This guide explores what credit notes are and why they will be issued. It also provides some scenarios and the resolutions that explains when credit note will be used.
What is a credit note?
A credit note is a document issued by a seller to a purchaser of goods or services for either the full amount of the original purchase (invoice) or a lower amount depending on the circumstance.
In essence, it is to either cancel or reduce debt or refund money to a purchaser. From the seller’s point of view, it reduces or cancels the value of a sale, while from the purchasers perspective, it reduces or cancels the amount they have to pay.
Typically, credit notes are usually issued:
When a client receives goods or services that are faulty
Any errors in the billing
Any disputes there may have been over the invoiced amount
Here are just a few scenarios of when you might want to credit your customers and how you should go about doing so.
For recording credit from suppliers see When to record credit from suppliers.
An unpaid invoice you've issued has an incorrect amount
Let's say that you've issued a sales invoice to one of your clients for a net figure of £1,000. However, before you have received a payment you realise that the invoice was only meant to be for a net value of £100. This is where you should use a credit note instead of a refund, because you can’t issue a refund of money that you never received in the first place.
Instead, you can raise and issue a credit note for £900, and your client will receive the credit note now documenting the error. Your accounts and that of the client should now reflect a debt of £100 after posting the original invoice for £1000 and the £900 credit note.
A customer has paid a proportion of the invoice but wants to pay less than the total
Imagine that you have performed a service for a client for which you have charged a total of £1,000+VAT, but they believe that they should pay you no more than £800+VAT. If you agree and wish to lower the total of the invoice to £800+VAT you should use a credit note. You’ll have to raise a credit note for the difference of the original amount (£1000) and the new amount (£800). So a £200 credit note will need to be issued for this invoice.
A customer has fully paid an invoice but wants their money back
For this example, let's imagine that you have issued a sales invoice of £500+VAT and your customer has paid you the full amount for the invoice. However, after reviewing your service they decide that they want their money back, and for this example, let's say that you agree. This is where you should use a refund. To create a refund you will first need to raise a credit note for the amount you wish to refund, and then to record how the money left your account you will need to create a refund and allocate it to the credit note.
In bank reconciliation, you’ll have to reconcile the initial client payment with when the money entered your account and then reconcile the refund with when the money went back out again.