Sometimes referred to as a credit memo, a credit note is an accounting document that identifies a positive balance adjustment or credit that has been applied to the recipient’s account. These legally binding records are typically issued to a buyer to counteract a problem with the purchase of a good or service — such as an invoice error or damaged shipment.
In this article, we’ll explore credit notes in more detail, particularly how, when, and why to use them.
Credit note meaning in accounting and how it works
In particular, credit notes help simplify your accounts receivable (A/R) efforts by allowing you to update the payment details surrounding an invoice without requiring you to alter the existing record or issue a new document. Instead, you simply need to update your accounting systems with the note details while sending a copy of the file to the relevant customer so that they might also update their financials. Each note should align with an already-issued invoice, indicating a negative balance that aligns with the issued credit.
To record this amendment, if you’re using a traditional — or single-entry — bookkeeping strategy, you will enter the sum of the credit note as a credit to the buyer in your sales journal. Conversely, suppose you’re using a double-entry bookkeeping method. In that case, you’d want to enter the credit note as a debit on the revenues line of your ledger and as a credit under accounts receivable.
Just as you might send a credit note to your customers, you may also receive one from a supplier or vendor. In that case, you’d want to note the value of the note as a debit in the appropriate supplier account within your accounts payable (A/P) record and as a credit in your purchase return account.
When to issue a credit note
While these records are typically created when a problem arises regarding a given invoice, they only apply when that challenge requires some form of compensation for the buyer. So, for example, when a customer wishes to increase their shipment size, you would not issue a credit note since the end result would be an increase in the debt the purchaser owes. Instead, you would cancel the existing invoice and send a new one with the updated totals.
It is also important to recognize that a credit note differs from a chargeback or refund. While these notes may serve as a precursor to or a replacement for a refund, they do not reflect an actual transfer of funds to the buyer. Instead, they document a bookkeeping adjustment to the purchaser’s account, which can be used to offset the price of future purchases.
You might issue or receive one of these credit notes for a variety of reasons, but they routinely are created in response to a:
- Cancellation
- Damaged shipment
- Invoice error
- Overpayment or duplicate payment
- Partial delivery
- Product or service decrease
- Refund request
- Return (full or partial)
What is the difference between a debit note and credit note?
Simply put, a debit note reflects the opposite side of the problematic sales conditions we just listed. These documents, also known as debit memos, are issued by the buyer to the seller and indicate that the customer expects to be issued a corresponding credit note. Debit notes will also indicate that certain supplies or goods are being returned. For service-based transactions, the customer may issue a debit note to indicate dissatisfaction with or the failure of the provided service.
What to include on a credit note
Given their close ties to your invoices, it shouldn’t be surprising that the details you want to include on a credit note are very similar to the details you should include on an invoice:
- Credit adjustment amount
- Credit note number (which should align with the corresponding invoice number)
- Customer information, including contact details
- Issue date
- Payment terms
- Reason for credit adjustment
- Sale details (e.g., quantities, pricing)
- Seller information, including contact details
- The phrase “Credit Note” or “Credit Memo” prominently displayed
How to create and record a credit note
Fortunately, the process for drafting credit notes is rather straightforward:
- Become aware of the problem: First, you’ll need to receive a debit note or another record indicating a problem with an already invoiced and delivered product or service.
- Draft and send the credit note: To create this record, you’ll want to clearly label it as a “credit note,” include any relevant details from the appropriate invoice and list the credited amount.
- Update your books: Credit the A/R line item in your general ledger and debit your revenues line.
- Dispense the credit: Either provide a refund to the customer (if requested) or discount the amount from the next invoice sent to the buyer.
- Resolve tax issues: Depending on your location, any issued credit notes may need to be adjusted or reported due to regional tax or accounting regulations — as always, check with local experts.
Credit note example
Eggsquisite Effigies creates ridiculously detailed and realistic sculptures of people from recovered egg shells and fig skins. Unfortunately, these artistic works are quite fragile and often lack the structural integrity to support themselves, making them prone to breaking under their own weight — at least on Earth. However, given their therapeutic properties for battling homesickness by offering three-dimensional, near-life-like renditions of loved ones, these pieces are frequently commissioned on behalf of astronauts for extended tours in manned space stations.
In late 2024, Eggsquisite Effigies was commissioned by Space BNB to produce 16 sculptures — two each for the 8 staff members rotating into their high-end, high-orbit bed and breakfast. Each sculpture was priced at $62,000, and the shipment was delivered on December 12 with an invoice indicating a $992,000 purchase. And while each sculpture was packed in a custom-designed foam frame for shipping, three pieces arrived damaged. Space BNB immediately returned the broken artwork and a debit note requesting a credit to their account for $186,000 — the cost of the ruined pieces. Upon receipt, Eggsquisite Effigies created a corresponding credit note indicating the same value.
After issuing this note, Eggsquisite Effigies entered a $186,000 debit on the revenues line of their ledger and a corresponding credit to their accounts receivable line item. Going forward, Space BNB will leverage this credit to their account, replacing the damaged sculptures and sending them up on the next launch in mid-2025.
Manage credits, debits, and all your A/R needs with Invoiced
Of course, the creation, tracking, and reporting of these legally binding documents can be greatly simplified by leveraging a comprehensive invoicing platform, like our Accounts Receivable Automation software. Our solution not only streamlines the drafting of invoices, but also lets you quickly and easily generate credit notes from these existing invoices, completing the entire process in just four steps. Even better, you can reduce your oversight burden and automate the application of open credit notes to any new invoices created for that specific customer — no extra labor required.
Our software also offers broad integration capabilities, making updating your backend accounting platforms a breeze while avoiding potential transcription errors. Navigating the complexities of varying, region-specific tax and accounting requirements is much easier than ever since we updated our software with Flywire’s global payment capabilities, empowering you to conduct business internationally in over 140 currencies.
So, if you’d like to make your A/R processes simpler — from credit notes to invoices to dunning — schedule a demo today.
