Internal Controls for Credit Card Transactions

Learning Outcomes

  • Describe the internal control processes related to credit card purchases and sales

A credit card.It is a common practice for business organizations to issue credit cards to employees in order to facilitate the purchase of goods and to document travel and entertainment expenses. Along with all other business transactions, there should be a thorough accounting and proper tracking of all credit card reimbursements and payments. This thorough accounting requires an adequate internal control system to facilitate payments that are properly authorized, valid, and appropriately business related.

Here are three key internal controls for credit card use that you may want to consider putting in place in your business:

  1. A formal credit card policy. A written credit card policy serves as the foundation of a good credit (or debit) card expense control system. This policy document should establish guidelines regarding the reimbursement of expenses for auto and air travel, lodging, meals, entertainment, and the procurement of goods. All cardholders should review these policies, sign off on them, and agree to abide by its rules. The policy should clearly state the types of allowable purchases and the procedures for documenting the business purpose for each respective expense. It is important to enforce this policy for all card users, regardless of their level in the company’s hierarchy. Allowing top-level employees to bypass these policies can create an atmosphere in which others may do the same. It is also important to spell out the consequences of inappropriate credit card usage.
  2. Substantiation. Original receipts must be submitted for all credit card charges, as these receipts substantiate the purchases made with the card. The business purpose should be documented on the receipt to ensure the charge was a legitimate business expense. The receipt also ensures proper GL coding of the expense. Expense reports and credit card receipts should be submitted for processing in a timely manner to allow proper review and reconciliation of expensed items.
  3. Regular statement reviews. A supervisor who is knowledgeable about the nuances of the business (ideally not a credit card holder) should open and review all credit card statements and supporting receipts to verify the propriety of the charges. The reviewer should be thorough and detailed and have a skeptical mindset. Reviewers should also be comfortable and willing to enforce the internal control policy regarding receipts and coding of expenditures. Employees should not be allowed to verify the authenticity of their own charges.

A few additional controls to consider:

  • Set monthly and overall credit limits for all employees who are issued credit cards.
  • Perform initial and annual credit checks on all employees who are issued a credit card.
  • Disallow cash advances.
  • Set up monitoring rights with the credit card issuer to allow online review and notification of any unusual activity.
  • Compare expense amounts to prior periods and to budgeted amounts.
  • Charging personal items to the business constitutes credit card abuse. With the proper internal controls, you can ensure credit card payments and reimbursements are made for legitimate business purposes and reduce the risk of fraudulent activity.

Accepting credit cards from customers presents a different set of internal control issues—the primary one being chargebacks from stolen or over-limit cards, but there are also ways to mitigate non-fraudulent chargebacks.

Fraudulent Chargebacks

A chargeback is a transaction reversal. The credit card processor withdraws the disputed transaction amount from the merchant’s bank account. The merchant may be given a chance to dispute the chargeback and may win. But if they lose, and they’ve already shipped or delivered what was purchased, they lose not only the sale but also their cost of goods for the item they shipped, their shipping costs, and any other costs associated with the transaction. To top it all off, merchant account providers also charge merchants a chargeback fee for each disputed transaction.

There’s no surefire way to prevent chargebacks. But there are things you can do to minimize them. If you are dealing with customers in person, you may be able to spot fake credit cards by looking over the card carefully. Among the parts of the card to check at are the appearance of the card, the numbers on the card, the magnetic stripe, and the hologram. A customer that seems evasive or fidgety could be a reason for concern as well.

For online sales, you don’t have those visual clues, but there are still steps you can take to reduce the occurrence of fraud.

  • Use address verification (AVS) and card code verification (CCV) for all card-not-present sales (e.g., online and mail-order sales).
  • Be on the lookout for “red flags, such as:
    • Unusually large orders placed through the Internet without any contact from the customer.
    • Rush orders for large quantities or high-priced goods.
    • Orders on U.S. cards shipped to foreign countries.
    • Billing addresses that don’t match the information on file with the credit card company.
Someone inputting credit card into a laptop.

Stolen and fake credit cards aren’t the only cause of chargebacks. Sometimes the cardholder who purchased the item is the perpetrator of the fraud. For instance, some customers may request a chargeback out of buyer’s remorse. Another common trigger is family fraud, which occurs when a friend or relative of the cardholder authorizes a purchase without the cardholder’s knowledge. Merchant errors can also be the cause of chargebacks, as can the simple mistake of having an unrecognizable name on the customer statement. For instance, if Nick Frank used with his credit card processor, customers may not recognize that the charge is legitimate.

Non-Fraudulent Chargebacks

Below is a list of common non-fraudulent reasons for chargebacks and some suggestions on how to reduce the incidence of these costly and time-consuming issues.

Quality Issues

Customer complaint: The quality of the product or service was not what was promised.

Your company’s prevention plan could include the following:

  • Accurately describe in detail the goods or services offered in order to reduce any potential for confusion or misunderstanding.
  • Obtain your customer’s signature after goods and services are rendered or delivered, acknowledging that the services or goods have been rendered or delivered as described.
  • Be available for your customer should they have any questions or concerns regarding the goods or services.
  • Adequate documentation supporting the above.

Delivery Issues

Customer complaint: Products were not delivered and/or services were not rendered.

Your company’s prevention plan could include:

  • Clear expectations regarding the estimated schedule for services to be rendered or for product delivery.
  • Clear communication over the course of the transaction to inform your customer of any potential delays or updated delivery or service dates.
  • A reminder on your Thank You page telling the purchaser to save their receipt and use it to reconcile their credit card statement.
  • An email to the customer that includes a copy of the receipt, what was purchased, the expected shipping time, and the name of your company.
  • Use a reliable carrier and provide your customer with tracking information, including the carrier, expected delivery date, and tracking number for all goods requiring shipping and handling.
  • Required signature from your customer to acknowledge when a delivery is complete or services are rendered.
  • Adequate documentation (e.g., signed pickup form, delivery confirmation, work order, etc.) or photographic evidence (e.g., services being rendered, installment completions, etc.) illustrating that the cardholder received goods or services. (The same goes for e-commerce transactions: documentation or proof that the digital product or service was provided, such as the date and time goods/services were downloaded.)

Cancelled Orders

Customer complaint: Cancelled order of goods or services.

Your company’s prevention plan could include:

  • Clearly stated refund, return, and cancellation policy on all transaction documents near the cardholder signature area (e.g., signed contract, bill of sale, etc.) and prominently displayed on the company website as well.
  • Quick and courteous responses to customer inquiries and concerns.
  • A good quality monitoring and control system.

Chargebacks directly reduce profit and incur indirect costs, such as additional labor, shipping, and other costs. Minimizing both fraudulent and non-fraudulent chargebacks increases both the immediate financial bottom line and, in the long-term, establishes the reputation of the company as a high-quality, reliable, customer-centric firm, increasing the overall value of the company. Recommending and establishing these kinds of procedures is a valuable service the accounting staff and consultants can provide.

Practice Question