How chargebacks work in accounting for small businesses

Published Friday 10 October 2025

Table of contents

• What is a chargeback in accounting?
• Steps of the chargeback process
• Common reasons for chargebacks
• Chargebacks vs refunds: key differences
• The true cost of chargebacks for small businesses
• Who is involved in the chargeback process?
• The effect of chargebacks on your business and finances
• Preventing chargebacks from occurring
• How to dispute and resolve chargebacks
• Managing chargebacks effectively for long-term success
• FAQs on chargebacks

Key takeaways

• Implement clear communication strategies including transparent billing descriptions, detailed return policies, and excellent customer service to prevent chargebacks before they occur.

• Respond immediately to chargeback notifications within the 10-30 day timeframe and provide compelling evidence such as delivery confirmations, signed contracts, and communication logs to maximize your chances of winning disputes.

• Recognize that chargebacks cost significantly more than the original transaction amount due to non-refundable processing fees, lost inventory, potential penalty charges, and administrative time, making prevention crucial for profitability.

• Monitor your chargeback rate closely to stay below the 1% threshold, as exceeding this limit can result in higher processing fees, account penalties, or complete merchant account closure.

What is a chargeback in accounting?

A chargeback is a payment reversal initiated by a customer's bank when they dispute a credit or debit card transaction. This process protects cardholders from unauthorized or problematic charges; for example, in Canada, when an unauthorized transaction is made with a credit card, a consumer's maximum liability by law can’t be more than $50.

If you run a small business, chargebacks can create significant challenges:

• Pay fees even if the chargeback is later reversed
• Lose inventory without receiving payment
• Face rising chargeback rates – up 76% year-over-year

You might see chargebacks if there’s fraud, a billing error, or a customer is unhappy with your product or service.

Steps of the chargeback process

Customers usually have 60 to 120 days to request a credit card chargeback. For other payment types, the window can be shorter. For example, with chequing or savings accounts, you usually have 30 days after the statement to dispute a transaction.

The chargeback process follows six key steps:

1. The customer disputes the charge

Your customer believes a charge on their card is invalid and contacts their bank to dispute it within the valid timeframe.

2. The issuing bank evaluates the dispute

The issuing bank reviews the dispute and decides if the reason is valid. Under certain regulations, such as Canada's code for debit card services, the issuer must investigate and respond within 10 business days. If the bank finds in favour of the customer, they grant a chargeback.

3. The issuing bank gives provisional credit

The bank credits your customer for now and contacts your payment processor. If the chargeback is denied later, the credit is reversed.

4. The acquirer notifies the merchant

Your payment processor debits your bank account and charges you a chargeback fee. The fee covers the payment processor's admin costs.

5. The merchant responds

You then decide whether to accept or dispute the chargeback. You must reply within the allocated time – usually 10 to 30 days, depending on your payment processor – or you could be charged a non-response fee. For example, Visa gives you 20 days to respond, while Mastercard gives you 45 days.

6. The dispute resolution process

If the merchant disputes a chargeback, they must give evidence to support their position, like proof of delivery, communications with the customer that prove they received the item, photographs, and sales receipts. You provide the evidence to your payment processor, who passes it to the bank for review. The bank decides whether to uphold or reverse the chargeback.

If the bank upholds the chargeback, your customer keeps the amount and you may be charged a fee. If the dispute is resolved in your favour, the bank returns the amount and any fees you paid.

Common reasons for chargebacks

Chargebacks can be started by your customers, your business (if you need to correct an error), or your bank (if they detect fraud).

The two main categories of chargebacks are:

• Fraud-related: Unauthorized transactions or intentional misuse
• Error-based: Mistakes in processing, delivery, or customer service

Fraud

• Use a card without the customer’s knowledge, leading to a dispute
• Claim a legitimate purchase as fraudulent to avoid payment (friendly fraud)
• Fail to deliver goods or services after receiving payment (business fraud)

Business errors

• Make an incorrect charge due to a processing mistake
• Send damaged or incorrect goods and do not offer a refund
• Miss a customer complaint, leading the customer to request a chargeback if there’s no resolution

Customer errors

• Use a business name or description that your customer does not recognize, leading them to request a chargeback
• Process multiple purchases or payments for the same item by accident

Errors relating to subscriptions and recurring payments

• Sign up a customer to a subscription service unintentionally or after they have forgotten about it
• Fail to cancel a subscription or recurring charge after your customer asks, and continue charging them

Chargebacks vs refunds: key differences

The key difference is who handles the dispute. Refunds go through you, while chargebacks go through your customer’s bank.

Refunds: Direct customer-to-business resolution where you can discuss the issue, receive returned goods, and maintain the relationship.

