A credit note is a form of documentation issued by a seller to inform a buyer that a credit will be applied to their account. Since the goal of a business is to make money, not give it away, companies may typically try to avoid issuing a credit note if they can. However, even with using top notch accounting software and adhering to traditional accounting practices, accidents happen and credit notes are often necessary.
According to CNBC, the average American spends approximately $164.55 every day.1 With people spending some much money on a daily basis, mistakes are bound to happen and consumers are likely to change their minds on at least some of the purchases they make.
What Is a Credit Note, or Credit Memo?
A credit note, also referred to as a credit memo or credit memorandum, is a legal document provided by a seller of goods or services to a buyer. The credit note will show a monetary amount that the seller owes a buyer. A credit memo is typically used with standard purchases or transactions, which means you probably would never receive a credit memo for a personal loan, installment loans, or other online loans.
Credit memos are necessary when a seller needs to provide a buyer with funding due to an incorrect invoice payment, or because the buyer is receiving a refund. According to a survey by the National Retail Federation and Appriss Retail, the average rate of returns for online purchases is 20.8%.2
Some situations that may require credit memos are if a seller identifies a discrepancy or error in an existing invoice, or if a buyer makes a purchase they want to return. In both of these cases, the credit memo would be used to indicate the amount that was overpaid by the buyer, and is therefore due to be returned to them by the seller. The seller would then typically repay the buyer by issuing a check, or using direct deposit.
A Breakdown of Credit Notes
|Typically have a validity period, after which they cannot be used or claimed.
|May or may not be transferable to other parties, depending on the issuer’s policy.
|Some allow partial use, meaning they can be used over multiple transactions.
|Combination with Offers
|Policies vary on whether a credit note can be combined with other offers or discounts.
|Issuers may have specific policies on canceling or altering a credit note once issued.
|Additional documentation (e.g., proof of purchase) might be required to issue or redeem a credit note.
|Refund vs. Credit
|Some businesses might offer a choice between a direct refund or a credit note for returns.
|Digital vs. Physical
|Can be issued in digital format (email, account credit) or as physical documents.
|Certain issuers provide reminders or notifications as the expiration date of a credit note approaches.
|There may be restrictions on what items or services a credit note can be applied to.
Disclaimers: Please note that the information provided in the above chart regarding a credit note is for general informational purposes only and may vary depending on the specific policies of individual businesses or issuers. It is advisable to consult directly with the issuing entity for detailed and accurate information regarding their specific credit note terms and conditions.
Credit Note Process
How does a credit note, or credit memo work? Let’s take a look at an example. Say a company sold 10 products at $20 a piece, and upon receiving the products the buyer noticed a defect with two of them. In this case, the buyer would probably return the two defective products, and the seller would issue a credit note with a corresponding credit note number to the customer account. In this case, the credit note would be for $40, since the two products were each $20. Although they are two distinct documents, credit notes may still play a role in the invoicing process.
From this point, how the buyer would receive reimbursement depends on whether they have already paid for all 10 of the products they originally ordered. If the buyer had yet to send payment, the amount on the credit note would probably just be deducted from their accounts receivable, lowering their due payment until the two defective products were replaced and reshipped. If the buyer had already submitted a cash payment and paid for all 10 products in full, the seller would have then issued a credit note and a cash refund.
Legalities of Credit Notes
There are some legalities to be aware of when sending credit notes. Just like an invoice, a credit note is considered a legal document and must be adhered to. If the seller failed to refund the amount that was issued on a credit note, the buyer would have the right to press legal charges.
Tax Implications of Credit Notes
If a seller fails to repay the amount issued on a credit note from a previously issued invoice and the amount is deemed “bad debt,” the seller may be responsible for claiming the amount they failed to repay as income on their taxes. According to the IRS, if a debt is canceled, forgiven, or discharged for an amount that is less than what the debtor owes, funds from that debt may be considered taxable.3
Credit Note vs. Debit Note
The purpose of debit notes is to notify a buyer that they have a debt to repay. If a buyer makes a purchase and receives an invoice, but fails to pay, the seller may send an additional debit note to remind them they have a payment to make. This is different from a credit note which represents funds that a seller must send to a buyer.
Credit Note vs. Original Invoice
An initial invoice is a summary of an order put in by a buyer, issued by a seller. Invoices will display items or services purchased by the buyer, along with the cost, shipping, and other expense details associated with that particular purchase. An invoice represents purchases made, while a credit note represents a refund or credit that may result from an error or other issue with an invoice.
Credit Notes vs. Vouchers
A voucher, similar to a coupon, represents a discount (which may reach up to 100%), for a good or service. While a company may give buyers a voucher if they received defective products or services that don’t meet previously promised standards, they are not the same as a credit note.
Evolution of Credit Notes
When companies first started issuing credit notes they were physical documents sent to buyers. Now with evolving technology, businesses can send credit memos online, and can make payments within just a few days or less. This technology makes credit notes much more accessible for not only businesses working within the same country, but companies doing international business as well.
Credit Note: FAQ
Generally, a credit note is issued in response to an original invoice. It serves to rectify or adjust the amounts on that invoice. In rare cases where a transaction occurred without an official invoice, issuing a credit note might be more complex and could require additional documentation to validate the adjustment.
Most modern accounting software seamlessly integrates credit memos into the financial records. These systems typically allow you to link a credit note to the corresponding invoice, automatically adjusting the accounts receivable and financial statements to reflect the corrected transaction values.
While credit memos are issued to signify a credit to the buyer due to overpayment or returns, debit notes are used when the buyer owes additional payment to the seller. Debit notes are often issued in cases of underbilling or when additional charges arise post the initial transaction.
Upon receiving a credit note, you should update your own accounting records to reflect the credit. If you use accounting software, enter the credit note to adjust the balance owed. If the credit note is for a returned item or overpayment, expect either a reduction in your outstanding balance or a direct refund, depending on the seller’s policies.
Ignoring a credit note can lead to discrepancies in your financial records. It’s important to reconcile credit memos with your accounts to ensure accurate financial reporting. Failure to do so can result in accounting errors, affecting your financial statements and potentially leading to issues during audits or tax assessments.
Bottom Line on Credit Notes
Credit notes are a way of holding businesses accountable for correcting mistakes and issuing refunds when necessary. If you are a buyer and notice a mistake with an invoice, need to return products you purchased, or want a refund for services you may have failed to receive, you are most likely in your right to contact the seller and ask for a credit note to rectify the situation.