What is a chargeback? How it works and how to avoid

Published Thursday 26 February 2026

Table of contents

• What is a chargeback in accounting?
• Chargebacks vs refunds: key differences
• How chargebacks work
• Who's involved in a chargeback
• Common reasons for chargebacks
• Chargeback costs and fees
• The effect of chargebacks on your business
• Preventing chargebacks from occurring
• How to dispute and resolve chargebacks
• How to record chargebacks in your accounting
• Manage chargebacks confidently with Xero
• FAQs on chargebacks

Key takeaways

• Prioritise offering refunds over allowing chargebacks since refunds cost nothing extra while chargebacks incur fees of $15-$100 plus the lost transaction amount, and you maintain control of the customer relationship.
• Respond to chargeback disputes within the tight deadline of 5-10 days (despite official timeframes of 20-45 days) by gathering strong evidence like proof of delivery, customer communications, and transaction receipts to maximise your chances of winning.
• Implement clear communication practices by using recognisable billing descriptors, setting delivery expectations upfront, and responding quickly to customer complaints to prevent disputes from escalating to chargebacks.
• Monitor your chargeback rate closely and keep it below 1% of total transactions to avoid triggering monitoring programmes, additional fees, or potential account termination with payment processors.

What is a chargeback in accounting?

A chargeback is a payment reversal on a credit or debit card, typically initiated when a transaction is disputed as incorrect, unauthorised, or fraudulent. The process protects cardholders from liability for charges they didn't make or authorise, a mechanism originally created by the Fair Credit Billing Act of 1974 as a consumer-protection tool.

Chargebacks can happen for several reasons:

• fraudulent or unauthorised transactions
• billing errors or duplicate charges
• dissatisfaction with products or services
• goods not delivered or not as described

Chargebacks significantly affect small businesses. You pay a fee whether or not you win the dispute, and you risk losing both the payment and your goods. Chargeback managers have reported a 76% year-on-year increase in chargebacks, making prevention and proper management more critical than ever.

Chargebacks vs refunds: key differences

Refunds are processed directly between you and your customer. You return the payment, and typically receive the goods back.

Chargebacks bypass you entirely. The customer contacts their bank, which reverses the transaction first and only gives you the chance to dispute it afterwards. Some customers incorrectly use chargebacks to avoid dealing with a business directly, often because research shows they find filing chargebacks simpler than following a merchant's refund process.

Here are the key differences:

• Fees: refunds typically cost nothing extra, while chargebacks involve processing fees and potential penalties
• Timeline: refunds resolve quickly, while chargebacks involve bank intervention and can take anywhere from two to three months to resolve
• Control: refunds follow your return policy, while chargebacks follow strict card network rules you can't change
• Risk: high chargeback rates can damage your standing with payment processors, while refunds carry no such risk

Understanding which option benefits your business more can help you make better decisions.

Are chargebacks or refunds better for merchants?

Refunds are better for merchants in almost every scenario. You avoid chargeback fees, maintain control of the process, and preserve your customer relationship.

When a refund or chargeback is approved, record it in your accounting software to keep your financial records accurate.

How chargebacks work

The chargeback process follows a standard sequence, though timelines vary by card network. From the time they receive their bill, customers typically have 60–120 days to dispute a credit card charge. Visa, Mastercard, Amex, and Discover generally allow up to 120 days depending on the reason code.

Here's how the process works:

1. The customer disputes the charge

The customer contacts their bank to dispute a charge they believe is invalid, unauthorised, or incorrect. This starts the clock on your response window.

2. The issuing bank evaluates the dispute

The issuing bank reviews the dispute reason against card network rules. If the reason qualifies under their guidelines, they proceed with the chargeback.

3. The issuing bank gives provisional credit

The bank issues a temporary credit to the customer while it investigates the dispute. This amount is debited from your account immediately. If you win the dispute, the funds are returned.

4. The acquirer notifies the merchant

Your payment processor debits the disputed amount from your account and charges a chargeback fee, typically $15 to $100. You pay this fee regardless of the dispute outcome.

5. The merchant responds

You must decide whether to accept or dispute the chargeback within your response window. While Visa officially gives you 20 days and Mastercard allows 45 days, your acquirer also needs processing time, meaning merchants may realistically only have five–10 days in which to respond. Missing the deadline means you automatically lose the dispute and may face additional fees.

6. The dispute resolution process

To dispute a chargeback, you submit strong evidence (like proof of delivery, customer communications, and transaction receipts) to your payment processor. However, merchants only win chargeback disputes 20% to 30% of the time.

The bank makes the final decision. If they uphold the chargeback, you lose the disputed amount permanently. If they rule in your favour, the funds and any associated fees are returned to your account.

Who's involved in a chargeback

Understanding who's involved helps you know who to contact and what to expect at each stage.

• Cardholder: The customer who made the purchase and disputes the charge
• Merchant: Your business, which receives the payment and must respond to disputes
• Acquirer: Your payment processor, which handles transactions and notifies you of chargebacks
• Issuer: The customer's bank or card company, which evaluates disputes and makes the final decision

Common reasons for chargebacks

Chargebacks happen when a customer, merchant, or bank disputes a transaction. Most commonly, the customer initiates the process by contacting their card issuer.

The main triggers fall into four categories: fraud, business errors, customer errors, and subscription-related issues.

