What is a Credit Note and When to Use One
Please note that this article is intended for educational purposes only and should not be deemed to be or used as legal, employment, or health & safety advice. For guidance or advice specific to your business, consult with a qualified professional.
The issue and receipt of credit notes is a common facet of business finance. They are commonly issued as a precursor or alternative to a cash refund, entitling the bearer to a predetermined sum of credit on their customer account. Businesses commonly give and receive credit notes. Here, we explore how they work and when they are used.
What is a credit note?
A credit note is a document that indicates a return of funds to the bearer. It is commonly issued following the cancellation of an order, invoice error, or lost or damaged goods. Credit notes may be used to refund a transaction either in whole or in part.
Credit note example
Independent record shop Vinnie’s Vinyl purchases £350 worth of records from its wholesaler ABC Media. The store receives an email from the wholesaler informing them that the wrong records were mistakenly added to the invoice.
ABC Media therefore issues a credit note to Vinnie’s Vinyl on the original invoice and sends it to the store, cancelling the invoice and recording the £350 value as a positive under accounts payable.
Because Vinnie’s Vinyl has already settled the original invoice, the store can either put the £350 in the credit note towards a new order or request a cash refund. However, if the credit note had been issued before the credit was received, the credit note would cancel the payment due and balance out ABC Media’s ledger.
Credit note in accounting
When a company issues a credit note to their customers it enables them to amend their invoice, without alteration or deletion. Thus, a credit note allows both buyer and seller to keep an accurate paper trail without amending any of their document histories.
In single-entry / journal bookkeeping, a credit note is entered as a credit to the recipient customer in the journal.
Companies that use double-entry bookkeeping will enter the credit note as a debit under revenues, and a credit under accounts receivable.
How does a credit note work?
Credit notes are issued to customers following the return of goods, and a copy retained by the issuing company.
Every credit note issued should correlate to an invoice and show a negative balance against it. For instance, if a company issues a full refund of a £100 order, the credit note should be issued for -£100. Alternatively, if a client is overcharged by £50, the credit note is issued for -£50.
This enables the company to keep its business finances streamlined and intact.
When to issue a credit note
Companies will typically issue a credit note under the following circumstances:
- If an order has been cancelled
- If an order needs to be amended after the invoice has been generated
- A mistake was made on the initial invoice
- The client requests a refund
If there is a change to an order where the amount is going to increase, then it would be necessary to reissue a new invoice. However, a credit note should always be used when there is a negative balance, and the customer is owed money.
What information should a credit note include?
As with the structure of an invoice, companies have room for experimentation and personalisation when it comes to the layout of their credit notes.
However, there are a number of things that you should include to keep things simple for both the issuing company and the customer.
A credit note should include:
- The date of issue
- The credit note number (this should correspond with the invoice number)
- A customer or order reference number
- Payment terms and conditions
- Contact details for both companies
- The reason the credit note was issued
The document should clearly identify itself as a credit note to differentiate itself from another invoice. If VAT was included on the initial invoice, VAT should be added separately on the credit note.
How long does a credit note last?
Accounting regulations state that a credit note should be stored for a minimum of six years, alongside the relevant invoices. While companies must still adhere to UK GDPR and delete a previous customers details if requested, financial information must still be retained for legal and auditing purposes.
Businesses have a responsibility to make these terms of use clear on all invoices and credit notes. These terms and conditions should be established as early as possible so that the customer knows what to expect.
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