When a buyer receives an order that is incomplete, incorrect, damaged, or erroneously invoiced, the seller may need to cancel the invoice–partially or in full.
However, in order to maintain a proper audit trail, many jurisdictions do not allow invoices to be edited after being issued. That is when a credit memo comes in, enabling a seller to reduce the accounts receivable balance by the required amount without deleting the invoice itself from the financial records.
In bank reconciliations, a credit memo is a statement issued by a financial institution to notify a depositor that an account balance was increased for a transaction, such as:
Credit memo is a short form of the more formal term “credit memorandum”, which is also known as a “credit note”.
The terms credit memo, credit memorandum and credit note have the exact same meaning and are used interchangeably.
Refund means that a buyer receives a certain monetary amount back from a seller, whereas a credit memo indicates that a seller has given credit to a buyer, which either reduces the existing outstanding balance on the buyer’s account or can be used against the buyer’s future purchase invoices.
Like a refund, a credit memo is typically tied to a specific invoice that has already been issued and the credit provided by the seller to the buyer can either be partial or for the full total amount of that invoice.
The debtor (i.e., buyer) can usually choose whether to use the credit memo to offset any future invoice payments to the creditor (i.e., seller) or exchange it for a cash payment instead, depending on:
The 10 most common reasons for issuing a credit memo:
Examples: Overstated invoice amount due to a clerical mistake or a discount being incorrectly applied.
Examples: Defective or incorrect product delivered, product does not meet the buyer’s specifications, buyer changes her/his mind.
Example: Goods became faulty or damaged within a warranty period.
Example: Customer was not happy with the service quality.
Example: Buyer made a purchase just before the price was heavily discounted and a seller agreed to match the difference between the original and the sales price.
Example: Clerical mistake on a customer’s end, where a member of the Accounts Payable team made an error when paying an invoice.
Example: Customer requests a decrease in order product quantity after an invoice is issued but before the order is shipped out.
Example: Customer cancels an order within the cooling-off period allowed in the seller’s payment terms.
Tip: Analyzing the reasons why credit memorandums are issued within an organization can help improve business performance by discovering the underlying causes and any reoccurring issues.
For example, misleading product packaging can be labelled more clearly, or an unreliable shipping partner can be replaced with a better delivery provider, in order to reduce the number of credit memorandums issued as a result of customer complaints and product returns.