A credit memo and a debit memo are both commercial documents that adjust the amount a buyer owes a seller on a previous invoice. A credit memo (or credit note) reduces the amount owed, while a debit memo (or debit note) increases the amount owed or requests payment for an undercharge.
What Is a Credit Memo?
A credit memo is issued by a seller to a buyer to correct an overcharge, reflect a return, or apply a discount after the original invoice has been sent. It effectively reduces the buyer’s outstanding balance or creates a credit balance that can be used toward future purchases. For example, if a customer was billed for 100 units but only received 95, the seller issues a credit memo for the 5 missing units. The memo includes the original invoice number, the reason for the credit, and the new balance due.
Credit memos are also used when a customer returns goods. The seller acknowledges the return and reduces the receivable. In accounting, the seller records a credit memo as a reduction in sales revenue and accounts receivable, while the buyer records it as a reduction in accounts payable and inventory or expense.
What Is a Debit Memo?
A debit memo is issued by a seller to a buyer to increase the amount the buyer owes. This happens when the original invoice undercharged, when additional goods or services were provided after the invoice, or when the buyer was charged for something like a late fee or interest. For instance, if a freight charge was omitted from the original invoice, the seller sends a debit memo for the freight amount. The buyer then owes the original invoice amount plus the debit memo amount.
Debit memos also appear in banking. A bank issues a debit memo to a depositor when it charges a service fee or when a deposited check bounces. In that context, the debit memo reduces the depositor’s account balance. This is different from a seller-issued debit memo, but the term is the same.
Key Differences Between Credit and Debit Memos
The fundamental difference is direction: a credit memo decreases what the buyer owes, and a debit memo increases it. Here are the other distinctions:
- Purpose: Credit memo corrects overbilling, returns, or discounts; debit memo corrects underbilling, additional charges, or fees.
- Effect on buyer’s balance: Credit memo lowers the balance; debit memo raises it.
- Effect on seller’s books: Credit memo reduces revenue and accounts receivable; debit memo increases revenue and accounts receivable.
- Typical timing: Credit memos often follow a return or dispute; debit memos follow a discovered error or late fee.
- Banking usage: Credit memos add to a bank account (e.g., interest), debit memos subtract (e.g., service charges).
How Credit and Debit Memos Work in Practice
When a seller issues a credit or debit memo, it should reference the original invoice number and clearly state the reason. The buyer then applies that memo to the outstanding balance. For example, if a $1,000 invoice has a $100 credit memo, the buyer pays $900. If a $1,000 invoice has a $50 debit memo, the buyer pays $1,050.
In accounting software, memos are often linked to the original invoice so the system can automatically adjust the balance. If the buyer has already paid the full invoice, a credit memo can be applied to future invoices or refunded, depending on the seller’s policy. Debit memos after payment mean the buyer owes an additional amount.
Both documents should be kept for audit trails. They are not new invoices; they are adjustments. They must be approved internally and sent promptly to avoid confusion.
Common Scenarios and Examples
Here are typical situations where each memo is used:
- Return of defective goods: Seller issues a credit memo for the returned item’s value.
- Price reduction after negotiation: Seller issues a credit memo for the agreed discount.
- Shipping overcharge: Seller issues a credit memo to refund the excess shipping.
- Omitted line item: Seller issues a debit memo for the missed product or service.
- Late payment interest: Seller issues a debit memo for the interest charge.
- Bank service fee: Bank issues a debit memo to the account holder.
How to Choose Between a Credit Memo and a Debit Memo
Choosing is straightforward: ask whether the buyer now owes less or more. If the buyer owes less, use a credit memo. If the buyer owes more, use a debit memo. If you are the buyer and receive a memo, verify the reason and the math. If you are the seller, ensure the memo is issued only after proper authorization and that it references the original invoice.
For internal controls, many companies require a manager to approve any memo above a certain amount. This prevents unauthorized adjustments. Also, decide whether a credit memo should be refunded or left as a credit on account. That policy should be written and communicated to customers.
Credit Memo vs. Debit Memo in Banking
In banking, the terms are used from the bank’s perspective. A credit memo is a transaction that increases a depositor’s account balance, such as interest earned or a correction in the bank’s favor. A debit memo is a transaction that decreases the balance, such as a monthly maintenance fee or a returned deposit. For example, if a bank charges a $12 service fee, it issues a debit memo, and the account balance drops by $12. If the bank later reverses that fee, it issues a credit memo, and the balance rises.
This usage is consistent with the general principle: credit adds, debit subtracts. However, in double-entry bookkeeping, a credit can reduce an asset account, which is why the seller’s credit memo reduces accounts receivable. The banking context is simpler: credit means money in, debit means money out.
Template for a Credit/Debit Memo
MEMO NUMBER: ______________
DATE: ______________
TO (CUSTOMER): ______________
FROM (SELLER): ______________
| Original Invoice # | Invoice Date | Memo Type (Credit/Debit) | Reason | Amount |
|---|---|---|---|---|
Total Adjustment: ______________
Remaining Balance After Adjustment: ______________
Authorized By: ______________
Sample (fictional): Memo #CM-1042, dated 2024-03-15, to Acme Widgets, from Global Supplies, referencing Invoice #INV-2091, type Credit, reason “Damaged items returned”, amount $150.00, remaining balance $0.00.
Frequently Asked Questions
Can a credit memo be used as a refund?
Yes, a credit memo can serve as a refund if the buyer has already paid the invoice. The seller can either issue a cash refund or apply the credit to future invoices, depending on the agreement. The memo itself is not a payment; it is a document that authorizes the reduction.
Do debit memos require buyer approval?
Generally, a seller can issue a debit memo without prior approval if the original contract allows for additional charges (like late fees). However, the buyer has the right to dispute it. In practice, many sellers send a draft for confirmation before posting to avoid disputes.
What is the difference between a credit memo and a credit note?
There is no practical difference; the terms are used interchangeably. “Credit note” is more common in some regions, especially in the UK and Australia, while “credit memo” is widely used in the US and in accounting software.
Can a debit memo be issued after the invoice is paid?
Yes, if an underbilling is discovered after payment, the seller can issue a debit memo for the additional amount. The buyer then owes that amount separately. The original invoice is not changed; the debit memo is a separate adjustment.
How long should I keep credit and debit memos?
Keep them as long as you keep the related invoices, typically 3 to 7 years for tax and audit purposes. Check your local regulations and your company’s retention policy. They are part of your financial records.
What if a credit memo is larger than the invoice balance?
If the credit memo exceeds the outstanding balance, the excess can be refunded to the buyer or left as a credit on account. The seller should have a policy for this situation. It is not an error; it just creates a negative balance.