A chargeback is a reversal of a payment made on a credit or debit card, when the payment is suspected to be incorrect or fraudulent.
The chargeback process is there to protect the cardholder against being liable, when charges have been made on their credit or debit card illegitimately, or incorrectly. It’s also meant to encourage businesses to increase their quality of service.
How are chargebacks different from refunds?
Refunds are dealt with directly between the customer and the business. This is the ideal way of working, as it allows the business to right any wrongs, and to receive their goods back in return for the refund.
Chargebacks are made directly with the cardholder’s bank, reversing the transaction, and only giving the business the opportunity to dispute it after. Some customers incorrectly use a chargeback to avoid dealing with the business if they have a complaint.
When do chargebacks happen?
Chargebacks can be requested by a customer or the business, but in most instances the customer is the one asking for a chargeback. The customer’s bank may also initiate a chargeback if its systems identify fraud. The common reasons for chargebacks are fraud and errors (intentional or unintentional).
- Unauthorised transactions on card
- Customer intentionally claiming a legitimate purchase is fraud
- Business intentionally failing to deliver orders
- Incorrect charges to the customer
- Sending damaged or incorrect goods
- Failure to refund or solve a customer complaint
- Accidentally not recognising a transaction
- Intentionally avoiding the return process
Who is involved in a chargeback?
The chargeback process involves:
- the customer (the cardholder)
- the business (the merchant)
- the payment processor connected to the business (the acquirer)
- the customer’s bank or card issuer (the issuer)
What does a chargeback mean?
A chargeback means the reversal of a charge on the card. The basic process is as follows but can vary:
- The customer believes a charge on their card is invalid and contacts their bank to dispute it
- The issuing bank decides if the reason is valid and if they find in favour of the customer grants a chargeback; if they decide it’s not valid no further action is taken
- The issuing bank gives the customer a provisional credit and contacts the merchant’s acquirer
- The merchant’s acquirer debits the merchant’s bank account and charges them a chargeback fee
- The merchant’s acquirer notifies the merchant and the merchant then decides whether to accept or dispute the chargeback; they must respond or they could be charged a non-response fee
How does a business dispute a chargeback?
After being notified by their acquirer the merchant can dispute a chargeback if they don’t feel it’s valid:
- The merchant contacts their acquirer within a set period (some countries state 30 days, for example)
- The merchant provides evidence that the chargeback has no grounds, such as showing documentation that the buyer received their purchase
- The issuing bank evaluates the evidence and decides whether to reverse or uphold the chargeback
How to handle chargebacks in accounting?
Chargeback fees are usually recorded as operating expenses (bank fees) and the chargebacks may end up written off as bad debt expenses if the business doesn't win the dispute or decides not to challenge the chargeback. A bookkeeper or accountant can advise a business on where to record the transactions and fees for their particular accounting setup.
Why do chargebacks matter?
If you’re a business owner, monitoring chargebacks and recording them correctly will help increase customer satisfaction, and ensure you aren’t being taken advantage of, losing unnecessary funds, and potentially losing the ability to accept card payments.
Increase customer satisfaction: If you’re dealing with a lot of chargebacks, the problem may be at your end. This is a good time to see how you might improve on your products, services, or refund and returns processes.
Avoid being taken advantage of: Investigating each chargeback is important to ensure you aren’t being scammed by a customer (purposely or accidentally) or missing out on revenue unfairly.
Avoid losing funds: On top of potentially losing money and your product, you’ll usually be hit with a chargeback fee, even if the chargeback is disputed and cancelled.
Avoid losing a payment processor: If you have too many chargebacks occurring, the acquiring bank that processes your payments may not want to work with you any longer.
The key to avoiding chargebacks is to follow payment card guidelines, be compliant with payment card industry (PCI) security standards, and keep track of your chargebacks correctly.
See related terms
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.