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Credit notes are a regular part of doing business finance. They’re commonly issued instead of a cash refund, giving customers a set amount of credit to use against future purchases. Businesses commonly give and receive credit notes, so it’s important to understand how they work and when to use them. Here, we explore how they work and they’re 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.
What is a 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 is retained by the issuing company for its records. Every credit note issued should correlate to its initial invoice and show a negative balance against it.
For example, if your company issues a full refund for a £100 order, the credit note should record –£100 against the original invoice. Alternatively, if a customer was accidentally overcharged by £50, you’d issue a credit note for –£50 to correct the balance.
This enables your 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:
- An order has been cancelled
- 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 issue a new invoice instead. A credit note should only be used when there is a negative balance, and the customer is owed money.
How to issue a credit note
Follow these steps to issue a credit note:
- Create the credit note, including all the key information (more on this below).
- Send the credit note to your customer promptly once its ready.
- Keep a copy for your records to ensure accurate bookkeeping.
- Update your accounts to reflect the credit.
How to receive a credit note
When you receive a credit note from a supplier:
- Check the credit note against the original invoice to ensure the amount and details are correct.
- Update your accounts to reflect the credit.
- Keep the credit note with your financial records.
- If you had already paid the original invoice, agree with the supplier if you will use the credit towards a future purchase or request a cash refund.
What information should a credit note include?
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 initial 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 credit amount
The document should clearly identify itself as a credit note to differentiate itself from another invoice. If VAT was included on the initial invoice, it should also be added separately on the credit note.
How long does a credit note last?
A credit note remains valid until it’s used or expires according to the terms set by the issuing business. These terms should be made clear on all credit notes so the customer knows what to expect.
While the credit itself may have an expiry date for use, accounting regulations state that the issuing business must store the credit note for a minimum of six years, alongside the relevant invoice. Companies should still adhere to UK GDPR and delete a previous customer’s details if requested, but financial information must be retained for legal and auditing purposes.
What is a credit note FAQs
Is a credit note a refund?
A credit note isn’t always a refund. It represents money owed to a customer, which can be used as credit towards future purchases or converted into a cash refund, depending on the agreement between the buyer and seller.
What is the difference between a refund note and credit note?
A refund note and credit note are essentially the same document: both record money owed back to a customer. Some businesses use “refund note” when issuing cash refunds, while “credit note” typically refers to credit applied to future purchases.
Who pays a credit note?
Nobody pays a credit note: the seller issues it to the buyer to acknowledge money owed back to them. It reduces the buyer’s debt or creates a credit balance that can be used for future transactions or refunded.
Does a credit note mean I owe money?
If you receive a credit note, it means the company that issued it owes you money. If you had not already paid the original invoice, the credit note will clear or reduce your debt; if you had already paid, the credit can be used for future purchases or a refund.
