How to record a credit note in bookkeeping

Issuing a credit note is only one part of correcting an invoice. After preparing the document, a business must also record the adjustment in its bookkeeping records so that customer balances, sales figures, purchases, and inventory values remain accurate.

For example, a supplier invoices a customer $1,000 for goods. The customer returns products worth $200, and the supplier approves the return by issuing a credit note. The supplier must record the $200 reduction in its sales and accounts receivable records. The buyer must also record the supplier's credit in its accounts payable and inventory or purchase records.

In the US, businesses commonly use the term credit memo instead of credit note. The accounting treatment depends on whether you issued the credit to a customer or received one from a supplier.

This guide explains how to record a credit note in bookkeeping, with journal entries, practical examples, and the records to keep.

What does recording a credit note mean?

Recording a credit note means entering the approved invoice adjustment into the appropriate accounts in a business's books.

The credit note acts as supporting documentation for the adjustment. The bookkeeping entry records its financial effect.

A credit note may affect:

• Accounts receivable: The amount a customer owes the business.
• Sales returns and allowances: A contra-revenue account used to record reductions in sales.
• Accounts payable: The amount the business owes a supplier.
• Inventory or purchases: The value of goods returned to a supplier or received back from a customer.
• Expenses: Costs that need to be reduced when a supplier issues a credit for a previously billed service or expense.
• Tax accounts: Applicable tax amounts may need to be adjusted according to the original transaction and relevant rules.

The exact accounts depend on the transaction, accounting method, inventory system, and chart of accounts.

How to record a credit note in bookkeeping

The process begins by identifying who issued the credit note and which original transaction it adjusts.

Step 1: Review the original invoice

Locate the invoice associated with the credit note. Check the customer or supplier name, invoice number, issue date, products or services, quantities, prices, and applicable taxes.

Confirm that the credit amount matches the approved adjustment. If the credit relates to returned goods, check the return documentation. If it corrects an overcharge, verify the agreed price or original order.

Step 2: Check whether you issued or received the credit note

The bookkeeping entry differs depending on your role.

• If you are the seller: You issue a credit note to reduce the amount a customer owes you. This generally affects sales returns and allowances and accounts receivable.
• If you are the buyer: You receive a credit note from a supplier. This generally reduces accounts payable and adjusts inventory, purchases, or the related expense.

Do not use the same journal entry for both sides of the transaction.

Step 3: Identify the accounts affected

Determine which accounts need to change.

For a seller-issued credit note, the common accounts are:

• Sales Returns and Allowances
• Accounts Receivable

For a supplier credit note received by a buyer, the common accounts are:

• Accounts Payable
• Inventory or Purchases Returns and Allowances

If the adjustment relates to a service rather than inventory, the buyer may need to reduce the relevant expense account instead.

Step 4: Prepare the journal entry

Record the adjustment using the appropriate debit and credit entries. The total debits must equal the total credits.

Use the examples below as a starting point. They illustrate simplified accrual-basis bookkeeping entries before any applicable tax adjustments.

Step 5: Update the customer or supplier balance

Post the entry to the relevant customer or supplier account.

For a seller, the credit should reduce the customer's accounts receivable balance. For a buyer, the supplier credit should reduce the amount payable.

If the credit is applied to a specific open invoice, make sure the invoice and credit memo are linked in the customer or vendor subledger.

Step 6: Reconcile the records

Compare the original invoice, credit note, journal entry, and updated customer or supplier balance.

If money has also been refunded or received, check the related bank or payment record. A credit note documents the adjustment, but it does not by itself prove that a payment has been returned.

How a buyer records a credit note received from a supplier

When a buyer receives a credit note from a supplier, the amount owed to that supplier decreases.

The corresponding credit usually reduces inventory, purchases returns and allowances, or the expense originally recorded.

Example: Business returns goods worth $300 to a supplier

A retailer purchases inventory worth $1,500 from a supplier on credit. Some products are defective, and the supplier approves a return worth $300 by issuing a credit note.

The buyer records the supplier credit.

Journal entry under a perpetual inventory system:

Account	Debit	Credit
Accounts Payable	$300
Inventory		$300
Total	$300	$300

The debit reduces the amount payable to the supplier. The credit reduces the inventory value because the returned goods are no longer held by the business.

