Businesses run on money, and invoices are crucial for maintaining their flow. But what happens when customers delay payments due to requests for returns, exchanges, invoice errors, or ungranted discounts? Have you ever faced these challenges, where small discrepancies threaten to disrupt your financial performance and the accuracy of your financial statements? Fortunately, these issues don’t have to derail your operations.
A credit memo or note can resolve discrepancies like returned goods, invoicing errors, etc., ensuring your books remain accurate and your customer relationships stay strong. It acts like a voucher indicating that the business owes money to the customer and credits the customers’ account.
Want to learn more about how a credit memo works and its accounting treatment? Read on to discover the details.
A credit memo is a document issued by a seller to a buyer to reduce the amount owed on an invoice. The credit memo meaning involves adjusting the buyer’s account balance in cases of product returns, overpayments, etc, lowering and reflecting the outstanding balance in the financial records.
Credit memos are widely used in B2B transactions and are crucial to accounting and customer service. They notify the customer that the business has reduced the amount owed and provided a corresponding benefit.
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A credit memo is different from a debit memo. A debit memo increases the amount a customer owes due to additional charges or underpayment. In contrast, a credit memo reduces the amount owed by a customer due to overpayment or returned goods.
Additionally, a debit memo increases a customer’s financial obligations, whereas a credit memo decreases the amount owed due to invoice inaccuracies or returned goods. A business issues a debit memo for additional charges, underpayments, or billing corrections. In contrast, a credit memo is issued in cases of returns, overcharges, discounts, or rebates.
A credit memo is issued to rectify or adjust a customer invoice. A business issues a credit memo when a customer returns the goods because it does not meet expectations, damaged goods being delivered, inaccuracies were found in the invoice, instances of overcharging of the goods, and so on.
Credit memo allows you to change or remove the invoice amount from your financial statements without deleting the invoice altogether in case of errors or billing adjustments. According to accounting principles, you cannot remove invoices from your financial records, and each amount relating to accounts receivable has to be accounted for.
Credit memos make it easy to reflect the changes in the outstanding amount in an accurate way without impacting the invoicing processing or the financial statements.
Here are some of the benefits of issuing credit memos.
A credit memo includes critical information like purchase order (PO) number, terms of payment, billing, shipping address, a list of goods, number of items, prices, quantities, and the date of purchases. This information helps businesses keep track of inventory and transactions.
A credit memo format will include the following elements.
Say a company named TechSolutions Inc. issues Credit Memo CM-2024-001 dated August 15, 2024, to XYZ Enterprises. The memo corrects an invoiced amount of $1,200 to $1,000 due to a billing error, resulting in a $200 credit. The adjustment is reflected in the Sales Returns,Allowances, and Accounts Receivable accounts. Here’s what the credit memo format will look like.
Follow these steps to create a credit memo.
Here are some practical methods you can adopt to track credit memos efficiently:
If a customer has paid the full amount to the business, they can do two things to settle discrepancies in their invoices. First, they can ask to create a credit memo and use it to settle payments for future purchases. Or, they can ask for a cash payment for the amount owed by the business.
However, if a customer hasn’t paid the business anything, they can only use the credit memo to offset the invoice partially. They will still have to pay the amount owed after it has been reduced from their invoices.
Now, to record a credit note, a customer will reduce the credit memo amount from the accounts payable in their financial books. On the other hand, the business or the seller will record the memo as a reduction in the receivable accounts (to reduce the expected cash inflow).
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Both the business/seller and the customer will record the credit memo journal entry in their financial books. The business or the seller will record the credit note as a reduction in the accounts receivable balance, while the customer will reduce the amount from its accounts payable balance. In addition, the larger credit memos will be issued only after the supervisor has approved them since these credits will reduce the cash inflow from the expected revenues.
In the books of seller
Date
Accounts Title
Debit
Credit
Sales return and allowances a/c
To accounts receivable a/c
This entry reflects the reduction in your receivables and your sales revenue. To record the inventory added back, the journal entry will be:
In the books of the seller
Date
Accounts Title
Debit
Credit
To the cost of goods sold a/c
In the books of buyer, the accounting treatment would look like:
In the books of the buyer
Date
Accounts Title
Debit
Credit
Accounts payable a/c
To purchase return and allowances a/c
A well-drafted credit memo example would include sections for:
A well-formatted credit memo can be represented like the one below:
The credit memo above indicates that XYZ Company issued a credit memo to ABC Company on 1st January 2023, crediting $50 due to an issue with ‘Widget A,’ as per the original invoice number INV-2022-034.
Managing credit memos is critical to maintaining accurate financial records and healthy customer relationships. Here are some best practices to consider to avoid credit memo errors.
To ensure accurate and efficient managing, tracking, and issuing of credit memos, the best way is to automate the process. While various sales invoice and tally software give you innumerable templates to choose credit memo format, a robust credit cloud like HighRadius will help the associated yet critical tasks like matching with invoices, aggregating data, monitoring customer behavior, etc.
HighRadius offers powerful, cloud-based Order to Cash software to automate and streamline financial operations. This comprehensive suite includes Collections Management, Cash Application, Deductions Management, Electronic Invoicing, Credit Cloud, and dotOne Analytics to enhance your team’s efficiency and optimize its workflows.
A company issues a credit memo to reduce a customer’s outstanding debt. This document corrects invoice errors, addresses returned goods, applies discounts, and rectifies overcharges. Additionally, customers can use a credit memo to offset future purchases.
For instance, if a buyer orders 100 units of goods, you issue an invoice for $1200 against the sale. However, the correct price should have been $1000 after the discount, but the invoice doesn’t reflect it. You can now issue a credit memo to adjust $200 and ensure your buyer isn’t overcharged.
Yes, a credit memo is a legal document that ensures accuracy in the financial statements. They are similar to sales invoices, record any invoice adjustments, and reflect the correct amount in the accounts. This formal document indicates that the seller will return the excess amount charged to the customer.
The seller issues a credit memo to the buyer to provide a credit or refund for returned goods, overpayments, or other billing discrepancies. It is issued after the seller has sent the invoice to customers to reduce the amount owed by the customer to the seller and can be used to settle the future.
A seller can only reverse a credit memo if done within the respective accounting period. Once the accounting period has ended and the seller has transferred the credit memo to the accounting department in the ERP or accounting system, it cannot be reversed, deleted, reposted, or altered.
Refund refers to remitting money back to customers in cash when customers return goods or are overcharged. However, with the credit memo, the seller doesn’t pay the customer. Instead, they rectify the invoice by reducing the amount or using the existing balance to offset future purchases.
