What Is a Credit Memo? Definition With an Example

A credit memo, also known as a credit memorandum, is a formal document issued by a seller to a buyer. It reduces the amount a customer owes or provides credit for future transactions, ensuring accurate financial records.

Understanding a Credit Memo

A credit memo is official documentation from a seller, confirming a reduction in a buyer’s financial obligation. Unlike a cash refund, it provides credit for subsequent invoices or to reduce an outstanding balance. Its purpose is to adjust a customer’s account, often due to a prior sale. The seller issues it, and the buyer uses it to offset future payments or decrease current debt.

Common Scenarios for Issuing a Credit Memo

Businesses issue credit memos in various situations to correct billing issues or acknowledge product-related adjustments. One common instance is when a customer returns goods, perhaps because they are no longer needed or do not meet expectations. The credit memo then reflects the value of the returned items.

Another frequent scenario involves damaged or defective goods. If a product arrives faulty or breaks shortly after purchase, a seller may issue a credit memo for its value. Pricing errors on an original invoice, such as overcharging a customer, also necessitate a credit memo to correct the discrepancy.

If a service provided does not meet the agreed-upon standards, a seller might issue a credit memo as a partial or full adjustment for service dissatisfaction. Lastly, if an order is canceled after an invoice has already been issued but before payment or delivery, a credit memo can be used to negate the initial charge.

Key Elements of a Credit Memo

A credit memo includes a unique number for tracking and the date of issue. It links to the original invoice number and contains both customer and seller information. The document states the reason for the credit, such as “returned goods” or “pricing adjustment.” It also details the specific items, quantities, and monetary amount credited. Applicable terms for applying the credit may also be included.

Credit Memo Example

Consider Office Essentials Inc., a business selling office supplies. On July 1, 2025, Tech Solutions LLC ordered 10 ergonomic chairs at $200 each, totaling $2,000. Office Essentials Inc. issued Invoice #INV-00123, and Tech Solutions LLC received the chairs on July 5, 2025.

Upon inspection, Tech Solutions LLC found one chair defective and contacted Office Essentials Inc. on July 8, 2025. Office Essentials Inc. agreed to issue a credit for the defective chair.

Office Essentials Inc. generated Credit Memo #CM-00456 on July 9, 2025, referencing Invoice #INV-00123. The memo stated “Defective product returned” for “1 Ergonomic Chair” with a $200 credit. This document was sent to Tech Solutions LLC.

Tech Solutions LLC can apply this $200 credit against their outstanding Invoice #INV-00123, reducing their payment obligation from $2,000 to $1,800. If they had already paid the full invoice, the $200 credit would remain on their account for a future purchase.

Accounting Impact of a Credit Memo

From the seller’s perspective, issuing a credit memo reduces accounts receivable, the money owed by customers. It also impacts sales revenue. When issued for returns or allowances, it reduces net sales. Accounting systems often categorize these adjustments under a “sales returns and allowances” account, lowering reported revenue.