The credit memo process saves time for both service providers and recipients, which is why it’s a popular billing method. However, a credit memo must also be properly reflected in the financial statements. Learn how to record a credit memo accounting entry in your accounts.

How to record a credit memo

Credit memos are an essential part of the billing process and must be recorded properly in your financial statements. A credit memo is typically issued by a seller to reduce the amount owed by a customer, but in some cases, a buyer may issue the credit memo under a self-billing arrangement — often used in ongoing business relationships to streamline invoicing.

Regardless of who issues the credit memo, accurate bookkeeping is key to maintaining clean financial records and staying compliant with tax regulations.

Simply follow these steps to record your credit memo journal entry:

  1. Receive or issue the credit memo
    Verify that the credit memo is complete and reflects the correct transaction amount.

  2. Assign a reference number
    Use a unique document number to track the credit memo within your accounting system.

  3. Enter the credit memo into your accounting software
    Record the credit memo just as you would an invoice — but with amounts reducing revenue or accounts receivable.

  4. Link the credit memo to the original invoice
    Match it to the corresponding invoice it is adjusting to maintain a clear audit trail.

  5. Adjust sales tax if applicable
    If the original transaction included sales tax, make sure the credit memo reflects the corresponding tax adjustment.

  6. Document everything
    Store the credit memo and related records according to your company’s retention policy and regulatory requirements. Proper documentation helps ensure you’re ready in case of an audit.

Note

This article refers to credit memos used to adjust or cancel an invoice. If you are correcting a previously issued invoice, the document should clearly indicate it is a corrected invoice or invoice adjustment — not a credit memo — to avoid confusion.

Credit memo journal entry example

Let’s say you’re a freelance graphic designer working with an agency. Typically, as the service provider, you would issue invoices. However, in some special cases, a self-billing agreement may be used, where the agency issues credit memos to document payment for services.

In this example, your agreed compensation for Q1 is $5,000, plus sales tax (let’s assume 8% = $400). Here’s how you, as the freelancer (seller), would record the journal entry upon receiving the credit memo and payment:

Credit memo Journal entry
Bank: $5,400 To Service Revenue: $5,000
To Sales Tax Payable (8%): $400

As the agency (buyer), assuming they are the end user (not a reseller), they would typically expense the full amount:

Journal entry Credit memo
Contracted Services Expense: $5,000
Sales Tax Expense: $400 To Bank: $5,400

To ensure the credit memo is valid and can be properly recorded, it should include:

  • Full names and addresses of both parties
  • Description of goods or services provided
  • Amounts, applicable sales tax, and total credit amount
  • Reason for the credit (e.g., return, overcharge, discount)
  • Reference to the original invoice

Please note the legal disclaimer for this article.

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