What is a credit memo?

Definition

A credit memo is a document that reduces what a customer owes on an already billed sale. It lowers accounts receivable and usually records a sales return or allowance on the Income Statement.

It is not cash leaving the bank unless you later refund. Most of the time it simply cuts the open invoice.

Where it shows up

Balance Sheet: Located in the current assets section, as a reduction to the receivable.

P&L: Related to the sales return or allowance the memo records.

Cash flow: Related to nothing extra unless a refund is later paid in cash.

See also: Sales Returns And Allowances · Invoice · Accounts Receivable

When you look at the Balance Sheet, the memo reduces the receivable sitting in current assets. The customer's open balance drops by the memo amount.

On the Income Statement, the offset is often sales returns and allowances, which reduces revenue to a net figure. It is not an operating expense line.

Cash on the Statement of Cash Flows is unchanged unless you later pay a refund. If the customer still owes more than the memo, you simply collect less; no cash moves on the day you issue it.

How it works

A customer returns goods, or you agree to a price cut, on an invoice that was already billed. You issue a credit memo instead of deleting the original invoice.

The memo names the customer, the original invoice, and the amount. Applying it reduces that invoice's open balance, or it sits as an open credit the customer can use against a later bill.

The journal is a debit to sales returns and allowances and a credit to accounts receivable. That debit is a contra-revenue account, so net sales go down while the receivable drops by the same amount.

Nothing about this step is a write-off. A write-off is for a balance you will not collect, and a credit memo is for a return, a pricing error, or an allowance you agreed to.

If you refund cash instead of cutting an open invoice, cash later leaves the bank. The memo itself is still the document that authorized the reduction.

The original invoice stays on file. The memo is the supporting document that explains why the customer now owes less.

A later payment is applied to whatever remains after the memo. Matching that cash to the reduced invoice is a different step from issuing the memo.

Example

A florist billed a cafe $400 for bread. The cafe returns stale loaves worth $80, and the florist issues a credit memo for $80.

Debit: Sales returns and allowances $80

Credit: Accounts receivable $80

Accounts receivable in current assets drops by $80, and sales returns and allowances reduces revenue on the Income Statement by $80. No cash moves unless a refund is later paid.

The cafe now owes $320 on that invoice. The original invoice stays on file, reduced by the memo.

Common mix-ups

A credit memo is not a write-off. A write-off removes a balance you will not collect, and a credit memo records a return or allowance you agreed to.

A credit memo is not a debit memo. A debit memo increases what a customer owes or adjusts a vendor balance, and a credit memo reduces what the customer owes.

A credit memo is also not a payment. A payment is cash in, and a credit memo cuts the receivable without cash unless you refund.

Related terms

• Sales Returns And Allowances: A contra-revenue account for goods sent back or price concessions given.
• Invoice: The document that bills a customer and creates a receivable.
• Accounts Receivable: Money customers owe the business for goods or services already delivered.
• Write-Off: Removing a balance from the books when it will not be collected or paid.
• Debit Memo: A document that increases what a customer owes or adjusts a vendor balance.
• Net Revenue: Gross sales after returns, discounts, and allowances are subtracted.
• Cash Application: Matching incoming customer payments to the right open invoices.
• Statement Of Account: A summary sent to a customer listing all open invoices and payments.