In this article, you’ll learn:
When to use a credit note
What information a credit note should include
The easiest way to issue a credit note
How to register credit notes in your accounting
If you’re familiar with the invoicing process, you’ve more than likely heard of a credit note. It’s possible you’ve issued one or been on the receiving end of a credit note. But it can be slightly confusing when it comes to knowing when and how to issue a credit note.
Credit notes are typically connected to an invoice and allow complete or partial cancellation of a sale. Because there are strict laws around deleting invoices in many countries, a credit note is also important in the case that an invoice needs to be ‘deleted’.
The sales process can involve a number of different documents, from quotes to invoices, delivery notes to reminders, and in some cases, credit notes.
When a credit note is necessary
As mentioned above, a credit note is used in situations where an invoice needs to be cancelled. This provides a legally acceptable way to keep the record of the sale in your accounts while clearly indicating that the order was cancelled and a specified amount of funds were returned.
However, a credit note can also be issued in the case that there is a change to an order - meaning that the invoice must be edited and re-issued. This can occur if there is a mistake in the order or if there is an error on the invoice.
In addition, if a customer wishes to amend their order, for example to reduce or increase the quantity of a product, or remove one (or several) products altogether, this would change the total of the invoice.
This change to the invoice typically requires it to be re-issued. Since a completed invoice should never be deleted, a credit note can be issued to effectively remove the amount from your finances (cancel it out).
What to include in a credit note
Credit notes follow a general outline, much like quotes and invoices. While invoices have a strict format and set of requirements to ensure they are legally binding, quotes have a less-strict structure and required information.
Credit notes that also include VAT have a clear set of requirements for what should be clearly stated. Essentially, a VAT credit note should reflect the details of the VAT invoice - specifically, why it is being issued, the total amount to be credited and the amount before VAT as well as the invoice number of the original invoice and the date.
An issued credit note is generally directly linked to an invoice, but there are situations in which a stand-alone credit note can be issued, which can be applied to an invoice at a later time, or can be applied to a different income source.
Issuing credit notes
Creating a credit note with the necessary details doesn’t need to complicated. Invoicing & accounting software provides a ready-made template that allows you to generate a credit note directly from an existing invoice.
This automatically links the credit note to the invoice and transfers the information from the original invoice to the credit note template. It can then be edited, if necessary - for example, if it is only a partial credit note, certain lines can be removed and amounts adjusted.
The credit note will then receive its own unique number in your invoicing sequence, allowing you to manage your records effectively and without gaps in your invoice numbers.
Credit notes and bookkeeping
When it comes to the financial records of your business, managing credit notes is fairly straightforward. Depending on at what point in the sales process the credit note is issued determines how it is handled in traditional double-entry bookkeeping methods.
For example, a credit note issued before an invoice is paid (for example, correcting a mistake) is debited the specified amount under ‘Revenue’ and credited under ‘Accounts Receivable’ for the particular customer, effectively crediting their account with your business to apply to future orders.
However, if goods are returned and a refund is provided, the credit note issued would simply be recorded under ‘Revenue’, and ‘Accounts Receivable’.These entries adjust the amount of revenue recorded in your accounts.
If you’re working with online invoicing & accounting software, the bookkeeping is built-in, meaning that as soon as you create a credit note it’s automatically linked to the original invoice, that the balances are updated.
Editing, cancelling, or refunding an invoice can be a pain. But credit notes can be simple to issue and ensure that they contain the correct information regarding your invoice. Online invoicing software makes this possible by providing templates for credit notes and automatically linking them to the corresponding invoice.