The revised supplier balance is:

Description	Amount
Original supplier invoice	$1,500
Supplier credit note	-$300
Revised amount payable	$1,200

Under a periodic inventory system, the buyer may credit Purchases Returns and Allowances instead of directly reducing the Inventory account. The correct treatment depends on the inventory method used.

How to record a credit note for services or expenses

Not every credit note relates to returned inventory. A supplier may issue a credit because it overcharged for a service, agreed to a discount, or billed for work that was not completed.

In this situation, the buyer generally reduces the expense originally recorded and reduces the amount payable to the supplier.

Example: Supplier issues a $150 service credit

A business receives a supplier invoice for $900 for professional services. The supplier later approves a $150 credit because part of the service was not delivered.

The buyer records the credit as follows:

Account	Debit	Credit
Accounts Payable	$150
Professional Services Expense		$150
Total	$150	$150

The credit reduces both the supplier balance and the expense recorded for the service.

If the original amount was recorded in a different expense account, use that account when recording the adjustment.

How to record a credit note against a paid invoice

A credit note can also be issued after the original invoice has been paid.

In this situation, the credit may create an amount owed back to the customer. The business can retain it as an account credit or process a separate refund, depending on the agreement.

Example: Customer receives a $250 credit after paying

A customer pays an invoice of $1,200 in full. The seller later approves a $250 credit for returned goods.

The seller first records the credit memo:

Account	Debit	Credit
Sales Returns and Allowances	$250
Accounts Receivable		$250
Total	$250	$250

The customer's account now has a $250 credit balance, assuming the original invoice has been fully settled.

If the seller refunds the $250 in cash, the separate refund entry is:

Account	Debit	Credit
Accounts Receivable	$250
Cash		$250
Total	$250	$250

The refund entry clears the customer credit balance and records the cash leaving the business.

If the customer chooses to apply the credit to a future invoice, the business retains the credit on the customer account and applies it when appropriate. No cash refund entry is made in that case.

How do credit notes affect sales, purchases, and financial records?

Credit notes can affect several parts of a business's bookkeeping.

Account or record	Effect of a seller-issued credit	Effect of a supplier credit received
Accounts Receivable	Decreases	Not applicable to the buyer's own receivables
Sales Returns and Allowances	Increases as a contra-revenue account	Not applicable
Accounts Payable	Not applicable to the seller's customer balance	Decreases
Inventory	May increase if returned goods are resalable	Usually decreases for goods returned to the supplier under a perpetual system
Purchases Returns and Allowances	Not applicable	Increases as a reduction of purchases under a periodic system
Expenses	Depends on the seller's adjustment	May decrease if the credit relates to a previously recorded expense

The IRS explains that sales returns and allowances are deductions from gross sales when calculating net sales, while purchase returns and allowances are deducted from total purchases. The precise bookkeeping accounts still depend on the business's accounting method and inventory system.

What happens to sales tax when a credit note is recorded?

If the original invoice included sales tax, a credit note may also require a related tax adjustment. The correct treatment depends on the original transaction, the type of adjustment, and applicable state and local rules.

For example, a returned taxable item may require an adjustment to the sales tax originally collected. However, businesses should not assume that every credit note has the same tax treatment.

Before posting the entry:

• Check whether the original invoice included sales tax.
• Confirm whether the credit applies to the taxable amount.
• Review the applicable state and local rules.
• Use the correct tax accounts and reporting process.
• Keep the original invoice and credit note together.

The journal entries in this guide exclude tax to keep the examples clear. Consult a qualified tax professional or the relevant tax authority when the adjustment affects tax reporting.

What records should you keep with a credit note?

A credit note should be supported by records that explain the original transaction and the reason for the adjustment.

Keep the following documents together:

1. Original invoice: The invoice being adjusted.
2. Credit note: The document showing the approved credit.
3. Customer or supplier details: The name and account associated with the transaction.
4. Reason for the credit: Such as returned goods, an overcharge, or an approved discount.
5. Return or delivery evidence: Relevant receiving records, return authorizations, or inspection details.
6. Journal entry reference: The bookkeeping record for the adjustment.
7. Payment or refund confirmation: If money was returned or received.
8. Related communication: Any approval or agreement supporting the adjustment.

The IRS recommends keeping supporting documents such as invoices, receipts, paid bills, deposit slips, and canceled checks to support entries in business books and tax records.

