Credit Memo Journal Entry: Seller and Buyer Examples

What a credit memo does in the books

A credit memo (short for credit memorandum) reduces a sale that has already been invoiced. The seller records the reduction in a Sales Returns and Allowances account rather than erasing the sale, and lowers Accounts Receivable, or Cash if the money is refunded (OpenStax 6.4). For tax purposes the IRS treats these credits the same way:

"Credits you allow customers for returned merchandise and any other allowances you make on sales are deductions from gross sales in figuring net sales."

For what a credit memo is and when to issue one, see the Guide to Credit Memos. The examples below use the perpetual inventory system, as OpenStax sections 6.3 and 6.4 do; OpenStax shows the periodic-system versions in an appendix.

The entries at a glance

All figures below are illustrations written for this guide: invoice INV-2045 sold 10 units at $40.00 on account, and each unit cost the seller $22.00.

Example 1: sales return, goods back in inventory

The customer returns 3 units before paying. They are in sellable condition, so they go back on the shelf. The credit memo is for 3 × $40.00 = $120.00; their cost was 3 × $22.00 = $66.00.

Source: OpenStax 6.4 — a return before payment "increases Sales Returns and Allowances (debit) and decreases Accounts Receivable (credit)", and returned goods in sellable condition are put back with Merchandise Inventory debited and COGS credited (section 6.4).

Example 2: allowance or price reduction, nothing returned

Two units arrive scratched. The customer keeps them and you agree to take $15.00 off each, so the credit memo is for $30.00. Nothing comes back, so there is no inventory entry.

Source: OpenStax 6.4 — for an allowance the seller "does not have to consider the condition of the merchandise or return it to their inventory because the customer keeps the merchandise" (section 6.4).

Example 3: a credit memo that includes tax

If the original invoice charged tax on the items you credit and the credit memo gives that tax back, the entry gets a tax line. How you then report it depends on the tax system.

VAT or GST (UK example)

"When you issue a credit note or receive a debit note, you must adjust: the records of the taxable supplies you have made; your output tax. The accounts or supporting documents must make clear the nature of the adjustment and the reason for it."

The 20% is the UK standard rate from our verified VAT rate data (GOV.UK / HMRC). Three HMRC details matter here. If the VAT was wrong and has already been declared on a VAT Return, paragraph 18.2.6 sends you to the error-correction rules in VAT Notice 700/45 instead. Otherwise the adjustment goes in the VAT account "in the accounting period in which the increase in price or decrease in price occurs. For decreases in price this will be the accounting period where the refunded amount is paid to the customer." And under paragraph 18.2.1, when the customer can reclaim all the VAT, you and the customer may agree not to adjust the VAT at all; paragraph 18.2.3 says such a credit note "should state 'This is not a credit note for VAT'". The fields a UK credit note must show are on our UK credit note template page.

US sales tax (Texas example)

The debit to Sales Tax Payable takes back the tax you recorded as owed when you invoiced. 8.25% is the total rate the Texas Comptroller lists for Austin (Travis Co) in its city sales and use tax rates, and it is also the state's ceiling: Texas "imposes a 6.25 percent state sales and use tax" and local jurisdictions "can also impose up to 2 percent sales and use tax for a maximum combined rate of 8.25 percent" (Texas Comptroller, checked 2026-09-25). The rate on your credit memo is the one on the original invoice. This guide says nothing about how any state lets you report the credit on a sales tax return; check with your state's revenue department.

Example 4: a credit memo on an invoice that is already paid

The customer paid INV-2045 in full and then returns 3 units ($120.00). You can leave the credit on their account to use against the next invoice, or refund the money.

With the credit left on the account, the customer's receivable now shows a $120.00 credit balance until you apply it to their next invoice. With a refund, Cash goes down instead: OpenStax's example of a return after payment says the refund "increases Sales Returns and Allowances (debit) and decreases Cash (credit)" (section 6.4). In both cases, add the inventory entry from Example 1 ($66.00) if the goods go back into stock.

