What Is a Credit Memo (Vendor Credit)?

What a credit memo does

A credit memo says, in writing, "you owe us less than we billed." No money moves when it's issued. It lowers the balance on an invoice, or on the customer's account as a whole, and the buyer uses it by paying less or by asking for the money back.

Sellers issue them for a handful of reasons:

• goods returned, in full or in part
• a price or quantity billed wrong on the original invoice
• an allowance, which is a price cut on goods the customer keeps, such as a scratched door or an order that arrived late
• a service cancelled after it was billed
• a rebate the vendor agreed to after a certain amount of buying

A proper credit memo carries its own number and date, the number of the invoice it corrects, the items and amounts being credited and the reason.

A credit memo only changes what's owed, while a refund sends cash back. Plenty of credits end in a refund anyway, when the buyer has already paid and has no new bills coming. A debit memo works the other way: it raises what the customer owes, for example when the seller undercharged.

Credit memo and vendor credit: one document, two sides

The seller and the buyer give the same piece of paper different names, because each records it in a different place. For the seller it's a credit memo, and it reduces accounts receivable, the money customers owe the business. For the buyer it's a vendor credit, and it reduces accounts payable, the money the business owes its vendors.

QuickBooks uses both names. Its credit memo is the form a seller uses to cut a customer's balance, and a vendor credit is what a buyer enters when a vendor sends one. Vendors and other software aren't so tidy, so expect "credit note," "bill credit" or plain "credit" on the paperwork too.

Journal entries for both parties

Every journal entry has two sides that must match: debits on the left, credits on the right, equal in total. Here is the shingle return from both sides. The supply house sold the contractor 80 bundles at $42 each on invoice 4471, $3,360 in total, on 30-day terms. The supply house had paid $30 a bundle. The contractor returns 12 unopened bundles before paying, and the supply house issues credit memo CM-218 for $504 (12 x $42). Sales tax is left out to keep the numbers simple.

The supply house's books:

Each entry balances: every debit has an equal credit. The two sets of books don't mirror each other line for line, because the seller also tracks what the shingles cost it, $30 a bundle, while the buyer only ever sees the $42 price. Sales returns and allowances is what the OpenStax accounting textbook calls a contra revenue account: it carries a debit balance and is subtracted from sales to arrive at net sales.

Cost of goods sold is the expense for what the seller sold, so the sale moves $2,400 (80 x $30) out of inventory and into that expense. The return reverses it for 12 bundles, $360 at $30 each, because they go back on the shelf. For an allowance, where the customer keeps the goods, the seller records only the sales returns and accounts receivable lines.

The contractor's books, where materials go straight to the job:

Accounts payable goes from $3,360 to zero ($3,360 - $504 - $2,856), and job 112 ends up carrying $2,856 of shingles, the 68 bundles it kept. A business that keeps materials in inventory credits inventory instead of the job. Accounts receivable at the supply house also ends at zero, so invoice 4471 is closed on both sides.

How to apply a vendor credit in QuickBooks Online

Intuit's help article on vendor credits and refunds covers this when you track vendor bills in QuickBooks Online:

1. Select + Create, then Vendor credit, and choose the vendor.
2. Enter the category or items, then save. Use the same ones as the original bill, plus the same customer or project if you track jobs, so the cost comes off the right place.
3. When you're ready to pay that vendor, select + Create, then Pay bills, and pick the bill. QuickBooks automatically applies the available credit to the bill, so check the amount before you save.

Two details trip people up. If you track inventory items, Intuit notes that QuickBooks will put a selected inventory item back into inventory, and that you can make an inventory adjustment if the item is defective or you don't want it added back. And if the vendor mails a refund check for a bill you already paid, create the vendor credit, deposit the check with Accounts Payable (A/P) as the account, then use Pay bills to link the deposit to the credit, with a total payment of $0.00.

Unused credits: the part both sides forget

For the buyer, a credit nobody applies is money sitting with the vendor. It shows up as a negative balance for that vendor. Check for negative balances whenever you run your AP aging report, the list of unpaid bills grouped by how many days past due they are. If you've stopped buying from that vendor, ask for a check.

Some organizations put a clock on this. Ohio State University's accounts payable policy aims to use supplier credits within 18 months and bills the supplier for any credit still open after that. A small business can copy the idea with a shorter deadline.

For the seller, an unused credit is money owed to the customer. Left long enough, it may have to be turned over to the state as unclaimed property. California's State Controller tells California businesses to review their records every year for property with no owner activity for the dormancy period, typically three years in California, and lists customer overpayments among the common types. Other states set their own rules, so ask your CPA whether old credit balances on your books need to be reported.

Common credit memo mistakes

• Recording a vendor credit as other income. It's a smaller cost, not income, and booking it as income overstates both your costs and your revenue.
• Short paying, meaning paying less than the bill, before the credit exists. Deducting $504 from an open invoice on your own leaves the seller showing $504 past due until the paperwork catches up.
• Entering the same credit twice, once from the memo and again from the monthly statement.
• Putting the credit on the wrong job or property, which leaves one job's costs too high and another's too low.

Catching billing errors before they need a credit

Some credit memos fix errors you could have spotted on the bill: a price above the quote, 100 bundles billed when 80 arrived. Comparing each bill with the purchase order and the delivery record before you pay, a practice called three-way matching, catches these while they're still a question rather than a refund.

Clyr's bill pay and accounts payable tools take vendor invoices by email, extract the line items and flag pricing or quantity discrepancies against the purchase order. Approvals route by your rules, so an overcharge can be questioned before anyone pays it.

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