By Hasaan Fazal on November 9, 2012
A credit note is a source document providing evidence that a credit entry has been made in the financial records for specific reason which is explained on the face of this business document.
Credit note is also known as credit memo or credit memorandum as it only notifies about the entry made in the financial records of party to the transaction. Although credit note is often discussed while discussing sale returns (return inwards) or purchases return (return outwards) but credit note is also used in banking sector and we will shed some light on such use of credit note as well in the discussion below.
In buy and sell transactions, whether it is a credit transaction or cash, credit note is used basically to modify the invoice already issued and such modifications may be necessary due to following reasons:
- Return of goods due to either of the following reasons:
- Damaged goods or expired goods
- Not according to specifications mentioned in the order
- More than ordered
- Any change in quantity of items in previously placed order
- Mistake in invoice
- Arithmetic mistake
- Misapplication of discount rate
- Misapplication of sales tax requirements
- Any other mistake giving rise wrong valuation of transaction involved
- Cancellation of order i.e. no sale or purchase transaction took place
- Waiving off partly or whole of the sale consideration involved
Usually credit notes come in action when customer asks to return purchased goods and suppliers accepts the returns . In other words supplier is accepting sales return and such acceptance will give rise to a source document called credit note or credit memo.
If sales were on credit then such sale returns will cause respective debtor account to reduce and accounting entry will be to credit the related customer’s account. It is this credit entry which credit note represents. So basically credit note sent by supplier to customer means that supplier has credited the
customer’s account in his accounting books as a result of accepting the returns from customer. Against such credit memo buyer will send a debit note or debit memo to supplier indicating that a liability towards supplier has been reduced by debiting supplier’s account in customer’s accounting books.
Although credit note is sent by supplier as a result of accepting sales return. But this does not mean that it is always the case. For example if a previous invoice sent by supplier is undercasted or undervalued or for whatever reason the amount involved is lesser than actual and needs correction. If this mistake is corrected, supplier’s assets in terms of receivables will increase and on the other hand customer’s liability towards supplier will increase. To record increase in receivables supplier will debit the account thus giving rise to debit note and customer will credit the payables account thus giving rise to credit note and so debit note will be sent by supplier to customer and credit note will be sent by customer to supplier.
As credit note is one of the source documents and works in combination with invoices therefore, credit note (and also debit note) must be taken serious as they can affect entity’s entity’s rights and obligations and careless use of such documents may materially misstate financial statements. Due to same reason such source documents play important role and auditors obtain sufficient appropriate audit evidence in respect of credit and debit memorandums.
Another document with the name of credit note is used in banking sector that basically serve almost the same purpose. Credit note issued by a bank is often sent to the account holder indicating that certain amount has been credited in the account. This credit may require clarification for some student unaware how banks work. In bank’s financial books the account of the depositor or beneficiary is of credit nature as any amount held by bank on behalf of account holder is the liability of the bank therefore a credit account. And any increase in such account will require credit entry and this explains why bank issues credit note.