Credit Memo (Definition, Journal Entries, Tips, and Free templates)

A credit memorandum, aka credit memo, is an articulated form indicating an amount the contractor owes to the client. Recording a credit memo’s journal entry is a must for an income statement or net sales revenue.

Not everyone knows how to record an accounting entry, which is why we have written this article. It helps record a certain transaction to maintain the financial statements. Plus, we have also shared how to make an entry if you are a client in the case of the credit memo issue.

So let’s know both the seller and the buyer side.

What is a Credit Memo?

A credit memo (or credit memorandum) is a financial document issued by the seller to the buyer, indicating a reduction or refund in the amount owed by the buyer. It is typically used as a correctional document to reduce the amount owed due to errors, price adjustments, or returns in sales transactions.

When Credit Memos are Issued?

Contractors, individuals, or small business owners issue credit memos to customers under different scenarios. Have a look:

1. When a customer feels that services rendered are not up to the expectations
2. Contractors not meeting deadlines
3. Prices charged are higher than the market rate

Why Do Businesses Use Credit Memos?

Businesses use credit memos for the following reasons:

• To record returns or refunds of goods/services rendered to customers
• To rectify the pricing errors or overcharges on the previously issued invoices
• To compensate customers for faulty, damaged, or incomplete orders
• To maintain accurate accounts receivable records
• To levy discounts or allowances once an invoice has been sent
• To offset future invoices instead of issuing refunds
• To facilitate the reconciliation of accounts between buyers and sellers
• To assure transparent communication about transaction adjustments, fostering trust among customers.
• To ensure transparency in transactions and build customer goodwill

Basic Credit Memo Accounting Entry

To record a credit memo journal entry, debit your sales returns, and allowances account and credit your accounts receivable account.  

Here is a visual representation to clearly understand the accounting entry:

Entry	Debit	Credit
Sales Return & Allowance	XXX	–
Accounts Receivable	–	XXX

This entry reflects the reduction in your receivables and your sales revenue.

Credit Memo Journal Entries for Certain Transactions

Businesses have several transactions, out of which, sales returns are one of them, which happens due to several reasons. Recording transactions for financial records is a must not only for future reference but also for taxation purposes.

So here are the three main reasons for sales return and issuing a credit memo.

1. Overstated amount in the original invoice

If the contractor mistakenly charges a higher price than what is fixed, it can issue a credit memo stating overstatement as a reason. Now the entry would be:

Entry	Debit	Credit
Sales Revenue	XXX	–
Accounts Receivables	–	XXX

Here, the sales revenue account has been debited, and the accounts receivable have been credited with the difference amount.

For better understanding, we have created an example:

Contractor A sold goods or services at $500 to company B, which actually costs $300. When found by Company A, they issued a credit memo stating the reason as overstatement. In this case, company A owes $200 to company B.

For recording this transaction, they have made the necessary entries.

Entry	Debit	Credit
Sales Return	$200	–
Accounts Receivable	–	$200

If you are preparing the necessary account for sales returns and allowances, then the entry would be:

2. Discount applied

Another reason for issuing a credit memo and recording entries could be a discount applied or allowed or forgot to apply in the original invoice.

The entry for such would be:

Entry	Debit	Credit
Discount Allowed	XXX	–
Accounts Receivable	–	XXX

For example, an invoice of $1000 has been generated by Company A and payment has been made by Company B. Due to good relations between both parties, company A decided to offer 10% discount to Company B.

In the above case, the entry would be:

Entry	Debit	Credit
Discount Allowed	$100	–
Accounts Receivable	–	$100

3. Goods return

Lastly, when the buyer receives damaged goods, incomplete order,s or the goods don’t match the buyer’s expectations.

Entry	Debit	Credit
Sales Returns	XXX	–
Accounts Receivable	–	XXX

For example, Company A sells goods worth $1000 to Company B and an invoice has been generated. After a week, the goods were returned by Company B stating they were damaged for which Company A issued a credit memo.

The entry for this transaction is:

Entry	Debit	Credit
Sales Revenue	$1000	–
Accounts Receivable	–	$1000

That’s how you will record journal entries for credit memos. Adding entries in your books of accounts will help you know your right sales and revenue. If you still have any questions, you can go through the next section.

