Credit memo vs. debit memo: the essential guide

Simply put, the credit memo is a document issued by a seller to a buyer that reduces the amount the buyer owes (hence, a “credit”), which the buyer can then apply to future purchases or use as a refund. A debit memo, on the other hand, is issued when there’s been an increase in the amount the buyer owes the seller, whether that’s the result of a price increase or underpayment.

This is just the tip of the iceberg, though. In this article, we’ll walk through the ins and outs of credit and debit memos, explain their differences in detail, and show you how they’re used in everyday small business situations. Read on as we explore credit memos vs. debit memos.

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What is a credit memo?

A credit memo, short for credit memorandum, is a commercial document issued by a seller to a buyer, reducing the amount the buyer owes. It is commonly used in situations where a customer is owed money back against a prior purchase or an invoice.

Here are some reasons why a credit memo might be issued:

• Returns and damages: When goods are returned or found to be faulty after a sale, a credit memo is used to reduce the accounts receivable and reflect the adjustment.
• Errors in billing or pricing: Should there be a mistake in invoicing – be it an accidental overbilling or a promotional discount that wasn't applied – a credit memo corrects that error, ensuring accurate financial records.

Customers can in turn use the credit they’ve received from a seller for future purchases, or they can request the credit be applied to a refund. The credit memo is a useful record, both for the seller and the buyer.

How do credit memos impact financial statements?

Needless to say, credit memos are important to review and track, and an important component of your month end close process. Here’s how credit memos are treated with respect to accounts receivable and revenue recognition:

• Accounts receivable: Issuing a credit memo reduces the amount due from a customer, affecting the accounts receivable balance.
• Revenue recognition: Since a credit memo usually reduces the sale amount, it may also impact when revenue is recognized, affecting the timing of income statement reporting.

What is a Debit Memo?

A debit memo is a document used by a vendor to inform the buyer of current or future debits made to the buyer's purchase account.

Some common reasons a debit memo might be issued include:

• Supplier overcharges: When a supplier bills for more than the agreed-upon price or quantity, the buyer may issue a debit memo to reduce the accounts payable, correcting the purchase price variance.
• Fee assessments and penalties: Charges such as late payment penalties or interest on overdue amounts sometimes require the issuance of a debit memo to communicate the additional expenses.

What are the accounting implications for debit memos?

• Accounts payable: A debit memo affects the accounts payable balance, reflecting the reduced amount or additional charges associated with a prior purchase.
• Expense incurrence: Expense accounts are impacted, aligning with additional charges or costs associated with the purchase.

Key differences between Credit memos and debit memos

While both credit and debit memos serve to rectify financial records, their operational motives and impacts are subtly distinct.

Credit memo vs. Debit memo:

• Credit memo always reduces the amount a customer owes, typically due to overpayment, returned goods, or pricing errors. In contrast, a debit memo serves to either decrease the amount the seller owes or increase the amount the buyer owes.
• The credit memo often has a direct correlation with customer satisfaction because it typically results from an acknowledgment of a fault or overcharge. A debit memo, while important for accuracy, is more commonly associated with mandatory charges and their communication to the buyer.
• From a financial standpoint, a credit memo directly impacts Services and Revenue accounts, altering the timing of income recognition, whereas a debit memo is oriented towards adjustments in Purchases and other Expense accounts.

Credit memos vs. debit memos: Relevance to small business

The use of credit and debit memos is integral to the day-to-day operations of small businesses.

For a small bakery owner, issuing a credit memo against a customer's overcharged bill can maintain customer loyalty; meanwhile, a farmer uses a debit memo to signify under-delivered produce, rectifying the situation and his account.

Inaccurate invoicing or mismanagement of these transactions can skew financial snapshots, leading to incorrect decisions and, ultimately, operational turbulence. Small business owners must understand and apply these memos to ensure their businesses are on financially sound footing. Indeed, managing credit and debit memos effectively—along with other financial records—is key to becoming agile in your accounting.

How Ramp can help you keep track of credit and debit memos

The day-to-day operations of a small business can be, to say the least, chaotic. Especially when a stack of credit and debit memos are involved.

Ramp’s one-of-a-kind small business expense software can handle a variety of time-consuming small business accounting tasks for you, including the tracking and reconciliation of credit and debit memos. Ramp’s platform not only automates much of the accounting process, but it gives you real-time insights into your financial picture, from spending to cash flow. All of this means more time for you to focus on your customers and growing your business.

Continue your learning with Ramp’s accountant-approved free guides, examples, and templates for the credit memo and debit memo.