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 to the seller n the trade receivables in the seller’s account.
Components of Credit Memorandum
A credit memo is similar to that of 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 and hence the usage of the same universal and globally accepted across all sectors and industries globally.
- Purchase Order number (PO)
- Terms of payment and bill
- Shipping address of a list of items
- Price of each item
- Quantity of each item.
- Date of purchase
- The total value of the transaction
- Total discounted amount in terms of each product.
Below is the picture of a typical credit memo format. We can see the parameters of the credit memo mentioned above in the particular format.
Significance of Credit Memorandum
Sellers use a credit memorandum instead of using a discount to save money. When sellers want to discount the price for the buyer, they are able to do only at the invoice level. This created confusion in the seller’s books of account when he is required to track back the particular product which was discounted. Also during calculating sales tax revenue summary, it is difficult to break down for discounted products. To avoid such a fuzzy business credit memo is issued.
The reduction of price in credit memo will be specified at a product level and are easy for transactions also. The seller can also track back the discounted product with ease in the case of the credit memo. The components listed in the above section will throw insight into how detailed invoices a credit memo will be.
Example of Credit Memo
Let’s discuss the credit memorandum in detail with an example. Company A is a manufacturing company with 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 actually lower than the past prices. This may be due to various reasons like 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 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 decrease in the price of products should be the amount mentioned and company A will reduce the same amount in their amount receivables. The credit memo will be in the opposite direction if the prices of products shipped to Company B have increased.
Usually, it comes into picture if the client has paid more or less than the actual price of the goods or services taken. It is a document prepared to adjust the errors made in the sales invoice which has been already processed and sent to the customer. The seller will inform the buyer how much extra he has paid in the document and he can keep the count of it during the next transaction.
Why a Seller will use a Credit Memo?
- The buyer might return a few or all purchased items to the seller.
- Items delivered might be defective, wrong size, color, in other words, the delivery doesn’t meet the buyer’s expectations.
- The buyer has a new kind of 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 on 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 notes cannot be pledged to liquidate it.
Limitations of Credit Memorandum
- When applying for credit, the total number of invoices should be less than or equal to 1000.
- When revoking the credit memo also the number of invoices should be less than 1000.
- Credit memo 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 a credit memo facility.
- The memo is created with a single click and is easy to document rather than doing 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 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 which in turn makes it easy for tracking and reporting.
A credit memorandum makes the business transaction between buyer and seller happen in a smoother way. It might incur some charges but compared 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. Price volatility of products over the course of time will decide the credit memo 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 receivable depending on the credit memo’s total amount.
This has been a guide to Credit Memo (Credit Memorandum) and its meaning. Here we discuss the components of credit memo along with its format and example. You can learn more from the following articles –