A credit memo is issued by a seller and given to a customer to indicate to the customer that the amount they owe or paid for goods or services provided by the seller has been reduced.
Why are Credit Memos Issued?
Here are the two most common reasons a credit memo is issued:
- Returned product: The customer has decided to return the product because it was damaged, failed to meet their expectations, or they changed their mind about purchasing it.
- Price dispute: The customer has indicated that the price of the product or service is not what they agreed to pay initially. Billing errors can occur during the billing process, which sometimes results in a customer being overcharged.
There are other reasons why a seller might create a credit memo to apply against a client’s account, as well.
These include reversing interest charges or late fees, applying referral credits, discounts, and rewards points, or writing off an unpaid invoice
Don’t Forget!
Suppose you have a negative balance on your account resulting from a credit memo. In that case, you can ask the vendor to issue you a cash refund instead of waiting to apply it against a future invoice.
Example of When a Credit Memo Can Be Used
Suppose you own and manage a retail store that sells landscaping supplies.
A contractor purchases hundreds of paving stones from you for use on a project they’ve agreed to undertake for a client.
You bill the contractor’s account for the paving stones, which they agree to pay within 30 days.
The contractor loads the paving stones into their truck and delivers them to the worksite.
A week later, the contractor pays the invoice in full.
Three weeks later the contractor returns to your store, indicating that you overcharged them for each stone.
They would like to be refunded accordingly.
Since the contractor has already paid their invoice, it’s easier to issue a credit memo equal to the amount you overbilled the contractor.
You would manually create a credit memo in your accounting system and send it to the contractor.
As a result, their balance owing will decrease.
The contractor, in turn, can use the credit memo to reduce a future payment.
Credit Memo vs. Refund
Both a credit memo and refund serve the same purpose: to reduce the amount a customer owes to the seller.
However, they accomplish this differently, and there are instances when it’s preferable to use one over the other.
A credit memo functions as a reverse invoice that the customer can apply against any future payments they make.
They input it in their accounting records as they would with an invoice.
The seller doesn’t transfer any cash to the buyer when they issue a credit memo.
Businesses typically create credit memos for customers that they have provided with a charge account.
Definition
A charge account is an account that allows the customer to purchase goods or services and pay for them in the future within a specified time period.
A refund refers to money a seller repays to a customer for a purchase they weren’t satisfied with.
The customer doesn’t enter the refund in their accounting records to apply against future payments the way they would with a credit memo.
The repaid funds are deposited into their bank account immediately.
A customer has a limited time frame to ask for a refund, while a credit memo has no expiry date and can be used at any time.
