As we move toward a truly electronic society, what we once demanded in print is changing before our eyes.

Electronic delivery is affecting almost every industry, and banking is no exception. In fact, many banks have already begun truncating checks by delivering photocopies of checks or by sending a list - detailing the check number, the amount and the clearing date - and holding on to the originals instead of sending them back to consumers.

On Oct. 28, 2004, the Federal Reserve authorized entities in the check clearing process to take this one step further. Any entity in the clearing check process will be able to truncate checks and forward an electronic copy of the check. When this occurs, the electronic image of the check must be capable of being transformed into a "substitute check," or a printed, electronic image of the original that will now be recognized as the legal equivalent of the original check.

The check truncation concept had been around for many years, and many drawer banks truncate checks in their monthly statements to customers. The passage of the Check Clearing for the 21st Century Act, or Check 21 Act, was helped by the terrorist attacks of 9/11. Grounded planes cost the banking industry billions of dollars as check processing was grounded as well.

Electronic delivery means that banks would no longer have to fly checks all over the country, and consumers may receive copies of their checks instead of cancelled paper checks. While the act is voluntary, most banks are expected to take advantage of the potentially significant cost savings, with the larger institutions leading the pack. It is expected that it will be a number of years before the process becomes ubiquitous.

The intent of the act is to cost-effectively and efficiently streamline check processing. The ability to process checks electronically would decrease processing time, transportation costs, and the possibility of items being lost or destroyed in transit. Checks would clear in hours instead of days, because a substitute check can be accepted as legal. And although the process is voluntary for all banks in the clearing process, once one bank decides to create a substitute check, all other downstream banks involved in the clearing process must use the substitute check.

Any bank in the check clearing chain can initiate "truncation" and create a substitute check. Whether the substitute check is then forwarded physically or is transmitted electronically will be determined by the agreements between banks in the clearing system. Banks and institutions will also make their own policies on how long to keep the original check.

What is a substitute check?

The Check 21 Act authorizes a new negotiable instrument called a "substitute check." A substitute check is a paper reproduction of the original check that contains an image of the front and back of the original check and bears a MICR line containing all the information appearing on the MICR line of the original check. It conforms, in paper stock, dimensions and otherwise, with generally applicable industry standards for checks, and is suitable for automated processing in the same manner as the original check.

To create a substitute check, an electronic image of the original check is made. Once this happens, the original check is truncated, or taken out of circulation. The substitute check contains a legend that reads, "This is a legal copy of your check. You can use it the same way you would use the original check."

The Check 21 Act provides that a properly prepared substitute check is the legal equivalent of the original check for all purposes. It does not require a bank to create substitute checks or to accept checks electronically. In addition, it includes new warranties, an indemnity, and expedited re-credit procedures that protect substitute check recipients. You will always be able to get substitute checks from your financial institution, but they may only be available upon request.

How will it affect users?

Although the effects of the act will not happen overnight, there are several implications to be aware of.

* You will see fewer and fewer original checks as they are replaced by substitute checks. Also, as banks begin to move towards electronic transmission, the physical substitute checks will be replaced by electronic images.

* Decreased processing time means that there will be a reduction in the "float time," the amount of time between when you write your check and when it clears. This can be a negative for consumers, because the speed of electronic transfers decreases the "float" that enables consumers to keep their money in their account until the check they have written clears.

* Deposit clearing rules are not affected by the Check 21 Act. Therefore, while the decreased processing time will reduce the length of time a check written on your account remains in the check clearing system before being charged to your account, the length of time that a bank holds checks deposited into your account before crediting your account will vary depending on your relationship with your bank.

* In disputes, substitute checks would be recognized as the original by the courts, retailers and other providers.

Detecting check fraud may be more difficult. But the Federal Reserve maintains that since the original check is no longer used for processing, the security of the electronic systems will reduce human access to your financial information.

In addition, the shorter processing time will allow the identification of check fraud or forgery more quickly. However, proving alterations and forgeries may become more difficult if there is no access to the original paper and ink, which can provide important clues such as pressure points.

Implications for auditors

Banks have never been required to return original checks to commercial clients. The new act does not specify what must be returned to the customer. That decision is left up to the bank. However, a customer can require the bank to return a "substitute check," if the customer has a need for a legal equivalent of the original check.

Because of the range of delivery options, understanding what a financial institution will return should be a top priority for auditors and for management. Management should make it a top priority to speak directly with their institutions to determine exactly what a bank will provide. Knowing exactly what a bank will disseminate and return will enable management to revise, if needed, their internal controls over cash.

Since the act specifically states that the substitute check has all the force and effect of the actual cleared check, auditors may use a substitute check as evidential matter. In certain cases, an electronic check image will suffice depending upon an auditor's judgment and her assessment of fraud risks. Since the original check will no longer be available, auditors should consider, while planning an audit engagement, what changes they need to make to their audit procedures.

Both auditors and their clients should be prepared to have these discussions during audit planning.

More information on the act can be found at

Alan W. Anderson, CPA, is senior vice president for member and public interests at the American Institute of CPAs.

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