A credit note (also known as a credit memo) is a formal document issued by a seller to notify the buyer of a reduction in the amount owed on a previous invoice. It serves as a correction tool for completed transactions – commonly used to account for returned goods, correct pricing mistakes or grant post-invoice discounts. The credit note adjusts the buyer's account balance, which can then be applied to a future purchase or refunded.
What should a credit note include?
A credit note should contain enough detail for both parties to trace the adjustment back to the original transaction and update their books accurately.
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A credit note can only be issued by the seller. If the buyer believes an adjustment is warranted, they must request one from the seller – they cannot create a credit note themselves. Always reference the original invoice number so both parties can reconcile the adjustment accurately.
Credit note vs. credit memo: In the US, the terms "credit note" and "credit memo" refer to the same document. "Credit memo" is the more common term in American business, while "credit note" is widely used in international trade and by businesses that deal with overseas clients. Both serve the same purpose – reducing the amount owed on a previous invoice.
When and why is a credit note used?
A credit note is issued after an invoice has been sent, whenever the invoiced amount needs to be reduced. Typical scenarios include:
Returned products – The buyer returns all or part of a delivered shipment. The credit note reduces the outstanding balance by the value of the returned goods.
Billing mistakes – The original invoice contained incorrect pricing, wrong quantities or a duplicate charge. A credit note corrects the record without voiding the entire invoice.
Service-related issues – The service delivered was incomplete, delayed or did not meet the agreed standard. A credit note acknowledges the shortfall and adjusts the amount accordingly.
Post-invoice discounts – A loyalty rebate, volume discount or promotional pricing agreed after the original invoice was issued.
Customer overpayment – The client paid more than the invoiced amount. A credit note records the surplus, which can be applied to a future invoice or refunded.
Order cancellation – The buyer cancels an order that has already been invoiced but not yet delivered. The credit note reverses the full invoice amount.
Sales tax on credit notes: If the original invoice included state or local sales tax, the credit note should adjust the tax proportionally. In most states, you can claim the sales tax reduction on your return for the period in which the credit note was issued. Keep the credit note and the original invoice together – your state's Department of Revenue may require both as documentation during an audit.
Always reference the original invoice – a credit note without an invoice reference is difficult to reconcile and may cause problems during audits.
Issue promptly – the sooner you issue a credit note after the issue arises, the easier it is to reconcile both sets of books.
Use a separate number series – maintain distinct numbering for credit notes (e.g. CN-001, CN-002) so they are easy to distinguish from regular invoices.
Keep records for at least 3 years – the IRS requires supporting documentation for all items on your tax return. Credit notes are part of that documentation.
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