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What is a Credit Memo?
A credit memo is a document provided to the customer to provide credit for a previously billed item for which you have already received payment. If you notice an error on an invoice before the customer remits payment, you can issue a corrected invoice; however, if the customer has already remitted payment, you must write a credit memo to correct the invoice error. The customer will use the credit memo to reduce the amount paid on a future invoice.
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When to Issue a Credit Memo
Depending on your business model, you may experience many different situations that require issuance of a credit memo. The following is a list of the most common reason for writing a credit memo:
- Over billing: If you issued an invoice for the incorrect amount, provide a credit memo to the customer that identifies the invoice and exact product and/or service that was over billed.
- Incomplete orders: If the number of product units received by the customer is less than what is billed, issue a credit memo to the customer providing a detail of the missing products for which he is receiving credit.
- Defective/substandard products: If products shipped are identified by the customer as defective or substandard quality, write a credit memo for the inferior products returned.
- Incorrect product: If you shipped the wrong product to the customer, issue a credit memo for the returned products.
- Discounts: If a product is not exactly what the customer wanted, sometimes, he will ask for a discount rather than returning the products for full credit. Issue a credit memo to the customer for the agreed-upon discount amount.
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Preparing a Credit Memo
Credit Memo Header
The top section of a credit memo should contain the following information:
- Your business name and contact information.
- The customer's business name and contact information.
- The words "Credit Memo" to identify this as a credit rather than an invoice.
- A unique number assigned to the credit memo.
- The date of the credit memo.
Credit Memo Body
The credit memo body must contain a description for the issuance of the credit memo along with detailed information such as the original invoice number to which the credit memo applies, the number of products adjusted, the pricing and the total amount of the credit per product.
Credit Memo Footer
The credit memo footer contains a total of all credits issued and the adjustments required for sales tax and shipping. You may also add comments or notes to the customer at the bottom of the credit memo.
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Credit Memo Accounting
If you use accounting software to prepare invoices, you can write a credit memo using your accounting software and the software will automatically process the appropriate journal entries for the credit memo to your accounting general ledger. If you have a manual billing system, you can use a word processing or spreadsheet program to write a credit memo.
If you manually prepare a credit memo, you must remember to reduce the appropriate income accounts based on the products/services for which you issued the credit memo.
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"Principles of Accounting"; A. Douglas Hillman, Richard F. Kochanek, Corine T. Norgaard; 1991