Chargeback Accounting

Table of Contents

1. What Is a Chargeback, Exactly?
2. What Is Chargeback Accounting?
3. Why Is Chargeback Accounting So Difficult?
4. How Do Merchant Account Types Affect Chargeback Accounting?
5. How Should Chargebacks Be Recorded?
6. Chargeback Knowledge Is Power
7. What Are Chargebacks in Accounting?
8. What Is a Chargeback in Accounts Receivable?

Chargebacks are a complicated issue for any merchant, and managing them properly involves nearly every part of a business. Customer service prevents chargebacks by addressing problems and issuing refunds, IT integrates and manages fraud prevention tools, and management uses the information gained by fighting chargebacks to make improvements to business operations.

One of the most affected departments, however, is accounting. A single chargeback can involve several different transactions. In fact, the original transaction can be reversed up to four times when all is said and done. And if you want to accurately track the total cost of your chargebacks, as you should, things get even more complicated. How is chargeback accounting done, and how can merchants make sure that their chargebacks are being tracked correctly?

Figuring out how to properly account for chargebacks may not carry the same urgency as figuring out how to fight and prevent them, but if you want to get an accurate handle on how chargebacks are impacting your bottom line, they need to be thoroughly and correctly recorded in your ledger.

Because various banks and payment processors handle chargeback activity in different ways, you can’t just assume that any reasonably competent number-cruncher is going to automatically know how to handle chargeback accounting.

Merchants should understand how chargebacks impact their accounts at every stage of the dispute process so that they can communicate effectively with their accounting staff and make sense of chargeback-related financial reporting.

In order to understand chargeback accounting, however, you'll need a much deeper understanding than this simple explanation. The chargeback process has several steps, each of which can result in further transactions that must be properly accounted for.

Once the initial chargeback has been filed, the merchant must issue a response. There are two options here.

If the chargeback is legitimate or too low-value to be worth fighting, the merchant can accept it. If the chargeback is illegitimate, the merchant can contest it through a process called representment.

In representment, the merchant provides evidence to the issuing bank based on the chargeback reason code. The reason code indicates the justification the cardholder gave for the chargeback. The merchant's evidence must demonstrate that this claim is false. If they succeed, the issuing bank will reverse the chargeback and return the funds to the merchant. If the issuing bank decides the evidence is insufficient, the chargeback will be upheld.

If the chargeback is reversed but the cardholder uses a new argument or new evidence to convince the bank that the chargeback might be valid after all, the bank can initiate pre-arbitration, essentially clawing back the money a second time.

If the merchant and the bank both refuse to accept liability for the chargeback at every stage, the case may go to arbitration. Then the card network will step in and make a final decision, charging hundreds of dollars in fees to the losing party. This decision is final and can't be appealed.

For merchants who receive chargebacks regularly, such as those in eCommerce, it's especially important for the person doing the accounting to have a thorough understanding of the chargeback process and how each part of it should be recorded.

Most issuing banks give their customers 120 days to dispute a charge on their account, and some have no time limit at all for opening a dispute. Even banks with stricter limits can't go below the 60 days set by federal law. That means when you get hit with a chargeback, it might be for a transaction that happened months ago.

Chargebacks can also wax and wane in unpredictable ways. Depending on the time of year, the condition of your industry, trends in the economy, and new developments in fraud, you could face far more or fewer chargebacks in any given month than you expect, making it difficult to anticipate and budget for these costs.

Chargebacks also come with fees attached, but the exact dollar amounts and fee schedule will vary by card network and payment processor, and these fees may be listed along with the chargeback as one transaction or as separate transactions.

Review your contracts and documentation so that your accountants will know exactly what fees to look for and when.

Tracking and categorizing the costs of chargebacks can also be difficult. If you have separate categories for fraud and chargebacks, where do you put a chargeback caused by fraud? How do you want to categorize the cost of merchandise and shipping for an order that was charged back?

If you want to not only balance the books but also figure out how much money you're losing to chargebacks, the whole process can get incredibly complicated.

If you obtained your merchant account directly from a major bank like Chase or Wells Fargo, you should find your chargebacks listed as individual line items on your bank statement.

Chargeback amounts and chargeback fees should be split out as separate amounts, as should chargeback reversals. These accounts tend to be easier to reconcile, as the banks make an effort to organize this information in a logical and readable manner.

Third-party merchant account providers, also known as independent sales organizations or merchant service providers, tend to focus on providing account services to small or high-risk merchants.

Their practices are less consistent than the big banks, and it’s not unusual to find them lumping chargebacks and fees into a one-line transaction on your bank statement. This can make it very difficult to identify individual chargebacks included in the lump sum, and your accountants may need to contact the account provider directly to get a breakdown.

If you do business in whole or in part through alternate payment platforms like Amazon or PayPal, they may use different methods or terminology to account for chargebacks on their platform.

It's also important to understand any reserve funds required for your merchant account. Some banks will hold transactions in reserve for a set period of time and may take chargebacks and fees out of these funds before they ever reach you. Don’t be afraid to ask your provider to go into more detail about their processes and policies if necessary.

While the specifics of how you should account for chargebacks will depend on your business, accounting practices, and software, here's one common example of how to account for chargebacks:

The initial chargeback—the reversal of the transaction the cardholder is disputing—should be posted to Accounts Receivable.

This positions each chargeback as funds that are owed to you and which you expect to recover. You can also create a special designation for this such as “Accounts Receivable – Chargebacks.”

If you fight the chargeback and win, you can clear the chargeback off the books by crediting cash and debiting Accounts Receivable. If the chargeback reaches the endpoint of the dispute process and is upheld (or if you choose not to fight it at all), you can write it off by adding it to a bad debts expense account.

Fees incurred for chargebacks should be treated as operating expenses. If you already have an account designated for bank fees you can post chargeback fees there, but if you’re dealing with a high volume of chargebacks it may be advisable to set up a separate sub-account for chargeback-related fees to make reporting and analysis easier.

Chargeback Knowledge Is Power

Accurate chargeback accounting is necessary for determining the true cost of your chargebacks and the significance of their impact on your business. A chargeback is more than just a reversed transaction — not only are you losing the paid amount and the product sold, you also have to consider the time, labor, and marketing costs associated with selling that product to be lost, and factor in the fees as well.

The true cost of a chargeback to the merchant can be more than double the amount of the original transaction. Proper chargeback accounting practices can help you track exactly how much revenue you’re losing to chargebacks.

Your accounting team has a very important role to play in your overall chargeback defense strategy, so make sure they have the information and guidance they need to do their jobs right.

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