What is a Credit Memo in Accounting?
Credit Memo Definition
A credit memo, short for “credit memorandum,” is a financial document generated by a seller or service provider to notify a customer that they have received a reduction on their balance owed.
Typically, credit memos would be issued after an invoice has already been supplied, to rectify any invoicing errors or provide compensation to the customer for any issues with a product or service.
A credit memo is very different to receiving a refund, as with a refund, the customer will receive cash back, whereas a credit memo just reduces the customer’s outstanding balance, or provides them with some ‘credit’ towards any future purchases.
A credit memo is often also called a “credit note”.
Why Credit Memos Are Issued
Credit memos can be issued by businesses for a variety of reasons:
Correcting Errors
Credit memos are generally used to rectify errors in previous invoices.
For example, if a customer was charged for an item they didn’t receive or if there was a pricing mistake on an invoice, a credit memo is issued to adjust the customer’s account.
Returns
When customers return products they are dissatisfied with or when a product is found to be faulty, a credit memo is issued to effectively refund the purchase amount.
This practice helps to maintain customer satisfaction and goodwill.
Compensation
Credit memos are sometimes issued as a form of compensation for inconveniences experienced by customers.
For example, if a customer received a late delivery, the seller might issue a credit memo as a gesture of goodwill, and give the customer a discount towards their next purchase.
Credit Memo Template
A standard credit memo includes several key components such as:
Date: The date the credit memo is issued.
Credit Memo Number: A unique identifier for tracking and reference purposes.
Customer Information: Details of the customer receiving the credit, including name, address, and account information.
Seller Information: Details of the seller or service provider issuing the credit memo.
Related Invoice: If the credit memo is used to ‘refund’ a previous invoice, then the related invoice number would be noted as reference.
Description: A brief description of the product or service for which the credit is being issued.
Quantity: The quantity of items involved in the transaction.
Unit Price: The price per unit of the product or service.
Total Amount: The total amount credited or refunded.
Reason: An explanation of the reason for the credit memo. This could be due to an error, return, or compensation.
Real World Examples of Credit Memos
To better understand credit memos, let’s explore a few real-world examples:
Product Return
Imagine a customer purchases a laptop online but receives a damaged unit.
The customer contacts the seller, and the seller agrees to accept the return.
In this case, a credit memo is issued to refund the customer for the laptop’s purchase price.
Invoice Discrepancy
A retailer sells 100 items to a business client, but the invoice incorrectly charges for 120 items.
The seller spots the error and issues a credit memo to the customer, correcting the invoice and crediting (reducing) the extra 20 items from the order.
Late Delivery Compensation
Due to unforeseen circumstances, a logistics company delivers a client’s goods later than promised.
In an effort to maintain the client’s trust, the logistics company issues a credit memo offering a discount on the client’s next shipment as compensation.
Duplicate Billing
A customer places an order but is accidently billed twice for the same item.
To rectify this error, the seller sends the customer a credit memo for the full price of the item, effectively cancelling the duplicate order.