The credit department prepares credit memos when goods are returned

Written by Eddy Hood

What is a Credit Memo?

A credit memo, or credit memorandum, is sent to a buyer from a seller. This document is issued to a buyer after an invoice is sent out. A credit memo may reduce the price of an item purchased by a buyer or eliminate the entire cost of an item. When a seller issues a credit memo, it's put toward the existing balance on a buyer's account to reduce the total. A credit memo is different from a refund. A customer who receives a refund for a purchase gets actual money back from the seller. Our knowledgeable accountants can help business owners with basic tasks such as issuing credit memos, keeping track of sales, and sending out invoices. Business owners who choose to have their accounting tasks outsourced to Ignite Spot are able to spend more time doing what they do best to boost company profits.

What Type of Information is on a Credit Memo?

A credit memo contains several pieces of important information. Most credit memos feature the purchase order (or PO) number, as well as the terms of payment and billing. The shipping address, a list of items, prices, quantities, and the date of purchase are other significant pieces of data found on a credit memo. All of this information helps a seller to keep track of inventory. This document also includes the reason for issuing the credit memo.

Reasons Why Credit Memos Are Issued

There are a variety of reasons why a seller may issue a credit memo to a buyer. One common reason is the buyer returns a purchased item to the seller. The item may be defective, the wrong size, or the wrong color or perhaps the buyer just changed his or her mind regarding the purchase. A price change is another reason why a seller may issue a credit memo. For instance, a buyer may purchase a product one day before its price is marked down 30 percent. The seller agrees to issue a credit memo for the difference between the price the buyer paid and the new sale price.

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A credit memorandum, aka credit memo, is an articulated form indicating an amount the contractor owes to the client. And recording a credit memo journal entry is a must for an income statement or net sales revenue.

Not everyone knows how to record an accounting entry, which is why we have written this article. It helps record a certain transaction to maintain the financial statements. Plus, we have also shared how to make an entry if you are a client in the case of the credit memorandum issue.

So let’s know both the seller and the buyer side.

How to Handle a Credit Note

Credit memos or notes are issued by contractors to the customer when the latter party informs to stop providing services in the middle of the tasks due to multiple reasons, such as

• services not up to the expectations
• not meeting deadlines
• The price offered is higher than the market rate

Besides, handling a credit memo involves two crucial things:

• Types of credit memos
• Either you are a buyer or a seller

So let’s have a look at the scenario when you are the customer:

If you are a customer availing services from a contractor, and you immediately inform them to stop offering services, you would be entitled to receive the amount that you already paid for.

The supplier is no longer your creditor, rather, you are his/her creditor. You can always ask for payment or goods or services.

When you are a customer of the goods or services and a credit memo is issued, make necessary accounting entries in your books.

When you are the contractor:

When you prepare a credit memo for goods return or stopping the services, the accounting entry would be

Here, the buyer’s account is credited and the sales return account is debited when the buyer returns the goods.

Review all the outstanding credit memorandums at the end of the month. Make sure you apply for credits as the buyer makes another purchase or demands a refund. This habit makes your general ledger look cleaner and better.

Now that you know how to make accounting entries in different scenarios, let’s also look at the benefits of recording entries.

Importance of Recording Credit Memo Entries

Credit memos are issued only when the product is returned due to being damaged or faulty. Or when there is an intimation from the customer’s end about not wanting to continue services.

The scenarios could be either the services/goods are not up to the mark, manufactured or packed properly, or there can be chances that your shippers mishandle them.

Another alarming situation could be when the number of credit memorandums is issued way higher than the average. In this case, the bookkeeping department might be committing some fraud.

Apart from this, the higher the credit notes issued, the lesser the actual sales. It also means the business is financially unstable. It can affect you when applying for loans or credit extensions from your suppliers. Another dent to your goodwill is big sharks may show less or no interest in your company.

Make sure you scrutinize your income statement and balance sheet to ensure everything is clear and transparent.

Since it is important to maintain the balance sheet and financial statements, you must automate your accounting software. Automating efficiently manages your general ledger.

Plus, the automation eliminates manual work and bookkeepers, eventually removing the frauds that might be committed by manpower. Another benefit of Automating is it ensures a proper application of credit memos.

In nutshell, these are the main benefits or importance of maintaining credit memo journal entries.

