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Journal Entry for Chargeback: a Quick & Easy Guide

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Accepting card payments streamlines the process, making it easier for customers to purchase goods and services. However, problems may occur after the payment, leading the customer to dispute the charged amount. For instance, the customer can claim that they simply didn’t receive the goods purchased or the goods received did not meet their expectations. In that case, their bank may lodge the dispute and place a chargeback.

In this article, we’ll discuss the accounting treatment for chargebacks by sharing journal entry examples for the merchant to record on their books. We’ll show you two scenarios: 1) when the bank sides with the customer and 2) when the bank sides with the merchant.

Understanding Chargebacks and the Accounting Treatment

A chargeback for merchants is a reversal of a credit/debit card transaction, typically initiated by the customer’s bank due to a dispute, resulting in the merchant being required to refund the transaction amount at least on a temporary basis.

Customers may initiate a chargeback for several reasons. Here are a few:

  • If they receive a damaged or incorrect item, they may ask for their money back through a chargeback. 
  • If an item they ordered never arrives, they can initiate a chargeback.
  • Suppose a customer does not recognize a charge on their statement because the store name appears differently, or perhaps the card information was stolen and used for unauthorized purchases. In that case, they will likely dispute the charge. 

However, not all disputes can be approved. This means there’s always a chance that the bank will deny the dispute lodged by the customer and reverse the chargeback, giving the money back to the merchant.

From an accounting standpoint, the merchant should place the amount in a temporary “receivable” holding account when the customer initiates a chargeback. What happens to the balance after depends on the result of the dispute. If the bank sides with the merchant and denies the dispute, the merchant can simply reverse the journal, and all the balances will be returned to their original position as if nothing has happened. If the bank sides with the customer, the merchant must write off the “receivable” and record a bad debt expense, representing a loss.

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Journal Entry Example for Chargebacks

For example, Cameron bought a pair of shoes from Shoe Co. for $200 and paid for them with a credit card. Cameron claimed he didn’t receive the purchase and disputed the charge with the bank. Let’s review the journal entries that Shoe Co. (the merchant) would record for this transaction.

Recording the Chargeback

First, we need to record the chargeback in a temporary holding (receivable) account.

Here is the journal entry:

Journal Entry for Chargeback - Initial Journal Entry

Notes on the entry:

  • The $200 debit to the Chargeback account holds the disputed charge. The Chargeback account functions similarly to a receivable account because there is a chance the amount will be returned to the merchant later. As a result, it is an asset account. While we await a final decision from the bank, we will temporarily hold the amount in the account.
  • We credit $200 to Cash because the bank has answered the dispute from the customer and temporarily placed a hold on the amount, preventing the balance from being available to the merchant.
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If the Dispute is in Favor of the Customer

Assuming the bank has verified that the customer’s claim is true, they’ll credit the customer’s bank account, essentially putting the money back into the customer’s pocket. On the merchant’s part, we need to recognize the chargeback as a loss in the form of a bad debt. 

Here is the journal entry:

Journal Entry for Chargeback - Bad Debt Expense

Notes on the entry:

  • The $200 debit to Bad Debt Expense is the loss recognized on the books due to the bank approving the customer’s dispute. In other words, the merchant has incurred a loss, which will appear on the income statement.
  • The $200 credit to Chargeback is simply the reversal of the “receivable” balance recorded earlier. Since the bank has made a final decision, we credit the Chargeback to write it off our books, meaning the amount will not be returned to the merchant.
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If the Dispute is in Favor of the Merchant

If the bank favors the merchant, the amount will be returned to the merchant’s bank account, and the charge will push through on the customer’s end. In this case, we simply need to reverse our first entry because the bank sided with us.

Here is the journal entry:

Journal Entry for Chargeback - Reversal

Notes on the entry:

  • The $200 debit to Cash effectively reverses the amount we previously removed in the initial entry, meaning they are available again in the merchant’s bank account.
  • The $200 credit to Chargeback eliminates the “receivable” balance from our books and clears the temporary holding account.  
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Key Takeaways

  • A chargeback happens when a customer disputes a charge to the bank for purchases charged to their account by mistake or when the goods didn’t meet their expectations or failed to be delivered.
  • Transactions that are erroneous or fraudulent can also be the subject of dispute. However, the bank will have to review the claim before deciding on the dispute.
  • The journal entries for this type of transaction involve recording the amount to a “Chargeback” account, which functions similarly to a “receivable” account. The Chargeback account is an asset account that we use as a temporary holding ground for charge disputes.
  • If the bank approves the dispute and sides with the customer, we recognize the Chargeback as a bad debt expense. The journal entry includes a debit to Bad Debt Expense and credit to Chargeback.
  • If the bank denies the dispute and sides with the merchant, we reverse the initial journal entry by debiting Cash and crediting Chargeback.

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