Credit Note – Definition & How to Issue One

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credit-note-definition-how-to-issue-one
Tally Solutions | Updated on: March 28, 2022

Some companies do not often use credit notes. However, credit notes can play a vital role in invoicing. It is essential for a person who works with invoicing to know what a credit note is and how it works. Credit notes help maintain a proper audit trail in the books of accounts. They help you in situations when an invoice needs to be edited.

What is a credit note?

Invoices are an essential part of the sales process. Even when the invoicing process is computerized, there is the possibility of the invoice having an error. This may be a mistake in the quantity or the price or any other item. A credit note is helpful in such a situation. A credit note is a legal document used to cancel a previously issued invoice partially or in full. So, when you issue a credit note, you can delete the amount of the invoice from the financial records without having to delete the invoice itself. It is essential to use credit notes to cancel an invoice as deleting an invoice may be unlawful. This is because the original invoice is essential to maintain an audit trail.

When to issue a credit note?

Credit notes are issued when there is a need to modify an invoice. This happens when there has been an error in raising the invoice. It can also occur when the customer changes the order after the invoice has been made. So, a credit note is helpful in any situation where the invoice has to be modified or reissued. A credit note must be linked to the invoice that it is modifying or issued to be used in an invoice in the future. Under no circumstances should the invoice that the credit is modifying be deleted. This is the main reason why the use of a credit note is so important. A credit note is not a refund. It indicates that the buyer can use this amount for future purchases. It is only sellers who issue a credit note. Buyers issue debit notes.

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When to issue a credit note

Sometimes Errors Occur In Invoices

How do you issue credit memos?

Creating a credit note is simple when you use an intelligent accounting software such as TallyPrime. The credit note would usually have the amount that is being modified on the main invoice as the negative of the same amount. So, if you have an invoice for $234, the credit note to cancel that invoice would have the amount of -$234. If you have raised an invoice for $300 instead of $250, the credit note modifying the original invoice would have the value of -$50. So, the credit note value corrects the mistake that was made in the invoice total. The credit note should ideally follow the invoice numbering sequence so that the audit trail is clear and easy to follow in the order of events.

What information should a credit memo include?

The information that goes on a credit note is similar to that on an invoice. In some cases, it is even simpler than an invoice. The credit note should contain all the relevant information that is required for the accounting purposes of both the seller and the buyer. Some of the essential information on a credit note includes:

  • Date of credit note issue
  • Credit note number
  • Customer reference number
  • Payment terms and conditions
  • Contact details
  • Reason for issuing the credit note and reference to the invoice

The credit note should clearly state that it is a credit note in order to differentiate it from an invoice. If the original invoice factored in taxes, the same should be reversed in the credit note as well. The details of the products/services, quantities and price should be detailed in the credit note. It should clearly reference the invoice that it is modifying. The credit note may be paid as money to the buyer or used against future transactions. Most companies prefer that the buyer use the credit note for future purchases.

What is a credit memo in accounting (bookkeeping notes)?

Good accounting management software such as TallyPrime helps you properly account for a credit note. However, it is important to know how a credit note should be recorded in the books of accounts for both the buyer and the seller.

Buyer

Sometimes a credit memo is raised when the buyer returns goods. This means that the liability of the money that they owe the seller is reduced. So the amount on the credit note is a debit of the creditor’s account and a credit on the purchase returns account. If the buyer has not yet issued payment for the original invoice, the credit note reduces the liability. But, if the invoice has already been paid for, the buyer can either ask for a refund or use the credit note against future purchases. So, on the buyer’s side, you debit the creditor’s account to debit the decrease in liability and then credit the purchase return account to credit the decrease in expense towards the invoice.

Seller

When goods are returned to the seller, they are called sales returns. This results in a decrease in revenue against the values that were previously recorded as sales and a decrease in assets since the buyer will not be making the payment for the canceled goods. So, the credit note is recorded as a debit to the sales return account to decrease the revenue and as a credit to the debtor’s account to decrease the assets. At the end of every reporting period, the seller company should review their credit notes and check if they are still linked to any accounts receivables. This can reduce the amount of outstanding invoices and therefore the payments to suppliers.

The accounting system being used must be able to create and manage credit notes easily. This is because mistakes and returns do happen and have to be accounted for without deleting raised invoices. TallyPrime seamlessly manages credit notes and helps report and manage them accurately. If you use the inventory module as well, you can easily reflect sales returns on accounting and inventory reports through TallyPrime.

Credit Note on TallyPrime

Credit Note On TallyPrime

Knowing more about the credit memos from banks

Credit notes are not only used by companies that sell goods or services. They are also used by banks to indicate that you have an increase in your balance. A credit note or memo issued from your banker will be shown on the bank’s account statements. It is the practice of companies to maintain current accounts with their bankers. This balance attracts interest and when the bank credits this interest to the account, the company receives a credit memo.

In some instances, a cheque or demand draft that is issued towards the company is processed by the bank. This amount is intimated to the company through a credit memo detailing the amount. In some cases, the charges that a bank collects on its services may be reversed and accounted for as a credit memo.

Using TallyPrime to account for credit notes and memos

Your accounting software must be able to handle and report for all kinds of credit notes and memos. This is essential for legal compliance and to maintain a proper audit trail. TallyPrime easily accounts for credit memos and intelligently credits and debits the appropriate accounts. It helps you trace and track the credit notes and ensures that they are accurate. It is straightforward to audit accounts on TallyPrime as it properly maintains the numbering sequence and organizes the audit trail. TallyPrime also links the credit note to the appropriate invoice and modifies the totals as indicated in the balances of the books of accounts.

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