What is a chargeback in small business accounting?

Published Tuesday 14 April 2026

Table of contents

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

Key takeaways

• Respond to chargeback disputes within 10-30 days with compelling evidence like proof of delivery, signed contracts, and communication logs to recover lost revenue and avoid automatic forfeiture of funds.
• Prevent chargebacks by using clear billing descriptions your customers will recognize, implementing fraud protection tools, and responding quickly to customer concerns before they escalate to their bank.
• Keep your chargeback rate below 1% of total transactions to avoid penalties and potential merchant account closure, as high rates signal operational problems to payment processors.
• Record chargeback fees as operating expenses and lost sale amounts as bad debt in your accounting system to maintain accurate financial records when disputes are unsuccessful.

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. Major card networks have committed to protect you against financial loss if your card is used without permission.

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, unless they demonstrated gross negligence.

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

• Pay processing fees even if the chargeback is later reversed
• Lose goods without receiving payment
• Face increasing chargeback volumes

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

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 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 in four main ways:

• Financial: Refunds typically don't include extra fees, while chargebacks involve processing costs and potential penalties
• Time: Refunds resolve quickly, while chargebacks take longer due to bank involvement and dispute processes
• Regulation: Refunds depend on your return policy, while chargebacks follow strict card network rules and timelines
• Reputation: Refunds don't affect processor relationships, while high chargeback rates can damage your standing

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.

Steps of the chargeback process

Customers usually have 60–120 days to request a credit card chargeback. For other payment types, the window can be shorter. With chequing or savings accounts, you usually have 30 days after the date of your statement to dispute a transaction. See the Financial Consumer Agency of Canada for more details.

Four parties manage every chargeback: the customer (cardholder), your business (merchant), your payment processor (acquirer), and the customer's bank (issuer). The 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. Learn more about online payment gateways.

5. The merchant responds

You then decide whether to accept or dispute the chargeback. You must reply within the allocated time, usually 10–30 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. Use Xero's receipt template to create professional 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).

Chargebacks fall into two main categories:

• Fraud-related: Includes unauthorized transactions, stolen card use, or intentional misuse by customers
• Error-based: Includes mistakes in processing, delivery failures, or unresolved customer service issues

Here's a closer look at each category.

Fraud

Fraud can occur when someone:

• uses a card without the customer's knowledge, leading to a dispute
• claims a legitimate purchase as fraudulent to avoid payment (friendly fraud)
• fails to deliver goods or services after receiving payment (business fraud)

Business errors

Business errors include:

• making an incorrect charge due to a processing mistake
• sending damaged or incorrect goods and not offering a refund
• missing a customer complaint, leading the customer to request a chargeback if there's no resolution

Customer errors

Customer errors can happen when you:

• use a business name or description that your customer doesn't 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

Subscription and recurring payment errors occur when you:

• sign up a customer to a subscription service unintentionally or after they've forgotten about it
• fail to cancel a subscription or recurring charge after your customer asks, and continue charging them

The true cost and impact of chargebacks for small businesses

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

• Lose both revenue and goods from the original transaction
• Pay a non-refundable fee for every chargeback, even if you win the dispute
• Face higher payment processing fees if your chargeback rate climbs. Learn more in our payments guide
• Spend valuable hours gathering evidence and responding to disputes
• Risk having your merchant account closed if chargebacks exceed thresholds

Your chargeback rate directly affects your ability to accept payments. If your rate goes above 1% of total transactions, most payment processors will penalize 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: Signals of operational problems to banks and processors

Preventing chargebacks from occurring

Preventing chargebacks protects your revenue, reduces admin work, and maintains good relationships with payment processors.

Key prevention strategies include:

• Clear communication: Use transparent billing descriptions, publish detailed return policies, and respond quickly to customer concerns
• Fraud protection: Choose payment processors with advanced detection tools that block suspicious transactions automatically
• Strong credit control: Verify customer identities, use address verification systems, and require CVV codes for all transactions

How to dispute and resolve chargebacks

Disputing a chargeback 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 within the deadline (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. Await bank evaluation: The issuing bank reviews your evidence and either reverses the chargeback (you win) or upholds it (customer keeps the refund)

Record and manage chargeback fees in accounting

If you lose the dispute or choose not to challenge the chargeback, record the transactions correctly in your accounts:

• Chargeback fees: Record as operating expenses under bank fees or payment processing fees. Learn how to claim expenses in Xero
• Lost sale amount: Write off as bad debt expense if the goods or services were already delivered
• Reversed revenue: Adjust your sales records to reflect the returned payment

Ask your bookkeeper or accountant how to categorize these transactions for your specific business structure.

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, organized records make all the difference.

Keep all your invoices, receipts, and customer details in one place so you can respond to disputes quickly and confidently. Learn about chasing outstanding invoices and scanning receipts.

Xero accounting software helps you maintain organized financial records, so you can focus on running your business. Get one month free.

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 Visa and Mastercard network rules. The process works similarly to other countries.

Are chargebacks illegal?

No. Chargebacks are a legal consumer protection tool. However, when a customer disputes a legitimate charge to get their money back without cause, it's called friendly fraud, which is a form of theft.

How long do I have to dispute a chargeback?

You typically have 20–45 days to respond, depending on the card network. Visa allows 20 days, while Mastercard allows 45 days. Act quickly once your payment processor notifies you.

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

A dispute is when a customer questions a transaction with their bank. A chargeback is the actual reversal of funds that happens if the bank finds the dispute valid. The dispute starts the process; the chargeback is the outcome.

Are chargebacks usually successful?

Merchants win roughly 20–40% of chargeback disputes when they respond with strong documentation. Your success rate improves significantly when you provide proof of delivery, signed agreements, and communication records showing the customer received what they paid for.