What is a Credit Note?
Credit Note is a commercial instrument which is issued by the seller of goods and services to the purchaser if goods and services are returned back to him by the purchaser informing that the account of the purchaser is credited in the books of accounts of the seller.
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 a good thing to happen to a seller; because this 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 number of sales?
Also, have a look at Credit Note vs Debit Note.
Why is Credit Note Issued?
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 number of goods that are defective or erroneous will be taken back. 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.
Accounting for Credit Note
Like debit notes, 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 were 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
There are a few important features we need to know. Here are they –
- It is issued by the seller: 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 of other goods for the same amount paid.
- It isn’t a good sign for a seller: It isn’t a good sign for the seller because by issuing a 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.
- It can be issued by the buyer as well: In one condition, the buyer issues a 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.
Credit Note Video
This article has been a guide to Credit Note and its meaning. Here we also discuss the accounting of credit notes, why they are issued, and its characteristics. You can also learn about basic accounting from these articles below –