The buyer's side: purchase returns and allowances

The customer who receives the credit memo reverses part of its purchase. Under the perpetual system in OpenStax 6.3, a return or an allowance before payment decreases Accounts Payable (debit) and Merchandise Inventory (credit); after payment, a cash refund increases Cash instead. The IRS rule for the cost of goods sold:

"You must deduct all returns and allowances from your total purchases during the year."

Tax on the buyer's side depends on the regime

VAT or GST. If a VAT-registered buyer reclaimed the VAT on the original invoice as input tax, it takes that back when the price goes down. HMRC, paragraph 18.2.1: unless both parties agree not to adjust, "you should both adjust the original VAT charge"; paragraph 18.2.3 adds that even without a VAT adjustment "you will still need to adjust your records of outputs and inputs in order to complete your VAT Return".

US sales tax on merchandise for resale. There is no separate tax line on the buyer's side, because the IRS says: "If the property is merchandise bought for resale, the sales tax is part of the cost of the merchandise." (Publication 334, chapter 8). The tax credited comes off Merchandise Inventory with the price.

Credit memos on a bank statement and in a bank reconciliation

Banks use the same word for something different: a credit memo on your bank statement means the bank added money to your account. The word reflects the bank's point of view; as the accounting text quoted below reminds readers, "a bank account is an asset to the company BUT to the bank your account is a liability".

"Credit memos reflect additions for such items as notes collected for the depositor by the bank and wire transfers of funds from another bank in which the company sends funds to the home office bank. Check the bank debit and credit memos with the depositor’s books to see if they have already been recorded. Make journal entries for any items not already recorded in the company’s books."

OpenStax lists the same kind of item among reconciling items: "Additions such as interest or funds collected by the bank for the client" (section 8.6). When you reconcile, an addition to the book side becomes a debit to Cash; the Lumen text puts it as "If we added to the book side in the bank reconciliation, we will DEBIT cash." The credit goes to the account the money belongs to:

If the bank charged a fee for collecting the note, the text's worked example records the fee as a separate debit in the same entry. A debit memo on the statement is the reverse: a deduction such as a service charge or an NSF check.

Common mistakes

• Crediting Cash when nothing was refunded, or Accounts Receivable when the money went back. The credit side follows what actually happened: Accounts Receivable for a credit on the account, Cash for a refund (OpenStax 6.4).
• Forgetting the inventory entry on a return, or making one for an allowance. Only goods that come back into sellable stock move from Cost of Goods Sold to Merchandise Inventory (OpenStax 6.4).
• Netting the credit straight into Sales. The textbook entries keep a separate Sales Returns and Allowances account, and the IRS figures net sales by deducting returns and allowances from gross sales (Publication 334).
• Leaving the VAT unadjusted without saying so. If you and a customer agree not to adjust the VAT, the credit note should say "This is not a credit note for VAT", and both of you still adjust your records of outputs and inputs (VAT Notice 700, paragraph 18.2.3).
• Fixing a VAT error already declared with a credit note entry. HMRC sends errors already on a VAT Return to the correction methods in VAT Notice 700/45 (paragraph 18.2.6).
• Booking US sales tax on resale merchandise as a separate tax line on the buyer's side. The IRS treats it as part of the cost of the merchandise (Publication 334, chapter 8).

Credit memo journal entry FAQ

Sources

All checked on 2026-09-25.

• OpenStax, Principles of Accounting, Volume 1: Financial Accounting (Franklin, Graybeal, Cooper): section 6.3, section 6.4, section 8.6.
• IRS, Publication 334 (2025), Tax Guide for Small Business, chapters 5, 6 and 8.
• HMRC, VAT guide (VAT Notice 700), paragraphs 18.2.1, 18.2.3 and 18.2.6 (last updated 25 June 2026).
• GOV.UK, VAT rates (UK standard rate, via our VAT rate data).
• Texas Comptroller of Public Accounts, Sales and Use Tax and City Sales and Use Tax rates.
• J. D. Edwards and R. H. Hermanson, Accounting Principles: A Business Perspective (Global Text Project, CC BY), Preparing a Bank Reconciliation (Lumen Learning).