Credit Note Accounting
What is a Credit Note?
Running a business isn’t always smooth sailing—sometimes things go wrong with invoices. Maybe a customer returned an item, you gave a discount after sending the bill, or you simply made a small mistake. That’s when a credit note comes to the rescue. Think of it as a straightforward way to correct an invoice without complicating your financial records. In this post, we’ll walk through what a credit note is, when you might need one, and how to use it in your business.
Credit Note Definition
A credit note is a document a business gives to a customer to correct or reduce the amount on a sales invoice. It’s often issued when goods are returned, a discount is applied, or an error was made on the original bill. Instead of refunding money immediately, the credit note indicates that the customer has a “credit” with your business that can be used against future purchases or refunded if needed.
A credit note is part of the double entry bookkeeping process and is usually created in an accounting package like QuickBooks, Xero or FreshBooks.
Credit Note vs. Refund: What’s the Difference?
A credit note doesn’t always mean you hand cash back to the customer. Instead, it shows that the customer has a balance (or “credit”) with your business that can be used to reduce future invoices.
A refund, on the other hand, is when you actually give money back to the customer.
Think of it this way:
- Credit note = “You don’t owe me as much as I first said.”
- Refund = “Here’s your money back.”
How Does a Credit Note Work?
A credit note works like a correction to an original invoice. Instead of changing or deleting the original invoice, you issue a separate document that reduces the amount owed.
Here’s the flow:
- Invoice issued – You bill your customer for goods or services.
- Problem found – Perhaps goods are being returned, a discount applies, or an error is identified.
- Credit note issued – You create a credit note showing the amount to be reduced.
- Customer’s balance updated – The customer now owes less, or if they already paid, they can receive a refund or use the credit against a future invoice.
- Accounts adjusted – In your bookkeeping, sales and VAT (if applicable) are reduced, keeping everything accurate.
👉 Think of a credit note as an “undo button” for part (or all) of an invoice — it keeps the paperwork clear for both you and your customer.
When Should You Issue a Credit Note?
Credit notes are used whenever you need to adjust an original invoice after it’s been sent. Some everyday situations include:
- Returned goods – A customer sends back items because they’re faulty, damaged, not what they ordered, or ordered the wrong quantity.
- Overbilling or mistakes – You accidentally charged the wrong amount, included the wrong product, or added too much VAT.
- Pricing corrections or discounts – You agreed on a discount after sending the invoice, or you need to adjust the price.
- Order cancellations – All or part of an order is cancelled after being invoiced.
👉 In short: if an invoice needs to be reduced or corrected, you should issue a credit note. It keeps both your books and your customers’ records accurate.
How to Issue Credit Notes
The easiest way to issue a credit note is to use invoicing software; the feature will be available to issue a credit note. If you have issued an invoice, it is always good practice not to amend or delete it but to create a credit note. This means the records are still correct, and the customer has the same paperwork.
Depending on the accounting system used will depend on how you issue a credit note. If you are using an accounting package, there may be an option to issue a credit note directly from the invoice. This means some details have been posted for you, but you may need to make some adjustments. All accounting packages can create credit notes in their systems. If unsure how to issue them, look at the help documents.
Some popular accounting packages include QuickBooks, Xero, FreshBooks, and a free version of Pandle, including online invoicing.
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Once the document is created, leave it until payment is received or allocate it against the invoice. Allocating it against the invoice will reduce the amount of the invoice.
If you use a manual system, then our free template in Excel is suitable. The template is available for download at the bottom of this page.
What Information Should I Include on a Credit Note?
The layout of a credit note is very similar to an invoice, and you should include as much information as possible.
Here is a list to include on a credit note:
- The word Credit note
- Your business information
- The customer information
- Unique credit note number
- Date
- The original invoice number
- Description
- Quantity
- Amounts
- Any discounts
- VAT (if registered)
- The total amount of the credit note
- Reason for the credit
Credit Note Example
Below are two examples created using our template. The first sample is when a credit note cancels an invoice in full for the return of goods.
The second is for services of 50.00 as the customer was not happy with the work carried out; this is a partial credit.
Credit Note Template
Our free credit note template is designed in Excel and is free to download using the link at the end of the page.
Follow the instructions below to create your own completed form to email or post to your customer:
- Open the document and create a template by adding your business logo and details.
- Save this as a template to use again.
- Once you have created the template, enter the rest of the details, including as much information as possible. It is always good practice to reference the original invoice number and include the reason for issuing the document.
- Save the credit memo using the document reference number.
Credit Note Accounting Entry
If you use a double-entry accounting system, the credit note will automatically post to your accounts once you save it. The entries will be:
- Debit Sales (or Sales Returns) – this reduces your sales figure.
- Credit Accounts Receivable (Debtors) – this lowers the amount your customer owes.
In short, the credit note reduces both your sales and the outstanding balance on the customer’s account.
Example: Recording a Credit Note in Your Accounts
Let’s say you issued an invoice for £240 (including £40 VAT).
The customer later returns goods worth £60 (including £10 VAT).
You issue a credit note for £60.
Original invoice posted as:
- Debit: Accounts Receivable (Debtors) £240
- Credit: Sales £200
- Credit: VAT Payable £40
Credit note posted as (to reduce the invoice):
- Debit: Sales Returns £50
- Debit: VAT Payable £10
- Credit: Accounts Receivable (Debtors) £60
Result:
- The customer’s balance is reduced by £60.
- Sales and VAT are adjusted correctly.
A Credit Note for an Unpaid Invoice
If you have an outstanding invoice and know that the customer will not pay it, a credit memo can be issued to clear the account. Before you issue it, ensure that you have gone down every route to try and receive payment. The invoice can also be written off as a bad debt.
Read our guide on credit control to find the best ways to request payment of invoices.
Licence Agreement
By downloading our free templates, you agree to our licence agreement, allowing you to use the templates for your own personal or business use only. You may not share, distribute, or resell the templates to anyone else in any way.
Other Useful Templates
At Business Accounting Basics, we have helped many small businesses by providing free Excel bookkeeping templates. Here are some of our templates that you may find useful:
Sales Invoice – Brand your sales invoices
Cash Book – Record income and expenses and produce a profit and loss account.
Credit Note Conclusion
Credit notes might sound a bit technical, but they’re simply a way to keep your invoices and accounts accurate. Whether it’s a return, a discount, or a simple mistake, issuing a credit note makes sure both you and your customer have a clear record of what’s changed.
By using credit notes properly, you’ll keep your bookkeeping tidy, stay compliant with HMRC rules, and build trust with your customers. It’s a small document that makes a big difference in keeping your business finances running smoothly.
