Credit Memos: What Are They & When Are They Required?

Last Updated October 21, 2024

A credit memo, also known as a credit note or credit invoice, is an important document in business accounting. Credit memos are issued by the seller to the customer when there is a reduction in the amount of money they owe on an invoice.

By understanding when to use credit memos, how to apply them properly to customer accounts, and how to keep careful records for your internal accounting purposes, you can maintain good relationships with customers and ensure the accuracy of your financial accounts.

What Is a Credit Memo in Accounting?

A credit memo (short for credit memorandum) is issued to serve as official documentation when the amount a buyer owes a seller is reduced. A credit memo is usually applied to a specific invoice, though in some instances it could be applied to the overall account balance that a buyer has accumulated with a seller.

When credit invoices are issued, the seller records it as a reduction of their accounts receivable. The buyer, on the other hand, will record the credit memo as a reduction of their accounts payable.

What Information Is Included on a Credit Memo?

When a credit memo is applied to a specific invoice, it will generally include the purchase order number, payment terms, and billing information. It may also include a list of items or services purchased, including their prices, quantities, and purchase date. The credit memo will also list why the memo was issued to a buyer, and list the total amount that has been reduced from the invoice or account.

If the invoice is still outstanding, the credit memo will list the new amount owed. If the client has already paid the invoice related to the credit memo, the “reduction” will be applied as a credit to the client’s account.

Purposes of a Credit Memo

What is the purpose of a credit memo? Here are some of the top reasons a credit memo may be issued.

1. Resolve Price Disputes

One of the most common reasons to issue a credit memo is to resolve a price dispute with a client. This could occur if a client purchases a product at full price, and then it goes on sale at a significant discount the next day. Or, the amount issued on an invoice may be different from what the client was told they would owe. In either situation, a client may dispute their total charges.

In these situations, a credit memo may be issued to resolve the difference between the original invoice amount and the new price. This creates a new total for the invoice.

2. Address Returns

Many businesses will use a credit memo as an alternative way of addressing product returns. Rather than providing a cash refund, a credit memo will be issued that is equal to the value of the defective item that was purchased. With this credit applied to their account, the buyer can then purchase a replacement product. This is especially common with clothing purchases, such as when a buyer might order an item that is the wrong size or color online and wishes to make an exchange.

3. Marketing and Relationship Building

Though less common, some businesses will issue credit memos to certain customers as part of their marketing and relationship-building initiatives. A credit memo may be issued as a “thank you” to a loyal customer or as part of a seasonal promotional effort. These credit memos can help encourage additional purchases from existing customers. Such credits may also be applied to an account if a customer submits early payment for an invoice (if specified in the invoice terms).

4. Banking

Credit memos from the bank may also be issued if your bank account earned interest or if the bank reimburses you for fees related to that account.

Example of When a Credit Memo Is Issued

Here’s a basic example of when a seller might issue a credit memo to a buyer. Let’s say that a buyer receives an invoice for $1,000, and the seller offers a 3% discount for payments made within seven days of receipt (rather than waiting until the end of the payment terms).

If the buyer submits payment within this promotional period, the seller could then issue a credit memo worth 3% of the transaction (in this case, $30). If the seller provided a credit memo rather than a refund, that credit amount would likely be applied to a future purchase.

Alternatively, if the buyer received a $1,000 invoice but then had to return $150 worth of products because they were defective, the seller could issue a $150 credit invoice. The buyer could then use this credit to purchase replacement products.

While both situations affect the seller’s accounts receivable, they do not require a direct cash return to the buyer.

In-Summary: What Is a Credit Memo?

Credit memos, also referred to as credit invoices or credit notes, are an important element of accounting, whether a seller wants to issue credit to a buyer to resolve price disputes, manage product returns, or offer promotional credits to improve existing customer relationships and encourage future purchases. Understanding credit memos and how they work is essential for any accounting team.

A detailed credit invoice that details the original invoice it is tied to, why the credit is being applied, and so on will help both sellers and buyers maintain accurate accounting records while also helping sellers build stronger relationships with their customers.

Credit Memo FAQs

Is a credit memo a refund?

No. A credit memo is issued from the seller toward the buyer’s account to reduce their total existing balance or to add credit to their account that can be used toward a future purchase. This is different from a refund, which provides cash back when a product or service is defective.

Is there a difference between a credit memo and a credit note?

No. A credit memo and a credit note are the same thing. These terms are fully interchangeable.

What does a check showing $0.00 mean?

A check for $0.00 is typically sent to validate a bank account’s information. Third parties, such as mortgage lenders, will send a statement of $0.00 (or a minimal amount of just a few cents) as a check or via direct deposit as part of their validation process.