Credit notes and debit notes are important supporting documents for buyers and sellers for their trade transactions.
These documents help both parties settle their mismatching transactions. Both documents serve similar purposes to both parties with contrasting accounting entries.
Let us discuss what are credit and debit notes and their key differences.
What is a Credit Note?
A credit note, credit letter, or credit memorandum (memo) is a document that denotes a change in the revenue and receivables of a business.
A credit note is issued by a seller to a buyer. It is issued to document a reduction in sales for any reason. Thus, it can be termed as a negative invoice as well.
By issuing a credit note, the seller agrees to reduce the amount receivable originally from the buyer. However, it may not promise a cash return as it is often issued to record a “credit” on the buyer’s account.
The buyer would acknowledge the credit note by issuing a debit note to the seller. However, the buyer does not need to reciprocate the process.
A credit note can be adjusted by reducing the amount payable or replacing the merchandise for the same amount for the buyer.
What is a Debit Note?
A debit note is a document that indicates a debt obligation for the receiving party.
A debit note can be issued by a seller or a buyer. However, it is commonly issued by sellers in business-to-business (B2B) transactions to send as a debt obligation reminder.
A debit note can be issued to adjust the invoice amount if already sent. For instance, a seller may issue a debit note to indicate an additional amount payable or a reduction in the invoice originally generated due to a change in the purchase order.
Who Issues a Credit Note and Why?
A credit note is issued from the supplier or seller of goods/services. It is often issued to denote a reduction in the invoice amount.
So, why do sellers issue a credit note instead of a new invoice?
Issuing a new invoice would mean creating a new debt obligation. A new invoice is issued for a new trade transaction.
A credit note is issued to adjust the amount receivable by a seller for an existing invoice.
Here are a few commonly known reasons for issuing a credit note.
- It is issued to record changes in an invoice for errors or mistakes.
- A credit note is issued to acknowledge the return of damaged or wrongly delivered goods to the buyer.
- It is commonly issued to buyers if the seller did not apply the available discount at the time of issuing an invoice.
- It is commonly issued to reduce the invoice amount to offer discounts or reduce the invoice amount.
- In rare cases, a seller may issue a credit note to document the removal of bad debts or to eliminate the accounts receivable from a particular buyer.
Who Issues a Debit Note and Why?
Unlike a credit note, a debit note can be issued by the buyer and seller alike. For various reasons, a debit note is issued to serve as a reminder of the debt obligation by either side.
A debit note is commonly issued in situations where the exchange of cash against returned goods is not applicable.
Here are a few reasons for sellers to issue a debit note.
- A debit note is issued to amend the invoice already issued to a buyer. It can be issued to reflect an increase or decrease in the invoice amount.
- It can be issued to the buyer as a reminder to pay the debt owed.
- A debit note can be issued for an irrelevant product or service offered by a business.
- It can also be issued as a replacement document for the invoice as a proactive reminder.
Here are a few reasons for buyers to issue a debit note.
- It can be issued to claim refunds for damaged or returned goods.
- It can be issued to claim the discount offered by the seller not included in the original invoice.
- It can be issued to adjust the product/service rates in case of market price changes.
- A buyer can send a debit note if the seller fails to deliver the goods/services on time.
Accounting for Credit Notes – Journal Entry Example
Credit notes can be issued for various reasons as stated above. However, accounting for credit notes is similar to an adjusting entry for revenue and accounts receivable.
Let us consider a few example transactions to record credit notes.
Suppose ABC Company needs an adjusting entry for its invoice for a $ 1,000 discount before payment is made by the buyer.
The journal entry will be:
| Account | Debit | Credit |
| Revenue | $ 1,000 | |
| Accounts Receivable | $ 1,000 |
ABC Company receives a complaint and returned goods worth $ 3,000.
The journal entry will be:
| Account | Debit | Credit |
| Revenue | $ 3,000 | |
| Accounts Receivable | $ 3,000 |
ABC company offers a discount of $ 500 to its customer.
| Account | Debit | Credit |
| Discount Allowance | $ 500 | |
| Accounts Receivable | $ 500 |
ABC Company makes a cash refund of $ 2,000 to one of its customers.
| Account | Debit | Credit |
| Accounts Receivable | $ 2,000 | |
| Cash | $ 2,000 |
Accounting for Debit Notes – Journal Entry Example
A company issuing a debit note will affect its accounts payable. The company receiving the debit note would record a change in its accounts receivable.
Continuing with our examples above, now suppose XYZ Company is the buyer.
Suppose XYZ Company wants to return damaged goods worth $ 3,000 to ABC Company.
The journal entry for XYZ Company (buyer) will be:
| Account | Debit | Credit |
| Accounts Payable | $ 3,000 | |
| Inventory | $ 3,000 |
For the same transaction, ABC Company (Seller) will record the journal entry:
| Account | Debit | Credit |
| Revenue | $ 3,000 | |
| Accounts Receivable | $ 3,000 |
Similarly, both companies can record journal entries for a debit note issued by either side.
Unlike a credit note, a debit can be issued by either side.
Credit Notes as Alternative Documents
A credit note is issued by a seller company. It can be an important accounting document that helps in the accuracy of invoicing of a business.
Another case of an entity issuing credit notes is from commercial banks.
A credit note issued by banks means a credit to the account holder’s bank account. A bank often serves as an intermediary for its customers for the collection of payments through different instruments such as checks, drafts, payment orders, LCs, etc.
Therefore, when a bank credits the account of a company, it issues a credit note. An appropriate term for such documents is a credit memorandum (Memo).
Debit Notes as Alternative Documents
Some other uses of debit notes can be informal. Many businesses use debit notes as internal bookkeeping documents to record transactions without sending them to clients.
A common practice is to issue debit notes before issuing an invoice that indicates a debt obligation. A debit note before an invoice creates a cushion for final price and billing adjustments for both parties.
Credit Note Vs Debit Note – A Summary of Key Differences
A credit note and a debit note serve similar purposes but with contrasting accounting purposes.
Let us summarize the key differences between a credit note and a debit note.
Definition
A credit note is a document issued by an entity to indicate a reduction in sales for some reason.
A debit note is issued to indicate a reduction in inventory (or accounts payable) by an entity.
Issued By
Credit notes are commonly issued by sellers to buyers only. In some cases, banks also issue credit memos.
Debit notes can be issued by sellers and buyers to either side as needed.
Purpose
A credit note serves the purpose of invoicing accuracy, hence the revenue for an entity. It also keeps the accounts receivable amount accurate.
Debit notes keep the purchases of an entity accurate. Often, debit notes serve buyers to keep their payables accurate.
Reasons to Issue
Credit notes can be issued to:
- Return damaged goods
- Change an invoice amount
- Adjust discounts
- Adjust price changes
Debit notes can be issued to:
- Serve a reminder by the seller
- A change in invoice from a seller
- Return damaged goods by a buyer
- Adjust pricing or discounts by a buyer
- Cancel a transaction from the buyer
Accounting Entry
From a seller’s perspective, the accounting entry for a credit note will be:
CR Accounts Receivable DR Revenue
The journal entry for a debit will be:
CR Inventory DR Accounts Payable
Impact on the Business
A credit note indicates reduced sales for a seller. For any reason, it will be issued when there is a reduction in the revenue or accounts receivable for the company.
A debit note will result in a reduction in the inventory as well as accounts payable for the buyer.
Therefore, a debit note reduces the purchases account, and a credit note reduces the sales account.
