A Credit Memo Journal entry is a way of offsetting the previously recorded sales transaction.
Not all Sales transactions are final; there can be sales returns.
The best example is the e-commerce business, which offers a 7-day return or replacement policy for each sale.
In other words, customers who purchase goods from e-commerce websites have the option to return the goods with full money back for any reason. Off-course, the caveat here is that the goods shall not be used.
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What is a Credit Memo?
A credit Memo is a statement from the debtor or customer confirming that they are returning the purchases made. It also confirms that the business owes money to its customers in case of cash sales.
This Memo comprises details of the Contract number, Purchase order, the quantity of goods, the reason for return, shipping details, etc.
The terms Credit Memo and Credit Notes are the same. We can use these two as interchangeable terms.
Recording Credit Memo Journal Entry
Recording the Credit Memos is nothing but a reversal of the sales transaction. We will examine how to record the sales transaction.
1. Cash Sales
2. Credit Sales
We can expect the credit memos often in credit sales in B2B transactions. However, there are returns in cash sales in case of B2C transactions.
There is no rule that only credit sales will have reversals. It can be in either of the sales. Let’s record the credit memo journal entries.
Credit Memo Journal Entry
In case of Cash Sales
In case of Credit Sales
All credit memo transactions are pretty straightforward. However, there can be some disagreements between the buyer and seller, which might lead to partial recognition of the credit memo after reaching a consensus.
There is no change in the entry structure.
The balance at which the entry is recorded will differ as per two parties understanding.
The traditional business accounting practice requires to post these reversals through a separate account called as Sales return GL account instead of recording it directly to Sales GL account. This different GL enables to have a detailed record of such transactions.
Initially, the reversals are recorded through sales return and subsequently, we offset the sales return with the sales GL account. The end result is same as the sales return is a parking account.
Frequently Asked Questions
Is a credit memo a refund?
The nature of the Credit Memo seems similar to a refund. Irrespective of Cash or Credit sales, there will be reversal of sales transaction.
Generally, there will not be any refund because none likes to give back the cash received (in case of cash sales). Instead they come up with arrangement which results in offsetting the credit memo amount with the further receivable balance from the same customer.
In other words, we can adjust the credit memo against the amounts which are upcoming due to the business.
Why is a credit memo issued?
The issuance of the Credit Memo can be due to the rejection of goods due to quality, not meeting the product specification, delay in shipping, product damages, etc.
Is a credit memo a journal entry?
Credit Memo warrants for recording it as a transaction. That’s because the previously recorded sale is no longer valid. So, the initial sales transaction is reversed in the books.
Is a credit memo a legal document?
Yes, a credit memo is a valid legal document. Raising of credit memo has a prerequisite of agreement of both parties (buyer and seller) for such a return of goods.
Is a credit memo a loan?
The loan is different from a credit memo. The underlying purpose of both these is different. The loan is to finance business operations or expand business boundaries. However, trading goods might result in returns, which is the basis for raising credit memos. So, a credit memo is a reversal of the sale transaction and relieves the customer from honoring the payment against the purchases.
What is another name for a credit memo?
A credit note is another name for the Credit memo.
Summary
Credit Memo is a document to confirm the reversal of sales. This transaction is recorded by debiting the sales and crediting the cash account or debtor account. Accounting of the credit memo happens once both the seller and buyer are good with such a return of sales. There shall be an agreement between the parties in the sale of the contract for such sales return.