• Maintaining Sound Business Health
• Eliminating Malicious Activities
• High Chances of Loans & Credit Extention from Banks

Without beating around the bush, let’s quickly know the entries to record in the books of accounts.

Journal Entries for Certain Transactions

Businesses have several transactions, out of which, sales returns are one of them, which happens due to several reasons. Recording transactions for financial records is a must not only for future references but also for taxation purposes.

So here are the three main reasons for sales return and issuing a credit memorandum.

1. If the contractor mistakenly charges a higher price than what is fixed, it can issue a credit memo stating overstatement as a reason. Now the entry would be:

   Entry	Debit	Credit
   Sales Revenue	XXX	–
   Accounts Receivable	–	XXX

   Here, the sales revenue account has been debited, and the accounts receivable have been credited with the difference amount.

   For better understanding, we have created an example:

   Contractor A sold goods or services at $500 to company B, which actually costs $300. When found by Company A, they issued a credit memo stating the reason as overstatement. In this case, company A owes $200 to company B.

   For recording this transaction, they have made the necessary entries.

   Entry	Debit	Credit
   Sales Return	$200	–
   Accounts Receivable	–	$200

   If you are preparing the necessary account for sales returns and allowances, then the entry would be:

2. Another reason for issuing a credit memo and recording entries could be a discount applied or allowed or forgot to apply in the original invoice.

   The entry for such would be:

   Entry	Debit	Credit
   Discount Allowed	XXX	–
   Accounts Receivable	–	XXX

   For example, an invoice of $1000 has been generated by Company A and payment has been made by Company B. Due to good relations between both parties, company A decided to offer 10% discount to Company B.

   In the above case, the entry would be:

   Entry	Debit	Credit
   Discount Allowed	$100	–
   Accounts Receivable	–	$100

3. Lastly, when the buyer receives damaged goods, incomplete order,s or the goods don’t match the buyer’s expectations.

   Entry	Debit	Credit
   Sales Return	XXX	–
   Accounts Receivable	–	XXX

   For example, Company A sells goods worth $1000 to Company B and an invoice has been generated. After a week, the goods were returned by Company B stating they were damaged for which Company A issued a credit memo.

   The entry for this transaction is:

   Entry	Debit	Credit
   Sales Revenue	$1000	–
   Accounts Receivable	–	$1000

   That’s how you will record journal entries for credit memos. Adding entries in your books of accounts will help you know your right sales and revenue. If you still have any questions, you can go through the next section.

Frequently Asked Questions

1. 1. What is the accounting entry for a credit memorandum?Here is a quick example to clearly understand the accounting entry:
      

      Entry	Debit	Credit
      Sales Return & Allowance	XXX	–
      Accounts Receivable	–	XXX

1. 1. Which account shall I record the credit memo?As a seller, you must credit the accounts receivables, while as a buyer, you need to debit accounts payable.

1. 1. Is a credit memo a debit or credit?A credit memo is an invoice indicating a negative amount that is yet to receive from a supplier, which depicts credit. So basically, a credit memo is a credit.

1. 1. Is a refund means a credit memo?A credit memo indicates that a supplier is obliged to pay a specific amount against the return of the goods. It depends on the buyer whether he/she wants a full refund or another order.

1. 1. Is a credit memo a sales invoice?No, credit memo and invoice are different. The requirement to issue a credit memo comes into the picture when the already generated invoice goes wrong. It means when the goods are purchased, payment is made, and then the buyer returns the goods.

1. 1. What is the meaning of a credit memo?A contractor issues a credit memo to the client. With the issue, the memo reduces the amount that the client owes to the contractor.

1. 1. Is a credit memo a receipt?A credit memo depicts a credit on the buyer’s account. When the invoice goes wrong and needs to be written off, you issue a credit memo. It means you have to credit your customer’s account.

1. Can a credit memo be reused?No, you cannot reuse a credit memo. Plus, you cannot void the credit memo.

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Conclusion

Any transaction that happens in the business should have accounting records. A credit memo is one of the transactions that take place post-sales when the customer sends back the goods, mentioning a reason for return. The credit note indicates the buyer’s outstanding balance, dates, sales price, and customer details.

If you want to quickly create a credit note, you can use credit memo/note software and create unlimited credit memorandums.