What Is a Credit Note

A credit note, also known as a credit memo, is a financial document issued by a seller to a buyer, indicating a reduction in the amount owed by the buyer due to various reasons such as returned goods, overcharged invoices, or errors in the original billing. 

It serves as an official acknowledgment that the buyer no longer needs to pay the full original invoice amount, and it may either be used to offset future purchases or be refunded, depending on the agreement between the two parties. 

Credit notes are important for maintaining accurate financial records, ensuring customer satisfaction, and complying with accounting standards, as they help correct mistakes and reflect the true value of transactions. 

Typically issued after an invoice has already been generated, a credit note references the original invoice and provides detailed information on the reason for the adjustment, the amount being credited, and any updated payment terms. 

In some cases, a credit note might be necessary when a customer cancels an order after being invoiced or if a product is returned due to damage or defects.

When to Issue a Credit Note

A credit note should be issued in the following situations:

• Overbilling or Invoice Error: If the original invoice was for a higher amount than it should have been (e.g., due to a pricing mistake, wrong quantity, or duplicate item), a credit note corrects the overcharge.
• Returned Goods: When a customer returns goods due to damage, defects, or dissatisfaction, a credit note is issued to reduce or cancel the value of the original invoice.
• Discounts or Rebates: If a post-sale discount, rebate, or price adjustment is agreed upon after the invoice is issued, a credit note reflects that reduced payment obligation.
• Service Not Rendered: If the customer was billed for a service that was not fully delivered or was cancelled, a credit note is used to correct or refund the charge.
• Customer Overpayment: If the customer pays more than the invoiced amount, a credit note may be issued to acknowledge the overpayment and apply it to a future invoice.
• Cancellation of Sale: If the sale is cancelled after invoicing but before delivery or service fulfillment, a credit note reverses the invoice.

Debit Note vs Credit Note

The main difference between a debit note and a credit note lies in who issues it and why it's issued. Here's a clear comparison:

Credit Note Example: A customer returns defective goods worth $100. The seller issues a credit note for $100.

Debit Note Example: A supplier forgot to include shipping costs in the original invoice. The buyer issues a debit note to acknowledge the additional $50 owed.

What Should a Credit Note Include

A credit note should include all the necessary details to clearly reference and correct a specific invoice. Here’s a breakdown of what it should contain:

• Header: The document should clearly be titled “Credit Note” and include a unique credit note number along with the date of issue.
• Seller’s Information: Include the company name, address, contact details, and tax identification number if applicable.
• Buyer’s Information: Add the customer’s name or company name, their address, and contact details.
  
• Original Invoice Reference: Reference the original invoice number that the credit note is related to, along with the date of that invoice.
• Details of Goods or Services: Provide a description of the goods or services being credited, including the quantity, unit price, and subtotal.
• Credit Amount: Clearly state the total credit amount, including any applicable taxes, and specify the currency.
• Reason for the Credit Note: Briefly explain why the credit note is being issued, such as a product return, billing error, or post-sale discount.
• Tax Details (if applicable): If taxes apply, include a breakdown of tax rates and amounts such as VAT or GST.
• Payment Details or Adjustment Info: Specify whether the credited amount will be refunded or applied to future invoices.‍
• Authorized Signature (Optional): Include the signature of the issuer or company representative, if required.

How to Create and Record a Credit Note

Issuing a credit note is a straightforward process once you understand the steps involved:

• Spot the issue: Identify the reason a credit is needed—this could be due to product returns, incorrect billing, or service cancellations. Often, this comes to light through a customer notification or internal review.
• Prepare and deliver the credit note: Clearly mark the document as a “Credit Note,” include the customer’s information, reference the relevant invoice, and outline the items or amounts being credited. Be sure to include a brief explanation for the adjustment.
• Record it in your accounts: Update your general ledger by reducing the amount in accounts receivable and adjusting your revenue figures accordingly.
• Apply the credit to the customer’s balance: You can either refund the credited amount directly or apply it as a deduction on the customer’s next invoice, depending on the agreement.
• Handle any tax implications: Adjust tax records if necessary to reflect the credited amount, and ensure compliance with local accounting or tax rules. Consult a professional if needed.

Credit Note Example

Bright Home Interiors ordered 50 decorative lamps from Luxe Lighting Ltd. on May 1, 2025. The total invoice amount was £5,000, and the lamps were delivered on May 10, 2025. Upon inspection, Bright Home Interiors discovered that 5 of the lamps were damaged during shipping and therefore could not be used or sold.

Action Taken: Bright Home Interiors contacted Luxe Lighting Ltd. on May 12 to report the damaged goods and requested a credit for the 5 faulty lamps.

Credit Note Issued: Luxe Lighting Ltd. reviewed the claim, confirmed the damage, and issued a credit note for the value of the 5 defective lamps. The credit note referenced the original invoice, specified the quantity and price of the returned lamps, and adjusted the total amount accordingly.

Result: The credit note reduced Bright Home Interiors’ outstanding balance by the value of the damaged goods. The credit was applied to their account and will be deducted from their next payment or invoice, depending on the customer’s preference.