Provisional Payment.

2. The ODFI also makes the following warranties that

  • Originated entries are in accordance with a valid authorization.
  • Entries are timely; that each debit entry is for a valid payment.
  • Entries comply with the Rules.
  • The Originator has complied with PIN Management Security standards if applicable (such as for debit card transactions).
  • Transaction information complies with the Rules
  • Reclamation entry information is accurate, complete and timely.

(ODFI warranties and liabilities apply to entries originated directly or through the use of a sending point to the ACH Operator.)

Rules Affecting RDFIs

1. An RDFI may request a copy of an authorization from the Originator but is not required to keep authorizations on file.

2. RDFIs must verify the account number on the pre-notifications they receive and must either return invalid pre-notification entries or send notifications of change to the ODFI which detail necessary corrections.

3. RDFI may rely solely upon the account number for purposes of posting to a Receiver’s account.

4 An RDFI must make funds available for consumer credit entries no later than the date of settlement. If entries are available by 5:00 p.m. on the day prior to settlement, funds must be made available at the opening of business on the settlement date.

5. An RDFI may not post a debit entry to a Receiver’s account prior to the settlement date.

6. An RDFI must initiate any returned entries in accordance with procedures and deadlines provided by the ACH Rules.

Legal Agreements Necessary

Authorizations

All ACH transactions between Originators and Receivers must be backed by valid authorizations. Authorization requirements differ for the various ACH transactions. While a verbal or other non-written form of authorization is permitted for consumer credit transactions, a written authorization form provides proper authorization for consumer debits. This authorization must be readily identifiable as a debit authorization, the terms must be clearly stated and procedures for revoking authorization must be explained. The authorization may specify that transactions will be for a fixed or variable amount.

Corporate (non-consumer) applications require more complex agreements that address the processing of payment-related data or the transfer of large dollars. The required authorization is generally included within a trading partner agreement that defines the responsibilities of each party under the agreement.

Agreements

Originators must enter into an agreement with their Originating Depository Financial Institution. All participating financial institutions, by act of receiving or sending ACH entries, agree to comply with the applicable ACH rules and agree that those rules shall govern relationships between the sending and receiving institutions (and other parties involved in items covered by those rules). Financial institutions execute an agreement with the Federal Reserve Bank (or ACH Operator), that defines their processing relationship.

Originating companies are legally bound to comply with the ACH rules through written agreement with the Originating Depository Financial Institution. The rules as they apply to originating companies should be addressed in this agreement. The agreement binds companies to the ACH rules and covers such items as compensation, communication between the parties and error resolution.

How Do Companies Benefit?

Direct Deposit

  • Streamlines the reconcilement process.
  • Eliminates critical delivery of checks since funds are automatically deposited.
  • Eliminates special checks for employees away from work or on vacation.
  • Minimizes storage and security of check stock.
  • Reduces employee time lost due to personal banking business on payday.
  • Additional employee benefit for little or no cost.

Direct Payment

  • Funds collected are available on a scheduled date such as the billing due date.
  • Check handling and manual payment processing are eliminated.
  • Costs associated with printing and mailing monthly bills may be eliminated. Item processing costs are reduced.
  • Delinquencies of receivables are significantly reduced.
  • Eliminates erroneous checks (i.e., no signature or wrong amount). Reduces the possibility of insufficient funds.
  • Eliminates costs associated with billing and second notices.
  • Allows businesses to offer additional customer payment service.

Cash Concentration

  • Funds are collected on predetermined dates
  • Cash flow forecasting and funds management are improved. Provides next-day funds availability from outlying locations. Provides the conveniences of automated transactions. Reduces the need for  expensive wire transfers.

Corporate Payments

  • Improves cash flow forecasting
  • Assures payment discounts for predetermined payment dates. Reduces internal processing costs. Reduce bank service charges
  • Improve vendor relationships as a result of more timely payments

Re-presented Check Entries

  • Improved collection rate on returned checks. Lower costs.
  • Faster notice of returned re-presented check entries via the ACH. Ability to transmit entries on specified dates.

Point-of-Purchase Entries

  • Faster collection of funds, Lower costs.
  • Faster notification of returned entries.

How are ACH Payments Used

Direct Deposit

Direct Deposit is used to disburse funds to consumer accounts. Direct Deposit of Payroll is the most widely used of the ACH deposit services. The feature is also used to distribute other recurring or one-time deposits. The U. S. Government uses Direct Deposit to disburse nearly 87% of Social Security benefit payments. Some other commonly used applications include:

  •      Dividends
  •      Pension Benefits ~ Interest
  •      Commission Disbursements ~ Trust Disbursements
  •      Expense Reimbursements ~ IRS Tax Refunds
  •     Child Support Disbursements

Direct Payment

Direct Payment provides the ability to collect funds from consumer accounts. Companies with billing operations participate through the automation of bill payment entries. This application is used for recurring bills that are either regular fixed amounts, or varying amount bills, such as utility payments. Some examples of Direct Payment applications include.

  •    Insurance Premiums ~ Utility Bills
  •    Mortgage Payments
  •    Subscription/Membership Dues ~ Loan Payments
  •    Monthly Pledges ~ Rents/Leases
  •    Tuition Payments

Cash Concentration

Cash Concentration through the ACH is a widely used and profitable cash management function. Often used by companies operating branches or sales outlets, and local governments to accumulate funds rapidly into a central corporate account. Cash Concentration through the ACH may replace the use of depository transfer checks or expensive wire transfers. Overall, this system improves a company’s total cash management capability.

