What is a Credit Memo?

A credit memorandum or credit memo is a document issued by the seller to the buyer, which acts as the source document for the sales journal that informs the buyers that the seller will decrease or credit the amount the buyer owes the seller in the trade receivables in the seller’s account.

Components

It is similar to a sales invoice and contains the following components, usually in a product-oriented industry. The detailing and particulars in the credit memo make it significant, hence the usage of the same universal and globally accepted across all sectors and industries.

  • Purchase Order number (PO)Terms of payment and billShipping address of a list of itemsPrice of each itemQuantity of each item.Date of purchaseThe total value of the transactionTotal discounted amount in terms of each product;

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Below is a picture of a typical credit memo format. We can see the parameters mentioned above in the particular format.

Significance

When sellers want to discount the buyer’s price, they can only do so at the invoice level. It created confusion in the seller’s books of account when he was required to track back the particular product, which was discounted. Also, it is difficult to break down discounted products when calculating sales taxCalculating Sales TaxThe government levies sales tax on the consumption of various goods and services as the percentage added to the product and services from which the government earns revenue and does the company’s welfare. In the United States, 38 different states have different taxes, from Alaska (1.76%) to Tennessee (9.45%).read more revenue summary. To avoid such a fuzzy business credit memo is issued. Sellers use this memo instead of using a discount to save money.

The reduction of price in the memo will be specified at a product level and is easy for the transaction. The seller can also easily track back the discounted product in the case of the credit memo.

Example of Credit Memo

Company A is a manufacturing company that provides goods to company B. These two companies have a track record and have been doing business for some time now. A has dispatched a certain quantity of goods to the B. The sales team of A has received a new price list of products. The new prices are lower than the past prices. It may be due to a decrease in raw material cost, a decrease in overheads, and so on.

The company would have charged as per past prices to B, and B would have cleared the account or not. In both scenarios, company A will send a Credit Memo to company B stating that B should reduce the amount they owe A, the price of products should be the amount mentioned, and company A will reduce the same amount in their amount receivables. The memo will be the opposite if the prices of products shipped to Company B have increased.

It is a document prepared to adjust the errors made in the sales invoice, which has already been processed and sent to the customer. Usually, it comes into the picture if the client has paid more or less than the actual price of the goods or services taken. The seller will inform the buyer how much extra he has paid in the document, and he can keep the count during the next transaction.

Why will a Seller use a Credit Memo?

  • The buyer might return a few or all purchased items to the seller.Items delivered might be defective, wrong size, or color; in other words, the delivery doesn’t meet the buyer’s expectations.The buyer has a new requirement for the same shipment from the same seller.Change is the price of items shipped to the buyer.When an invoice amount is overstated;The discount is not applied properly to the products.When the delivered goods or products get spoiled or damaged before their expiry tenure;

The above-said reasons make credit memorandum important for conducting the business transaction of buy and sell. In other words, a credit memo is the opposite of the invoice, which is generated and given to the buyer by the seller of the product or provider of service. Unless invoices, credit notesCredit NotesA credit note is a financial document that sellers provide to buyers as a token of confirmation against registered returns. It acknowledges the cancellation and lets the sellers make a credit entry to the buyers’ account for the required amount. read more cannot be pledged to liquidate it.

Limitations

  • When applying for credit, the total number of invoices should be less than or equal to 1000.When revoking the credit memo, the number of invoices should also be less than 1000.Its issuance will incur an overage smoothening rollover charge.The transaction also considers the ethical trust between the two parties in the business.The buyer might wrongly argue about the delivered goods with the sole purpose of availing of a credit memo facility.

Advantages

  • The memo is created with a single click and is easy to document rather than manual entries, which will require more time and HR.No Need to manually create negative revenue for the projects to create a credit note;The single entry containing all particulars of the business transaction and thus easy to track in the book of accounts;In the case of tracking back for discounted products, it is easy when a credit note is used instead of just an invoice.It is nothing but the invoice receipt of sale but in the exact opposite direction in terms of the book of accounts.It decreased the number of journal entries in the account, making it easy to track and report.

Conclusion

A credit memorandum makes the business transactionBusiness TransactionA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company’s financial statements.read more between buyer and seller more smooth. It might incur some charges but compared to the advantages it has when compared to the invoice receipt, a credit note is handy. It can be credit or debit, depending on the price fluctuation from the actual price. The price volatility of products over time will decide the frequency between the two parties. Overall, it can be concluded that a credit memo, when used, makes the backtracking of a particular product’s discount history easy for the seller. The seller will increase or decrease his receivables, depending on the total amount.

This has been a guide to Credit Memo (Credit Memorandum) and its meaning. Here we discuss the components of a credit memo along with its format and example. You can learn more from the following articles –

  • Debit MemoWhat is Credit Sales?Journal Entry of Sales CreditNet Credit Sales FormulaReconciling Account