When a company sells its products and services, it recognizes any proceeds as revenues. In the case of credit transactions, the transaction value will be the agreed or perceived value of the products. For companies, revenues represent the primary income source from operations. However, these revenues do not ascertain that a company will receive its proceeds.
In many cases, companies offer customers additional protection. This protection comes in the form of sales returns or allowances policies. However, these policies may not give a customer full protection. The company still has the right to deny them. In these cases, customers may not have other options but to initiate a chargeback transaction.
What is a Chargebacks?
A chargeback is a charge for refunds from a payment cardholder. Usually, the process for chargebacks is lengthy. It begins with a customer buying a product or getting a service. However, they may not receive the product they expected or wanted. Therefore, they will contact the company that sold them the underlying product or service.
Most companies usually return the customer’s payment and receive their product back in exchange. In some circumstances, the company may persist that it is not at fault in the transaction. The company may have a valid reason for these claims. However, customers can still get their money back by contacting their payment card company.
Customers can dispute a transaction with a payment card company to receive their money back. However, their card company will first investigate the transaction to ensure there is no foul play involved. There is no difference between credit or debit cards in these transactions. For debit cards, however, the underlying bank account will also get the chargebacks.
In some cases, the customers may not be successful. If the card company investigates the matter and finds the customer at fault, they will not dispute the transaction. Therefore, the seller will not receive a chargeback on their account. There are several reasons why customers may not get approval for a chargeback. Usually, the card company inquires both parties involved and asks for evidence from both before deciding.
Overall, a chargeback transaction involves the return of any payments made through payment cards. This payment gets credited to the customer’s account. However, it also means the seller receives a negative charge on their bank. Several regulations govern the chargeback reversals process. Payment card companies ensure they protect both buyers and sellers. However, buyers get an advantage most of the time.
What is the Accounting for Chargebacks?
Accounting for chargeback transactions is a long and complicated process. However, this process can become simpler by explaining the basic principles behind chargebacks accounting. For most companies, this process involves receiving a dispute through a bank account. Usually, companies cannot predict how many disputes or chargebacks they will get on their accounts.
Chargeback transactions, in essence, represent a reduction in a company’s revenues. For the receiver, they are a reduction in expenses. Usually, when a buyer opens a dispute, there are several processes that the card company must complete. As mentioned, this involves investigating both parties and their claims for the transaction. On top of that, it is unsure whether the dispute will be successful or not.
For the buyer, the chargeback transaction will give rise to an asset. However, the certainty involved in receiving a chargeback may be low. Under accounting principles, they cannot record this value unless there is virtually certain about it. Therefore, they must wait until there is reasonable evidence to allow them to record an asset. Usually, it is when they receive the amount on their account.
For the seller, however, chargebacks may give rise to a provision or contingent liability. The seller may have to record the transaction if they see a probable future outflow of economic benefits. This requirement comes under the criteria for recognizing provisions from IAS 37. However, if the seller perceives a possible or lower chance of the return, they can ignore its recording. Instead, they must make the relevant disclosures.
On top of the chargeback amount, this process also involves other costs. Usually, these costs come in the form of chargeback expenses that the bank charges. For the buyer, it also involves additional costs, such as shipping expenses of the original transaction. Therefore, the process of accounting for chargebacks can be complex.
What are the Journal Entries for Chargebacks?
There are two aspects of recording chargeback transactions in accounting. The first involves the buyer who buys a product and initiates the chargeback transaction. The second is for the seller who sells the product and receives a dispute from the customer. The accounting for chargeback transactions for both these parties will differ.
For buyer
For buyers, the accounting for chargeback transaction initiates from the dispute. When a buyer contacts their card company, they will receive a confirmation about whether the company will allow it. Usually, buyers have a window of 120 days to do so. Once the card company creates a dispute, the buyer can expect future inflows of economic benefits.
However, buyers cannot record an asset unless they are virtually certain about the chargeback transaction succeeding. In most circumstances, this assurance does not come until after the transaction gets completed. Therefore, buyers can only record a chargeback transaction when it goes through in their account. The journal entries for chargeback transactions for the buyer will be as follows.
| Account | Debit | Credit |
| Bank / Credit card | XXXX | |
| Expense | XXXX |
The buyer may also need to account for any relevant chargeback expense on their account. For example, if the payment company charges a chargeback expense on the account, the journal entries will be as below.
| Account | Debit | Credit |
| Chargeback expense | XXXX | |
| Bank / Credit card | XXXX |
For seller
For sellers, the chargeback transaction process is more complex. For most sellers, it is impossible to predict how many of these transactions they will get. However, when they get a dispute, they may need to create a provision. Usually, companies must ensure the chargeback transaction succeeding is probable to do so. If it is not, then they must disclose them using the relevant disclosures in the financial statements.
In practice, however, companies do not create a provision for every transaction. Usually, companies estimate how much expense they will bear due to these transactions based on historical data. Once they do so, they will create a provision based on a percentage. If there is an existing balance in the account, companies will only record the difference from one period to another.
The journal entries to create provisions for companies will be as follows.
| Account | Debit | Credit |
| Chargeback expenses | XXXX | |
| Provision for chargeback expenses | XXXX |
Similarly, the chargeback transaction will affect a company’s revenues. However, it is not similar to sales returns or allowances. Companies do not treat chargeback transactions as a contra revenue account. Instead, they account for it as a reversal of revenues. The journal entries to record chargeback transaction for the seller is as follows.
| Account | Debit | Credit |
| Revenues | XXXX | |
| Bank | XXXX |
Similarly, the seller may also incur some bank charges related to these. The accounting treatment for these costs will be the same as for the buyer.
Example
A company, ABC Co., sells highly fragile products. During an accounting period, the company sold products worth $100,000 through its online platform. ABC Co. receives orders directly to its bank account through this platform. Customers pay for these transactions using their credit cards. ABC Co. recorded these transactions using the following journal entries.
| Account | Debit | Credit |
| Bank | $100,000 | |
| Revenues | $100,000 |
Of these, some customers found the goods to be damaged or broken. ABC Co. believes the issue arose after it delivered to goods. However, the customers claim otherwise. Either way, ABC Co. suffered $20,000 worth of chargeback transactions, confirmed through its bank statement. Therefore, the company recorded this amount as follows.
| Account | Debit | Credit |
| Revenues | $20,000 | |
| Bank | $20,000 |
Overall, the total revenues reported through the online platform in ABC Co.’s financial statements were $80,000. This amount was the residual value after deducting the chargeback transactions from ABC Co.’s online revenues.
Conclusion
Chargeback transactions are the reversal of a company’s revenues in its bank account. Usually, these transactions occur when customers create a dispute. Once these transactions succeed, they can formulate a reversal of revenues in the accounting records. The accounting for chargeback transactions differs from seller to buyer, as mentioned above.