Corporate Payments

Corporate Payment applications through the ACH network provide the ability to collect and disburse funds between companies. They are used by businesses paying one another for goods or services. These applications continue to grow and are currently being used by the U.S. Treasury Department in the Vendor Express program to pay government suppliers.

Corporate Payments replace checks with an electronic process of debiting and crediting for invoices between the financial institutions of participating companies. ACH Corporate Payments allow payments to be accompanied by additional payment information, such as the details of the invoices being paid. This is done by adding an ACH addenda record to the payment format. Some commonly used applications for Corporate Payments include those listed below:

  •      Vendor Express Payments > Invoice Payments
  •      Federal and State Tax > Trade Payments
  •      Royalty Payments > Debt Repayment

Financial Electronic Data Interchange (FEDI)

FEDI is an enhancement to Corporate Payments, which utilizes the ACH addenda record. It provides for the exchange of machine-readable documents and information between businesses. For example, a payment may be sent to a vendor with details of the invoice being paid in an electronic format for automated posting to a receivable accounting program. FEDI is also used with zero-dollar transactions to exchange information such as requests for quotations, order placements and shipment advice’s.

Customer Initiated Entries

Telephone bill payment services are a common application of the ACH network’s Customer Initiated Entry option. This application provides the ability for a consumer to initiate non-scheduled payments to a company or consumer account. Payment information may be submitted manually, by the consumer, to the ODFI or through a mechanical device (i.e., telephone, ATM or computer).

Re-presented Check Entries

A re-presented check entry is an ACH debit application used by Originators to collect funds for paper checks that have been processed through the check collection system and returned due to insufficient or uncollected funds. Originators of re-presented check entries must provide notice to the check writer, prior to the receipt of the check, informing the check writer that any insufficient or uncollected funds returned checks might be collected electronically. An interim rule effective September 18, 1998 through September 14, 2000 provides a rules framework for transmitting these entries using the PPD standard entry class code. Effective September 15, 2000, a new SEC code of RCK was established to be used to re- present insufficient or uncollected paper checks electronically.

Point-of-Purchase Entries

A point-of-purchase entry is an ACH debit application, used by Originators (merchants, billers, etc.) as a method of payment for the in- person purchase of goods or services by consumers. These non-recurring ACH debits entries are initiated by the Originator based on a written authorization and account information drawn from the source document (check or share draft) obtained from the consumer at the point of sale. The source document, which is voided and returned to the consumer at the point of sale, is used to collect the consumer’s routing number, account number and check serial number that will be used to generate the debit entry to the consumer’s account. An interim rule effective September 17, 1999 through September 14, 2000, provides a rules framework for transmitting these entries using the PPD standard entry class code. Effective September 15, 2000, a new SEC code of POP will be established for the transmission of point-of-purchase entries.

Lockbox Truncation (Accounts Receivable Conversion – ARC)

Consumers mail their bill payments to companies, realizing some advantages of mail and collection float associated with such payments. For companies, the cost of processing and collecting these checks is high. There are methods that remittance processors or billers may use to increase efficiencies within the lockbox or biller’s process by reducing collection float and other check float collection costs, through the truncation of paper checks to electronics via the ACH.

Truncation in this instance means that the payer issues a paper check and sends it through the mail to the payee; at the point of receipt (Lockbox), the check is converted to an electronic payment. Presentment is made to the payers financial institution electronically and the paper check or image is stored for a legally specified period of time by the remittance processor.

A short-term rule amendment, effective December 17, 1999 through December 14, 2000, enables Originators to use the PPD format to truncate consumer checks received through the US mail for the payment of goods or services and to collect those checks via an ACH debit. This short-term rule amendment provides a legal framework for the protection of the participants while testing the impact of this consumer check truncation application. ODFls must sign an agreement with NACHA in order to originate these entries.

Cross-Border Payments

In the cross-border payment environment, the Gateway Operator acts as the entry point to the national payments system for entries received from another country and the exit point from the national payments system for entries originated in another country. The Gateway Operator assumes responsibility for foreign exchange conversion and settlement, format mapping and translation of data.

Effective September 15, 2000, two new Standard Entry Class Codes, CBR (Corporate Cross-Border) and PBR (Consumer Cross-Border) will be used for the transmission of cross-border entries. These new SEC codes will allow cross-border transactions to be readily identified by financial institutions so that any special handling requirements may be applied and additionally will allow ACH participants to transmit and receive detailed information unique to cross-border payments.

Other Applications

Uses for the ACH network are unlimited. Other applications include machine transfer entries, point of sale transactions, truncation applications and payment message and payment advice applications.

Overall Benefits

Benefits to Corporate Originators

  •      Cost reduction.
  •      Eliminates critical delivery of checks since funds are  automatically deposited.
  •      Predictability of funds.
  •      The reduction of paper handling, which comes from automation.

Benefits to Originating Depository Financial Institutions

  •      Reduction in processing costs
  •     Stronger customer relationships. Revenue generation

Benefits to Receiving Depository Financial Institutions

  •      Shorter lobby lines
  •      Improved customer service
  •      Reduced costs in processing incoming entries. Immediate collected funds for credit entries

Benefits to Receivers

  •      Convenience of use
  •      Increased control over account balances. Reduced payment costs