Fraud

• Unauthorised transactions: Someone uses the customer's card details without their knowledge, prompting a dispute
• Friendly fraud: A customer falsely claims a legitimate purchase was fraudulent to avoid paying. This is a common issue, with merchants reporting it's responsible for an estimated 42% of their chargebacks.
• Merchant fraud: A business fails to deliver goods or services after receiving payment

Business mistakes can also lead to chargebacks.

Business errors

• Incorrect charges: Billing mistakes or processing errors lead the customer or merchant to dispute the transaction
• Damaged or incorrect goods: The customer receives defective or wrong items and files a chargeback when a refund isn't available
• Unresolved complaints: The customer escalates to a chargeback after their complaint goes unanswered or unresolved

Sometimes customers themselves cause chargebacks unintentionally.

Customer errors

• Unrecognised transactions: The customer doesn't recognise the charge because the billing descriptor differs from your trading name
• Accidental duplicate purchases: The customer or merchant disputes extra charges when the same item is purchased or billed twice

Subscription and recurring payment issues also trigger chargebacks.

Errors relating to subscriptions and recurring payments

• Unwanted subscriptions: The customer disputes charges for a subscription they forgot about or didn't realise they'd signed up for
• Failed cancellation requests: Charges continue after the customer requested cancellation, prompting a dispute

Chargeback costs and fees

Every chargeback costs you more than just the disputed amount. Here's what to expect:

Chargeback processing fees

Payment processors charge a fee for each chargeback, which can range from $15 to $100 or more per dispute.

You may also lose the value of goods or services you've already provided.

Lost product or service costs

If the customer keeps the goods, you lose both the payment and the product. For service businesses, you've already delivered work you won't be paid for.

High chargeback volumes can trigger extra penalties.

Additional penalty fees

Exceeding your processor's chargeback threshold can trigger additional costs. You may face:

• monthly monitoring fees
• increased processing rates
• reserve account requirements
• programme compliance fines

There are also hidden costs in time and effort.

Administrative and dispute costs

Fighting a chargeback takes time. You'll spend hours gathering evidence, writing responses, and following up. For small businesses, this time has a real cost.

The effect of chargebacks on your business

Chargebacks cost you money, time, and potentially your ability to accept card payments.

Beyond the immediate financial loss, frequent chargebacks damage your standing with payment processors. Most processors flag accounts that exceed a 1% chargeback rate. Crossing this threshold can trigger monitoring programmes, additional fees, or account termination.

Preventing chargebacks from occurring

Reduce your chargeback risk with these practical steps:

• Communicate clearly: set expectations about delivery times, billing descriptors, and return policies before purchase
• Use recognisable billing descriptors: ensure your business name on card statements matches what customers expect
• Implement fraud detection: use payment processors with address verification (AVS) and CVV checks
• Document everything: keep proof of delivery, customer communications, and signed agreements
• Respond to complaints quickly: resolve issues before customers escalate to their bank

How to dispute and resolve chargebacks

When you receive a chargeback notification, you can challenge it by submitting a dispute with supporting evidence. Here's how:

1. Respond within the deadline: contact your payment processor within the required timeframe, typically 10 to 30 days. Missing this window forfeits your right to dispute.
2. Gather your evidence: compile documentation that proves the transaction was legitimate. Strong evidence includes proof of delivery, signed contracts, customer communications, and transaction receipts.
3. Submit your response: send your evidence package to your payment processor, who forwards it to the issuing bank for review.
4. Await the decision: the issuing bank evaluates your evidence and decides whether to reverse or uphold the chargeback. Complex cases may be escalated to the card network for final ruling.

How to record chargebacks in your accounting

When a chargeback is finalised against you, record it properly in your accounts:

• Chargeback fees: record as operating expenses under bank fees or payment processing fees
• Lost revenue: write off the disputed amount as bad debt expense
• Reversed chargebacks: if you win a dispute, record the returned funds as recovered revenue

Track your chargebacks in a dedicated report or category so you can identify patterns and measure the true cost to your business. A bookkeeper or accountant can help you set up the right account codes.

Manage chargebacks confidently with Xero

Chargebacks are part of accepting card payments, but they don't have to derail your business. With clear processes and accurate records, you can minimise their impact and respond effectively when they occur.

Xero helps you stay on top of your finances by tracking chargeback fees, categorising expenses correctly, and giving you real-time visibility into your cash flow. When disputes happen, you'll have the records you need to respond quickly.

Get one month free and see how Xero simplifies your financial management. For help with complex chargeback situations, find a Xero advisor who can guide you through the process.

FAQs on chargebacks

Here are answers to common questions about chargebacks for small businesses.

How long do I have to respond to a chargeback?

Response windows vary by card network. Visa gives you 20 days, while Mastercard allows 45 days. Check your payment processor's notification for the exact deadline.

What's considered a high chargeback rate for small businesses?

Most payment processors flag accounts exceeding a 1% chargeback rate (chargebacks divided by total transactions). Staying below this threshold helps you avoid monitoring programmes and penalties.

Can I refuse to accept a chargeback?

No. Once a customer files a dispute with their bank, the chargeback process begins automatically. You can dispute it by submitting evidence, but you cannot refuse to participate.

Does a chargeback affect my business credit score?

Chargebacks don't directly impact your business credit score. However, high chargeback rates can damage your relationship with payment processors and may affect your ability to secure favourable processing terms.

What happens if I don't respond to a chargeback?

You automatically lose the dispute. The customer keeps the refunded amount, you forfeit the sale, and you may be charged additional non-response fees by your payment processor.