Chargeback Accounting Best Practices for Merchants

Chargeback accounting reconciles disputed card payments, fees, recovered funds and final outcomes to the original orders and processor payouts. The entries depend on the payment flow, accounting policy and jurisdiction.

Chargeback impact on eCommerce businesses has been discussed extensively in the industry. One chargeback can create a disproportionate ripple effect across every part of a business.

But what hasn't received equal airtime is accounting for chargebacks: how to track and record the overall cost of your disputes.

This piece will unveil all the chargeback accounting best practices to help you create effective chargeback bookkeeping. And remove the headache from dispute-related financial reporting.

But before we dig in, let's clarify the basic concept.

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What Is Chargeback Accounting?

Chargeback accounting links each dispute to the original sale, the processor’s debit or payout adjustment, any separately charged fees and the final outcome. Keep the underlying dispute separate from the accounting classification: contesting a payment does not automatically establish a receivable or a bad debt.

For accurate chargeback accounting, the bookkeeper must make room for both chargeback, reversals, and ancillary fees. These unpredictable costs can stretch into different accounting periods.

The bookkeeper must also remember that the various banks and processors have different methods for handling chargebacks.

These complexities often make accounting for chargebacks a nightmare for businesses. Plus, chargeback accounting demands real-time reporting and post-dispute activities such as installing chargeback analytics and diagnostics.

So you can't just assume that anyone who can crunch numbers and analyze data will readily handle the work with ease. The handler needs more in-depth knowledge of the chargeback process.

That's especially true for vendors that get frequent payment disputes. A thorough knowledge of the chargeback process and how to account for every moving part is crucial.

Accurate Chargeback Accounting is Vital for Business Sustainability

Chargeback represents a growing business sustainability risk. If you don't have a reliable system to track dispute-related losses, you should consider establishing such a system immediately.

Without proper chargeback accounting, you might not readily grasp the impact on your business' bottom line.

Accounting for chargeback helps you measure and improve your dispute mediation efforts to ensure operational efficiency and long-term risk management. Yet, your merchant account type often determines the accuracy of your chargeback reports.

A provider may show the disputed principal, fees and later credits as separate lines. Use those event references to match the dispute to the original order and the payout or bank transaction.

Other payout reports net several adjustments into a single deposit. Obtain the underlying transaction report before splitting the principal, dispute fees, fee credits and recoveries in your ledger. If your books run on QuickBooks, follow these steps to record a chargeback in QuickBooks Online.

And since that's information you might not readily have, some transactions could go unrecorded, resulting in incorrect accounting logs.

Sometimes, your provider might hold a specific amount of your revenue in a merchant account reserve to cushion potential risks. The funds are only made available for use at the end of the risk period, usually up to six months. Even at that, a portion of your revenue is unavailable as the account reserve might be rotational.

If you don't have proper chargeback accounting, it'll be hard to understand how much working capital you have. More so, you won't know the extent of your dispute liabilities or losses, which means forecasting future revenues will also be challenging.

With all that said, below are three solid ways to make your chargeback accounting more effective.

3 Ways to Simplify Your Chargeback Accounting

Separate the disputed payment from the cost of the underlying goods and from processor fees. A chargeback and a voluntary refund are different operational events, but their accounting treatment depends on what was originally recognized and your accounting policy.

The challenge often lies in excavating the input data, understanding how many chargebacks you have, and being up to date with your chargeback situation.  

Here are some ideas to simplify your chargeback accounting.

Use Chargeback Automation for Centralized Information

Apart from the ROI benefits that a chargeback automation solution like Chargeflow provides, the intuitive dashboard also helps you harmonize the different touch points in the dispute process. When evaluating a platform, use our guide to chargeback management software for finance teams to check fee traceability, export fields, and settlement matching.

It's impossible to manage disputes effectively when the data you need spreads across a thousand different touchpoints. With Chargeflow's centralized dashboard, you can quickly track active chargeback cases, real-time chargeback rates, and the win-loss probability of open disputes. And you can use such information to plot your revenue projections graph with ease.

Chargeback Analytics Helps Optimize Long-term Risk Management

As we noted earlier, one of the crucial aspects of a solid chargeback accounting strategy is chargeback analytics. If you can't see (or quickly grasp) your numbers, you might face cash flow problems.

Tracking your chargeback rate seems relatively effortless. But it's not. The formula for calculating chargeback-related financial losses isn't always straightforward. The chargeback amount does not tell the whole story of your losses. There are so many ancillary costs with EVERY dispute; you might overlook those costs in the calculation.

Chargeflow features robust analytics that helps you create relevant reports and develop actionable strategies to keep up with what really matters.

Use Real-time Reporting to Stay Up to Date

With real-time reporting in Chargeflow Insights, you can effectively forecast chargeback success rates and get a better understanding of your current efforts up to the minute. By analyzing a massive body of data with proprietary algorithms, Insights can determine with high accuracy your chances of recovering each chargeback and how much money you expect to recover from ongoing chargebacks.

5 Chargeback Accounting Best Practices to Consider

It's worth re-emphasizing that accounting for chargebacks is a fuzzy area.