Chargebacks: Bank-initiated reversals that bypass your business entirely, giving you limited opportunity to respond or recover goods.

Refunds and chargebacks differ from each other in four main ways:

• Financial: Refunds typically don't come with extra fees, while chargebacks involve processing costs and potential penalties.
• Time: Refunds are much quicker than chargebacks, which take longer to resolve as banks and a dispute process are involved.
• Regulation: Refunds depend on a business's return policy, while chargebacks are governed by strict rules and timelines separate from the merchant's business.
• Reputation: High chargeback rates can affect a business's standing with payment processors, while refunds don't carry this risk.

Are chargebacks or refunds better for merchants?

Ideally, your customer is happy with what they bought, so you keep your income. If not, a refund helps you keep a good relationship with your customer.

If a chargeback or refund is approved, make sure you record it correctly in your accounts.

The true cost of chargebacks for small businesses

A chargeback costs you more than just the sale amount. The costs can add up quickly and affect more than just your revenue.

• Lose revenue and goods from the sale
• Pay a non-refundable fee for every chargeback, even if you win the dispute
• Face higher payment processing fees if you have too many chargebacks
• Spend valuable time gathering evidence and responding to disputes
• Risk having your merchant account closed if you have too many chargebacks

Who is involved in the chargeback process?

Four key parties manage every chargeback dispute, each with specific responsibilities:

• Customer (cardholder): Initiates the dispute with their bank
• Business (merchant): Provides evidence to defend against the chargeback
• Payment processor (acquirer): Facilitates communication and processes fees
• Customer's bank (issuer): Reviews evidence and makes final decisions

The effect of chargebacks on your business and finances

If your chargeback rate goes above 1% of your total transactions, most payment processors will penalise you and may close your account.

The business impacts include:

• Financial losses: Chargeback fees, lost revenue, and potential penalty charges
• Administrative burden: Time spent gathering evidence and managing disputes
• Relationship damage: Strained partnerships with payment processors
• Reputation risk: High chargeback rates signal operational problems

Preventing chargebacks from occurring

Preventing chargebacks helps you protect your revenue, reduce admin work, and keep good relationships with payment processors.

Key prevention strategies:

• Clear communication: Transparent billing, return, and refund policies reduce customer confusion and disputes
• Fraud protection: Secure payment processors with advanced detection tools block suspicious transactions
• : Proper verification processes ensure legitimate customers and reduce payment issues

How to dispute and resolve chargebacks

If you dispute a chargeback, you can recover lost revenue and reduce fees, but you need to act quickly and provide strong evidence.

The dispute process involves three critical steps:

1. Respond quickly (10-30 days): Contact your payment processor immediately to avoid automatic forfeiture of funds.
2. Submit compelling evidence: Provide proof of delivery, signed contracts, communication logs, and transaction receipts that demonstrate the charge was legitimate.
3. Bank evaluation: The issuing bank reviews your evidence and either reverses the chargeback (you win) or upholds it (customer keeps the refund). Complex cases escalate to the card network for final decision.

Record and manage chargeback fees in accounting

If you do not win the dispute or choose not to challenge the chargeback, record chargeback fees as operating expenses (bank fees). You may need to write off the chargebacks themselves as bad debt expenses.

Ask your bookkeeper or accountant how to record these transactions and fees.

Managing chargebacks effectively for long-term success

Stay on top of chargebacks by being proactive. Communicate clearly, set fair policies, and offer excellent customer service. When a dispute happens, keep your records organized.

When you keep all your invoices, receipts, and customer details in one place, you can respond to disputes quickly and confidently. Xero accounting software helps you keep your financial records organized, so you can focus on running your business. Start a free trial of Xero accounting software.

FAQs on chargebacks

Here are answers to a few common questions about chargebacks.

Can you do a chargeback in Canada?

Yes. Chargebacks are a standard consumer protection right for credit card users in Canada, governed by the rules of card networks like Visa and Mastercard. The process is similar to that in other countries.

Are chargebacks illegal?

No, chargebacks themselves are a legal consumer protection tool. However, when a customer disputes a legitimate charge just to get their money back, it's known as 'friendly fraud', which is a form of theft.

How long do I have to dispute a chargeback?

The timeframe to respond to a chargeback varies but is typically between 20 and 45 days, depending on the card network. It's important to act quickly once you're notified by your payment processor.

What’s the difference between a chargeback and a dispute?

A customer initiates a 'dispute' with their bank when they question a transaction. The bank then investigates. If the bank finds the dispute valid, it results in a 'chargeback', which is the actual reversal of the funds from your account to the customer's.