What is a credit note?
A credit note is a document a seller issues to cancel or reduce an invoice, so the customer owes less than the invoice first said. Sellers raise one when goods come back, when an invoice charged too much, or when the two sides agree a discount after the sale. The original invoice stays on file and the credit note sits against it. In the US the same document is usually called a credit memo.
A credit note does not move any money by itself. It lowers the balance on the customer's account, and the customer then either pays the smaller amount, keeps the credit for a later invoice, or asks for a refund. That is why it matters in accounts receivable: if the credit note is missing, your ledger says the customer owes money they do not owe, and every reminder you send is wrong.
It reduces an invoice.A credit note lowers or cancels what a customer owes on an invoice you already sent.
It is not a refund.No cash moves until the customer pays less, uses the credit later, or you pay it back.
Tax follows it.Where VAT or GST was charged, the credit note reverses the tax in the same proportion.
When to issue a credit note
Issue a credit note whenever the amount on a sent invoice is no longer the amount the customer should pay. The common reasons are:
- The customer returned some or all of the goods.
- You charged the wrong price, the wrong quantity, or the wrong customer.
- You agreed a discount, rebate or allowance after the invoice went out, for example for late delivery or damaged goods.
- You are cancelling an invoice that should never have been sent.
Do not delete or edit an invoice that has already gone to a customer. Raise a credit note against it, then send a new invoice if a corrected amount is still due. That keeps the audit trail clean and keeps your invoice numbers in sequence.
What goes on a credit note
A credit note looks like an invoice with the amounts shown as a reduction. For VAT purposes in the UK, HMRC lists what it must show in VAT Notice 700, paragraph 18.2.3, and the list below follows it.
A number and a dateIts own identifying number and the date you issue it.
Both partiesYour name, address and VAT number, and the customer's name and address.
The original invoiceThe number and date of the invoice it credits.
What is creditedA description of the goods or services, with the quantity and amount for each line.
The totalsThe total credited before VAT, and the rate and amount of VAT credited.
HMRC also says a credit note must reflect a genuine mistake, an overcharge or an agreed reduction in the value of the supply. It must also give the customer the value it shows, and it cannot be used to deal with a bad debt.
Credit note rules by country
The name and the tax rules change by country, but the job is the same everywhere: reduce an invoice and reverse the tax on it. The table shows the term each tax office uses.
| Country | Usual term | Official source |
|---|---|---|
| United Kingdom | Credit note (VAT credit note) | HMRC VAT Notice 700, section 18 |
| Australia | Adjustment note (for GST) | ATO, adjustment notes |
| New Zealand | Supply correction information (formerly credit note) | IRD, credit and debit notes |
| United States | Credit memo | No federal VAT; any sales tax charged is reversed under the rules of the state that taxed the sale |
In New Zealand the term changed on 1 April 2023, when IRD replaced credit and debit notes with supply correction information. It needs the seller's name and GST number, the date of the correction, details that identify the original supply, and the correction itself, according to IRD.
Credit note vs debit note vs refund
| Document | What it does | Moves cash? |
|---|---|---|
| Credit note | Lowers what the customer owes on an invoice | No |
| Debit note | Raises what the customer owes, for example after an undercharge | No |
| Refund | Pays money back to a customer who has already paid | Yes |
A credit note and a refund often go together. If the customer already paid the full invoice, the credit note records that they overpaid, and the refund sends the money back. If they have not paid yet, the credit note alone is enough, because they simply pay the lower balance.
How a credit note is recorded
In the seller's books a credit note reduces accounts receivable and reduces sales (or increases a sales returns and allowances account), plus the output tax where tax was charged. In Xero and QuickBooks Online you create the credit note against the customer, then allocate it to the invoice it corrects. Once allocated, the invoice shows the lower balance and drops out of the aging report if the credit clears it.
An unallocated credit is a common source of confusion. The customer sees a credit on their account but the invoice still looks unpaid, so a reminder goes out for money they do not owe. Allocate every credit note as soon as you raise it.
What is a credit note in simple terms?
Is a credit note the same as a credit memo?
Is a credit note a refund?
Who issues a credit note, the buyer or the seller?
Can I just edit or delete the invoice instead?
Does a credit note need VAT on it?
Credit notes and getting paid
Credit notes are easy to raise and easy to forget. A credit that is not allocated, or not shown to the customer, makes your statements wrong and your reminders look careless. When you send account statements from Paidnice, credit notes can show as negative lines next to the open invoices, so the customer sees the same balance you do. You can make one with the free credit note generator if you do not raise them in your accounting software.
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