Managing your business' finances is complex enough. Chargeback accounting only makes financial reporting more daunting. But if you apply the following hacks to the aforementioned best practices, you can get the best from your chargeback accounting.

Check Tax Eligibility Before Writing Off a Loss

A lost chargeback is not automatically a deductible bad debt. For U.S. taxpayers, IRS Topic 453 describes conditions such as a valid debt, prior income inclusion or cash advanced, and worthlessness. The applicable rules differ by accounting method and jurisdiction.

Keep the original transaction, processor debit, collection or dispute-response history, and final outcome. Ask your accountant whether the loss is a revenue adjustment, an expense or an uncollectible recognized receivable under the applicable policy.

Book treatment and tax deductibility are separate decisions. Do not assume that a partial recovery is impossible or that a tax write-off follows automatically from accepting a dispute.

Track Dispute Fees and Fee Credits Separately

Dispute fees are not universally non-refundable. Stripe distinguishes received and countered fees, with contract and location exceptions. Shopify Payments documents returned fees after a win. Verify the applicable country and provider terms, and reconcile the fee credit when it actually posts.

Use a separately identifiable expense or fee account consistent with your accountant-approved chart of accounts. Separate the fee from the disputed principal so a returned fee does not get mistaken for recovered sales revenue.

If such is your reality, financial analysts say you should consider creating a different dispute-related sub-account for these charges. And you can equally use the same account to register every other ancillary expense.

Assess Whether a Disputed Amount Is a Receivable

A disputed transaction may be valid, fraudulent or affected by a service or processing issue. Read the claim and permitted response options before deciding to contest it; the reason code does not itself establish fraud or recoverability.

Do not create an accounts receivable balance merely because a dispute is being contested. Your accountant should determine whether a receivable qualifies for recognition, which counterparty owes it, and how the processor debit affects cash, a clearing account or previously recognized revenue.

When funds are recovered, match the credit to the prior debit and the balance actually recorded. If the case is lost, close or reclassify that balance under the approved policy. Avoid reversing revenue twice or recording recovered principal as both a cleared receivable and new sales income.

Classify Lost Payments Under the Applicable Policy

Accepting or losing a dispute does not make every payment a bad debt. The appropriate treatment can differ for an uncollectible recognized receivable, a canceled sale or a processor adjustment. Document the event and have the accountant confirm the classification rather than applying one label to every loss.

Keep Your Chargebacks Under Control

In the final analysis, maintaining a low chargeback and fraud percentage is one definitive way to ensure you have fewer chargeback accounting headaches.

But to maintain a low chargeback and fraud ratio, you need tools and systems that can go beyond guesswork in preventing fraud. You need more relevant and comprehensive data on each transaction.

By and large, chargeback automation proves to deliver the best results in helping merchants save time and resources. Again, you equally have easy access to the relevant documentation for your chargeback accounting instead of struggling to gather all the reports needed for a complete ledger.

Example Chargeback Journal Entries

These illustrations show how the cash and fee events can be separated; they are not a universal accounting policy. Have a qualified accountant confirm recognition, the chart of accounts and tax treatment before using them. Stripe Revenue Recognition, for example, uses its own dispute contra-revenue and recoverables accounts rather than automatically creating customer accounts receivable.

1. Recording a separately charged dispute fee: If your approved policy recognizes the charge as a fee expense, debit that expense account and credit the processor balance, cash or payable account actually affected. If the fee is later returned, record the credit against the fee treatment already used. Keep received and countered fees separately identifiable.

2. Recording disputed principal under a recognized-receivable policy: Only where your accountant has determined that a dispute receivable should be recognized, a processor debit can be illustrated as a debit to that receivable and a credit to the processor balance or cash account affected. A later recovery clears that receivable against the actual incoming funds. This assumption does not automatically reverse or re-recognize sales revenue.

3. Closing a recognized balance after a loss: If a receivable was properly recognized and is now uncollectible, clear it against the allowance or loss account required by your approved policy. If no receivable was recognized, do not invent one to write it off. Tax deductibility requires a separate assessment.

Confirm the entries against both the processor transaction report and the bank deposit. Treatment can differ when revenue is deferred, the original invoice is still collectible, the sale is canceled or funds are recovered in a later period. Use the relevant accounting framework and local tax rules with your accountant.

Reconcile Dispute Events to the Payout

For example, a $100 principal debit, a separate $15 received fee and a later $100 recovery leave $15 of fee cost if that fee is not returned. If a $15 fee credit also posts, that fee cost is reversed separately. These amounts illustrate arithmetic only; they are not a provider price quote or a journal-entry prescription. For the full matching process, see our guide to chargeback reconciliation.

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Use Chargeback Accounting to Track Dispute Losses

Accounting for chargebacks is a vital aspect of financial prudence. Chargebacks represent a rising cost for all businesses. The negative effects on profitability cannot be overstated. Chargebacks create excessive financial losses and result in high overhead costs. They diminish profit margins and lead to loss of future revenue due to a bad reputation.

Effective chargeback accounting helps you track dispute losses to better design mitigation strategies. Use the best practices in this article to improve your reporting efforts and make your books make sense. See how Chargeflow can help you recover chargebacks on autopilot.