Credit Note

What is Credit Note?

When the purchaser sends the debit note, the seller approves of it and then sends back a credit note stating that in the books of the seller, the purchaser would be credited.

Even if it is issued just to respond to the purchaser’s debit note, it isn’t actually a good thing to happen to a seller; because a credit note is an indication that the amount of sales would be reduced.

But why the seller issues this even if he knows that it will reduce the amount of sales?

Also, have a look at Credit Note vs Debit Note

Why is credit note issued?

Basically, a business can’t exist in a vacuum. A business needs to thrive and without the reputation and the goodwill, it will not be able to perpetuate for very long.

Issuing this note is a gesture of goodwill which is shown by the seller to the purchaser by offering a credit memo stating that the amount of goods that are defective or erroneous will be taken back and for the returned amount the purchaser can avail something from the seller.

This gesture makes the relationship between the buyer and the seller rock-solid and as a result, both of these companies will thrive.

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Accounting for Credit Note

Like debit note when it is issued, one journal entry is passed.

Let’s say that MNC Company has bought goods worth of $40,000 from S&S Traders. And MNC Company finds out that 2% of the total goods purchased are defective. MNC Company would issue a debit note stating the same. What would be the journal entry in S&S Trader’s books of accounts?

To S&S Traders, $40,000 worth of goods was sold. And now it was reversed. So the journal entry would be –

Sales A/C …….Dr            800    –

To MNC Company A/C      –      800

Again one can argue that the “sales” wouldn’t be debited but to create the effect in the ledger, we will debit the “sales” account.

Here’s the full version of the journal entries before and after the issuance of this note –

MNC Company A/C………Dr      40,000     –

To Sales A/C                                     –         40,000

 

Sales A/C………..Dr          800      –

To MNC Company A/C        –      800

 

Sales Return A/C………Dr    800    –

To Sales A/C                            –      800

 

Characteristics of a Credit Note

There are few important features we need to know. Here are they –

• Credit note is issued by the seller: When the buyer issues the debit note, the seller responds by issuing this note which states that the seller would credit the buyer’s account so that the buyer needs to pay less or can avail other goods for the same amount paid.
• Credit note isn’t a good sign for a seller: It isn’t a good sign for the seller because by issuing credit note, the seller has to reduce the amount from the sales they have charged from the buyer.
• Red ink is used: Since the amount is reduced from the sales, it is perceived as a negative amount. That’s why red ink is used.
• Credit note can be issued by the buyer as well: In one condition, the buyer issues credit note for the seller. When the seller undercharges the buyer, the buyer issues the credit note for the seller.
• Sales return book is changed: As it is issued, in certain cases, sales return book is changed if the amount of sales is reduced because of defective goods.

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This has been a guide to Credit Note and why is it issued? Here we also discuss the accounting of credit notes and its characteristics. You can also learn about basic accounting from these articles below –

• What do you Mean by Financial Accounting?
• Notes Payable
• Assets vs Liabilities | Top 9 Differences
• Accounting vs Auditing Differences
• Financial Accounting vs Management Accounting