Definition
A credit memo is a written notification or a document that contains a notice sent by one of the parties in the settlement relationship (supplier) to the other party (buyer) about the credit entry to their account for a certain amount due to the fulfillment by the buyer of the special conditions provided for in the initial contract. In other words, a credit memo means a reduction by the supplier of the buyer’s debt.
There are two types of credit memos that one can come across:
- An adjustment credit memo. This type of note is used when you have an invoice that is not paid yet or only partially paid, and you need to change the amount owed by the customer. It is usually created when you want to provide a discount and need to reduce the price/amount owed. It is also created when an invoice has been written off.
- A refund credit memo. This type of credit memo can be created if the customer already paid for the goods or services, but you want to give the customer a portion or a whole amount back for various reasons, whether it is due to a claim made by the customer, an incorrect invoice, or any other reason. Depending on your policies, the money can be refunded or applied to the existing unpaid invoices to cover a portion or the whole amount still owed to you by the customer or have an option to use it for future invoices.
Usage Cases
There are several situations when a seller would need to issue a credit note:
- If a customer returned goods due to damage or not being according to buyers specifications
- Warranty claims
- Invoice amount correction
- Correction of discounts, if not applied
- Discount or other incentive given by seller to buyer (e.g. early payment discount)
- Purchase cancellation by the buyer.
Example
Flower Shop purchased fresh flowers from its supplier for $8,000. At the time of delivery, Flower Shop found that $2,000 worth of flowers were broken and damaged in other ways, so it notified the supplier at the time of the delivery.
In this case, the supplier will issue a credit memo on the name of the Flower Shop company by stating the quantity and value of damaged flowers. After receiving this note, as it is often referred to, the Flower Shop will have to pay only $6,000 to the supplier. The following journal entries will be made in the supplier’s books.
Accounts Receivable Flower Shop
Debit
$8,000
Sales Revenue
Credit
$8,000
To record the sale of flowers to the Flower Shop.
Sales Revenue
Debit
$2,000
Sales Returns
Credit
$2,000
To record issuance of a credit note for damaged goods to Flower Shop.
Cash
Debit
$8,000
Accounts Receivable Flower Shop
Credit
$8,000
To record the payment by the Flower Shop for goods sold on credit.