Have you ever billed a customer for a product and realized you overcharged them? Or has one of your customers ever opened a package to find damaged or defective goods? In either case, you should know about a credit memo. A credit memo can help fix these problems. Read on to learn how.
What is a credit memo?
Credit memos are also known as credit memorandums or credit invoices. A credit memo is a negative invoice you send to buyers to reduce the price of a previous invoice. Generally, you’ll issue the memo whenever the buyer has a qualifying reason not to pay the total amount of an invoice.
You may issue a credit memo if the
- Buyer returned goods or rejected services (e.g., damaged product)
- Price on the original invoice was incorrect
- Buyer overpaid on the original invoice
Remember, the memo isn’t the same as a refund. A refund reverses the original purchase. A credit memo is a separate transaction that amends the original invoice.
Credit memo vs. debit memo
While credit memos and debit memos are corrections to invoices, they are entirely different corrections. Credit memos reduce a buyer’s total invoice. Debit memos increase the buyer’s total invoice.
Use a debit memo if the:
- Costs of services have increased (e.g., a price increase in materials or labor)
- Original invoice was too low
Banking credit memos
Banks can also issue credit memos to amend different transactions. Generally, banking credit memos operate differently than credit memorandums for business. Instead of reducing the total of an invoice, banking memos often increase the balance of a checking account.
Banks issue credit memos when:
- Adding interest earned from money on deposit
- Collecting a note for the account holder
- Refunding a previous bank charge
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Credit memo format
A credit invoice isn’t that different from an invoice. The main difference is that the credit invoice must reference the original invoice (it amends the original, after all).
Your credit invoice should include:
- “Credit Invoice” in a prominent place at the top of the invoice
- Company information
- Customer information
- Date issued
- Credit memo number
- Original invoice number
- Description of goods (e.g., quantity and price)
- Total amount credited
To avoid employee fraud or kickback schemes, you may want to require a manager’s signature to authorize the credit memo. That way, a manager or supervisor can approve the memo before sending it to the buyer.
Settling a credit invoice
So, you’ve sent a credit memo to a buyer. What’s next?
If your buyer’s already paid the full invoice amount, they have two options. Either they can use the credit memorandum on future payments or receive the difference between the credit memo and the original invoice as a cash payment. For instance, if the credit memo reduces the original invoice by $35, the customer can request the $35 credit in cash.
If the buyer hasn’t paid the invoice yet, they must use the credit memo to reduce the total of the first invoice. Once the credit memo reduces the original invoice, the buyer must pay the remaining balance.
Here’s how to record a credit memo in your accounting system:
| How to Record the Credit Memo | |
|---|---|
| Seller | Record it as a reduction to the accounts receivable balance |
| Buyer | Record it as a reduction to the accounts payable balance |
Examples of credit memorandums
Let’s take a look at a few examples of credit memorandums.
Credit memorandums for returned goods
You buy products from a manufacturer to sell in your store. Once you receive the new products, you realize some items were damaged during shipping. Instead of paying the full price for the damaged goods, you let the seller know, and they send you a credit memo to reduce your overall bill. Then, you pay the remaining balance and record the credit memo as a reduction in your accounts payable.
Credit memorandums for incorrect prices
You sell paper goods to a restaurant and later realize that you overcharged them. You can write up a credit memo and send it to the company to bring the balance of their invoice to the right place. A credit memo can also help if a customer’s overpaid their invoice. In this case, you would send a credit memo for the overpaid amount.
Issuing credit memos is easy with Patriot’s online accounting software. With Patriot, you can apply a credit to multiple invoices or multiple line items with just a few clicks. Try it for free today!
This is not intended as legal advice; for more information, please click here.
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