Organize these records by customer or supplier, transaction date, and document reference so that the adjustment can be traced later.

Common bookkeeping mistakes when recording credit notes

1. Recording the credit on the wrong side of the transaction

A seller issuing a credit to a customer and a buyer receiving a supplier credit do not use the same journal entry. Identify your role before posting the adjustment.

2. Reducing accounts receivable without recording the sales adjustment

A seller should not simply reduce the customer's balance without recording the corresponding sales return, allowance, or other appropriate account.

3. Reducing accounts payable without adjusting the related purchase or expense

When a supplier credit is received, the buyer should identify which inventory, purchase, or expense account the credit relates to.

4. Forgetting the inventory adjustment

If goods are returned, the inventory and cost-of-goods-sold entries may also need to change. The treatment depends on the inventory system and the condition of the returned goods.

5. Treating a credit note as a refund

A credit note records an adjustment. A separate entry is needed when money is actually returned to the customer.

6. Recording the same adjustment twice

Check whether the credit note has already been entered or imported into the accounting system. Duplicate entries can incorrectly reduce customer or supplier balances.

7. Failing to retain supporting documents

Keep the original invoice, credit note, approval, and any return or refund evidence together. This makes it easier to reconcile the accounts and explain the adjustment.

Frequently asked questions

Is a credit note recorded as a debit or a credit?

It depends on which business is recording it and which account is affected. A seller generally debits Sales Returns and Allowances and credits Accounts Receivable. A buyer receiving a supplier credit generally debits Accounts Payable and credits Inventory, Purchases Returns and Allowances, or the relevant expense account.

What is the journal entry for a credit note issued to a customer?

A simplified seller-side entry is:

• Debit Sales Returns and Allowances.
• Credit Accounts Receivable.

This records the reduction in sales and the amount the customer owes. Tax and inventory adjustments may require additional entries.

How do you record a credit note received from a supplier?

A simplified buyer-side entry is:

• Debit Accounts Payable.
• Credit Inventory, Purchases Returns and Allowances, or the related expense account.

The appropriate credit account depends on the type of purchase and inventory accounting method.

Does a credit note reduce revenue?

For a seller, a credit note related to a sales return or allowance generally increases the Sales Returns and Allowances contra-revenue account, reducing net sales. The exact account treatment depends on the reason for the adjustment.

Does a credit note affect accounts receivable?

Yes. When a seller issues a credit memo against a customer's invoice, it generally reduces the customer's accounts receivable balance. If the invoice has already been paid, the credit may create a customer credit balance until it is refunded or applied elsewhere.

How do you record a credit note after an invoice has been paid?

The seller records the approved credit against the customer's account. If the business returns the money, it records a separate cash or bank refund entry. If the credit is retained for a future purchase, it remains on the customer account until applied.

Does a credit note affect inventory?

It can. When a customer returns resalable goods, a seller using a perpetual inventory system may restore the goods to inventory and reverse the related cost of goods sold. When a buyer returns goods to a supplier, the buyer may reduce inventory. The treatment depends on the inventory system and the condition of the goods.

Is a credit note the same as a journal entry?

No. A credit note is a business document that supports an invoice adjustment. A journal entry records the financial effect of that adjustment in the accounting books.

Do credit notes need to be recorded for tax purposes?

Credit notes can affect reported sales, purchases, and applicable tax amounts. The treatment depends on the transaction and relevant tax rules. Businesses should retain supporting records and follow the requirements that apply to them.

Final thoughts

Recording a credit note correctly helps keep customer balances, supplier accounts, sales, purchases, and inventory records accurate.

If you issue the credit to a customer, record the reduction in sales and accounts receivable. If you receive a credit from a supplier, reduce accounts payable and adjust the related inventory, purchases, or expense account. If money is refunded, record that payment separately.

Always connect the credit note to the original invoice and retain the supporting documents. This makes bookkeeping easier to reconcile and gives the business a clear history of every adjustment.

If you need to prepare the supporting document, use the free Credit Note Generator to create and download a credit note PDF. The generator prepares the document; journal entries and account updates must be handled separately in your bookkeeping system.

Sources and further reading

• IRS Publication 334: Tax Guide for Small Business
• IRS Publication 583: Starting a Business and Keeping Records
• AccountingCoach: What Is a Credit Memo?