Chargebacks are costly. Simply put, chargeback fees, issuer penalties, and lost sales hurt your bottom line. Without a defense strategy, chargebacks pose a direct threat to earned revenues.
But chargebacks also create hidden expenses, particularly in accounting. Think of your Shopify finances, which must balance profit and loss statements each day. That task becomes far more complex when numerous customers dispute each transaction. Constant sales reversals disrupt your cash flow, confuse record-keeping, and introduce data discrepancies. Those problems are partly why for every $100 in chargebacks, your true chargeback cost is $240.
To limit such hidden accounting expenses, you need to reconcile each chargeback. Let's explore chargeback accounting and how you can accurately track, investigate, and manage disputes.
The Accounting Challenges of Chargebacks:
A single chargeback causes a series of challenges for you or your accounting team:
- Fluctuations in revenue recognition: In bookkeeping terms, chargebacks represent a reversal of previously recognized revenue. Those losses impact your top-line income statements across multiple reporting periods. That makes settlement confusing. It also skews your gross profit numbers because you lose the revenue while the cost of the product sold may no longer be recoverable. Profit margins shrink, which confuses the future outlook of your business.
- Cash flow impact: Chargebacks include a time delay. It can take up to 120 days to resolve a single dispute. During that time, the revenue from the sale debits from your account. That removes liquidity from your finance department. What should be accessible money turns into a cash outflow. As a result, resource allocation becomes far more complex. Some large enterprises even hold vast cash reserves for potential future chargeback losses.
- Administrative effort: A chargeback demands additional labor for you or your accounting teams. Someone has to track the status of each dispute. And someone must readjust all previous accounting entries for the reversed transaction. Even a valid chargeback creates a second return transaction that requires more paperwork. Yes, maintaining financial integrity is crucial for compliance. But it certainly also extends your administrative burden.
- Strategic planning: Chargebacks introduce additional penalties and fees that limit your financial flexibility. For example, your budgets must now include secondary ledgers that forecast chargeback-related losses. Or a sudden increase in disputes can distort performance evaluations and chargeback ratios. Surprise losses from unexpected chargeback volume hinder strategic initiatives.
Steps to Reconciling Chargebacks in Accounting:
Luckily, you can manage the challenges of chargeback accounting via reconciliation. Standard reconciliation refers to the “balancing of your books,” where you cross-reference two or more accounts or ledgers. If the two sets of numbers align, your finances are likely correct.
Likewise, the goal of chargeback reconciliation is to adjust your accounting statements to fully reflect the financial impact of a chargeback. A business that does not include the cost of chargebacks will simply have incorrect profit statements. To address that problem, you account for each dispute and its outcome in your Shopify store and bank accounts. The practice is essential to maintain the accuracy of your financial position.
Chargeback reconciliation follows a general four-step process:
- Identify: First, you will receive a chargeback notification from your processor or bank. That alert will include identification data, such as the payment date, reason code, and dollar amount. Match the notification data to the correct transaction in your records.
- Classify: Next, determine the validity of the chargeback and define the reason (fraud, merchant error, etc). That will inform whether you can fight and win the dispute. It will also determine the type of evidence you must gather.
- Record: Third, create an entry in your chargeback ledger. Note that the funds will debit from your chargeback expense account and change revenue statements (some banks do this automatically). In addition, track and record the chargeback fee and any additional penalties (some banks will lump the dispute amount and fees together).
- Adjust and recover: Once the dispute resolves, record the outcome. Final judgment data will help determine future defense strategies. In addition, update your finances to reflect the resolution. If you lost the dispute, debit the sales/revenue account and note the loss in your chargeback expense account.
How To Incorporate Chargebacks in Financial Reports:
Every merchant’s financial records are unique and demand a custom reconciliation process. Still, it is a good idea to update the following financial reports for each dispute.
- Expense recognition: Chargeback fees from valid disputes are an operational expense. Allocate those losses in the correct expense category of your income statement. If need be, add the cost of goods sold as a separate expense category to fully reflect the lost product value. For chargebacks proven as invalid, log those in your Account Receivable.
- Revenue recognition: Create additional revenue categories in your profit and loss statement, such as total revenue and revenue adjusted by chargebacks. Adjusted revenue helps distinguish between your gross sales and the “realistic” revenue numbers impacted by surprise chargeback losses.
- Cash flow recognition: Record all outflows of cash related to a chargeback. List those outflows under operating activities and ensure they reconcile with your chargeback expense account.
- Disclosure: Note in your quarterly or yearly statements the impact of chargebacks. Include information such as the percentage of chargebacks to sales and the total chargeback volume in a reporting period. You can add that data in the analysis section of your reports or the footnotes or related documents.
Mitigating the Accounting Complexities of Chargebacks:
While it is a complex task, there are several ways to relieve the administrative burden of chargeback reconciliation. Use the following tips and tools to streamline your accounting:
- Standardize reconciliation actions: Invest in standard chargeback procedures. Consistent response templates make accounting workflows efficient. For example, you could create reason code label systems. Those labels make it far easier to take appropriate reconciliation actions. Any chargeback defined as “uncollectible” automatically saves for tax seasons since it can be written off. And any chargeback you decline to fight is labeled as bad debt and reconciled as an expense (not a refund). Standard responses simplify your reconciliation tasks.
- Use automated accounting software: Finance tools can relieve the majority of your manual accounting labor. For example, you can let the automated service do the heavy lifting and match all chargeback data to collected transaction data. Or use it to filter orders for easy account adjustments. Look for solutions designed specifically for Shopify, such as Reconcile.ly.
- Schedule audits: Conduct periodic audits of your chargeback accounting. Regular analysis of your financial data can help catch problems before they become hard to find in past quarters.
- Use chargeback recovery software: The primary purpose of a recovery tool is to recover lost revenue. However, such solutions often include extra services that apply to your chargeback accounting. For example, Chargeflow has services that can monitor chargeback disputes as they resolve, automate data matching, or assign accounting tasks.
Chargeback accounting can be complex. Luckily, there are available solutions that make reconciliation far simpler. With a little tracking support and know-how, you can maintain the financial integrity of your Shopify store with limited hassle. In turn, you will recover lost revenues, gain a reputation as an honest merchant, and earn higher levels of customer satisfaction.
Written by Ariel Chen, CEO and Co-Founder at Chargeflow.io