A credit note (also called a credit memo) is a document issued by a seller to reduce the amount a customer owes on a previously issued invoice. It serves as an official adjustment to correct an invoice after it has been created, while keeping a clear audit trail of what changed and why.
Credit notes are commonly used when goods are returned, services are cancelled, the wrong price was charged, or an invoice contains an error. In accounting, they ensure customer balances, revenue figures, cash flow↗ reporting, and tax reporting reflect the corrected transaction rather than the original, incorrect amount.
What is a credit note?
A credit note is essentially the opposite of an invoice: instead of requesting payment, it confirms that the customer’s account has been credited for a specified amount. It may reduce an outstanding invoice balance or create a credit balance that can be refunded or applied to future invoices.
Importantly, a credit note does not usually replace or delete the original invoice. Instead, it links back to it and records the adjustment formally—this is key for accounting accuracy and traceability.
When should you issue a credit note?
Credit notes are issued when the original invoice needs to be reduced after the fact. Common scenarios include returns, cancellations, or billing mistakes that are discovered after the invoice has been sent.
For example, a credit note may be required when a customer returns part of an order, when an item is damaged and a partial discount is agreed, or when an invoice was issued with the wrong quantity, unit price, tax rate, or discount. Credit notes are also used when a duplicate invoice was issued or when a service is not delivered as agreed. Being able to issue credit notes is an important part of effective invoice management↗.
How does a credit note work?
A credit note is typically created with a reference to the original invoice and the amount being credited. What happens next depends on whether the invoice is still unpaid or has already been paid.
If the invoice is unpaid, the credit note reduces the amount due and the customer pays the corrected balance. If the invoice has already been paid, the credit note records that the customer is owed value back. Businesses usually handle this either by issuing a refund or by applying the credit to a future invoice.
Either way, the credit note creates a clear accounting record that ties the correction to the original transaction.
Credit note vs. refund
A credit note and a refund are related but not the same thing. A credit note is the accounting document that reduces what the customer owes (or creates a customer credit balance). A refund is the action of returning money to the customer.
In many workflows, a credit note comes first to document the adjustment, and the business then decides whether to refund cash or apply the amount as credit toward a future purchase.
Credit note vs. debit note
A credit note reduces the invoiced amount. A debit note is generally used in situations where the amount should be increased, such as when the customer was undercharged or additional goods/services were provided after the original invoice.
In simple terms: credit notes decrease balances, while debit notes increase them.
What information should a credit note include?
To be useful operationally and in accounting, a credit note should clearly identify the transaction it relates to and the nature of the adjustment. Most credit notes include a unique reference number and date, supplier and customer details, the original invoice number, a description of what is being credited, and the credited amount (often including tax treatment where relevant).
Clear references and consistent formatting reduce disputes and make invoice reconciliation↗ significantly easier.
How are credit notes recorded in accounting?
Credit notes affect both customer balances and financial reporting↗. They typically reduce accounts receivable↗ and reduce revenue (or are recorded against returns/allowances, depending on the accounting setup). If the credit relates to returned goods, there may also be inventory and cost-of-goods adjustments.
The main purpose is consistency: credit notes ensure the accounting records reflect the corrected reality of the transaction, rather than leaving the original invoice unadjusted.
Why credit notes matter for tax and compliance
Credit notes play an important role in keeping tax reporting accurate, because they change the taxable amount of a sale. When an invoiced amount is reduced, businesses may need to reflect that reduction in VAT or sales tax reporting, depending on local rules.
They also support audit trails by showing exactly what changed after invoicing and maintaining a consistent link between the original invoice and the correction.
Best practices for managing credit notes
Credit notes are easiest to manage when they are created consistently and linked directly to the original invoice. It’s also helpful to standardise common credit note reasons (such as returns, pricing errors, cancellations) so reporting remains clean and disputes are easier to resolve.
Finally, finance teams typically separate the ‘credit note issued’ step from the ‘refund processed’ step to avoid over-crediting a customer or duplicating adjustments.
Summary
A credit note is a formal document that reduces or corrects a previously issued invoice. It is used for returns, cancellations, discounts, and invoice errors, helping businesses keep customer balances, accounting records, and tax reporting accurate while maintaining a clear audit trail.