Free Credit Memo Templates

There is no more manual processing of individual credit memos and refunds. InvoiceOwl’s freely available credit memo templates, part of our robust invoice and estimate app, allow you to easily edit and tailor credit memos to match your brand identity. These industry-specific templates are available in different file formats like Microsoft Word, Microsoft Excel, and Adobe PDF.

So, without any further ado, quickly make things right with our free printable credit memo template. It swiftly turns apologies into action.

How to Handle Credit Memos?

To handle credit memos, you need to be precise. This is because credit memos are an important accounting tool for correcting invoices, processing returns/refunds, and adjusting customer accounts. However, there are different types of credit memos available, and issuing the right one is important. 

There are several scenarios where credit memos come into play, each requiring a specific approach. Let’s have a look:

When you are the customer:

If you are a customer availing services from a contractor, and you immediately inform them to stop offering services, you would be entitled to receive the amount that you already paid for.

The supplier is no longer your creditor, rather, you are his/her creditor. You can always ask for payment or goods or services.

When you are a customer of the goods or services and credit memos are issued, make necessary accounting entries in your books.

Entry	Debit	Credit
Creditor’s A/C	XXX	–
Purchase Return A/C	–	XXX

When you are the contractor:

When you prepare a credit memo for goods return or stopping the services, the accounting entry would be

Entry	Debit	Credit
Sales Returns A/C	XXX	–
Accounts Receivable A/C	–	XXX

Here, the buyer’s accounts receivable account is credited and the sales returns account is debited when the buyer returns the goods.

Now that you know how to make accounting entries in different scenarios, let’s also look at the benefits of recording entries.

Why Credit Memo Journal Entries Are Important?

Credit memos are issued only when the product is returned due to being damaged or faulty. Or when there is an intimation from the customer’s end about not wanting to continue services.

The scenarios could be either the services/goods are not up to the mark, manufactured or packed properly, or there can be chances that your shippers mishandle them.

Another alarming situation could be when the number of credit memorandums is issued way higher than the average. In this case, the bookkeeping department might be committing some fraud.

Apart from this, the higher the credit memos issued, the lesser the actual sales. It also means the business is financially unstable. It can affect you when applying for loans or credit extensions from your suppliers. Another dent to your goodwill is big sharks may show less or no interest in your company.

Since it is important to maintain the balance sheet and financial statements, you must automate your accounting software. Automating efficiently manages your general ledger.

Plus, automation eliminates manual work and bookkeepers, eventually removing the frauds that might be committed by manpower. Another benefit of Automating is it ensures a proper application of credit memos.

In a nutshell, these are the main benefits or importance of maintaining credit memo journal entries.

• Maintaining Sound Business Health
• Eliminating Malicious Activities
• High Chances of Loans & Credit Extention from Banks

Without beating around the bush, let’s quickly know the entries to record in the books of accounts.

10 Best Tips to Avoid Credit Memo Accounting Errors

• Verify whether the credit memo details match the original invoice or not. (For instance: invoice number, customer, items/services)
• Double-check the calculations, especially for partial returns, discounts, or complex adjustments.
• Maintain standardized credit memo formats across the organization for consistency.
• Issue credit memos promptly to prevent financial reporting issues and improve customer satisfaction.
• Implement an approval workflow so all credit memos undergo verification before being issued.
• Integrate credit memo management with invoicing/accounting software to reduce manual errors.
• Train staff handling credit memos on procedures, approval policies, and best practices.
• Conduct periodic audits of credit memos to identify and rectify any lapses.
• Analyze credit memo patterns to identify areas for process improvements.
• Maintain clear documentation linking credit memos to their originating invoices/transactions.

Conclusion

Any transaction that happens in the business should have accounting as well as financial records. A credit memo is one of the transactions that take place post-sales when the customer sends back the goods, mentioning a reason for return. The memo issued indicates the buyer’s outstanding balance, dates, sales price, and customer details.

If you want to quickly create a credit note, you can use credit memo/note software and create unlimited credit memorandums.