Credit Note vs Debit Note

Credit Note is a letter send from supplier to customer in order to notify the credit balance has been applied to him or her. A credit note may result from goods return or error in the original invoice issued by the supplier. In simple word, it is the negative invoice which has the opposite meaning from normal invoice. Supplier issue credit note to cancel the original invoice or reduce the amount in the original invoice. The customer needs to pay only the remaining balance (original balance less amount on credit note). If the remaining balance is zero, the customer does not require to pay, and the credit note completely cancels the original invoice.

Reasons for using Credit Note:

  • Customer returns the goods due to the quality issue
  • Customer claim for credit note due to damage during transportation
  • The price on the original invoice is different from Purchase order due to the mistake of supplier
  • Customer overpaid the previous invoice due to the error during payment processing
  • The supplier delivers wrong product to customer

Journal Entries for Credit Note

Example 1

Company ABC sells some kind of raw material to XYZ on 01 Jan 202X. Due to the good relationship, XYZ has the right to return

  • ABC has issued an invoice of $ 50,000, they record revenue and accounts receivable into their system.
  • XYZ has accepted the invoice and record Accounts Payable.
  • On 05 Jan 202X, XYZ has found that some of materials have a quality issue that must return to supplier.
  • ABC has checked and accepted the return of material amount $ 10,000
  • On 08 Jan 202X, ABC issue the credit note amount $ 10,000

Please prepare the accounting record for both companies.

Here are the journal entries for Company ABC (Supplier), on 01 Jan 202X:

Account Debit Credit
Accounts Receivable $ 50,000
Revenue $ 50,000

Journal entries for Company ABC (Supplier) on 08 Jan 202X:

Account Debit Credit
Sale Return $ 10,000
Accounts Receivable $ 10,000

Note: we ignore the double entries of inventory and COGS as it is related to write off due to quality issues.

Here are the journal entries for Company XYZ  (Customer) on 01 Jan 202X

Account Debit Credit
Inventory_Raw Material $ 50,000
Accounts Payable $ 50,000

Journal entries for Company XYZ (Customer) on 08 Jan 202X

Account Debit Credit
Accounts Payable $ 10,000
Inventory_Raw Material $ 10,000

Example 2

Company ABC provides consultant service on annul tax return to company XYZ with the amount of $ 10,000. However, the accountants have mistaken issue invoices on accounting service to XYZ. So they have issued a credit note of $10,000 to cancel the previous invoice. The correct invoice will issue later.

Journal for ABC company (Supplier)

Account Debit Credit
Accounts Receivable $ 10,000
Accounting Service Income $ 10,000

Journal of ABC (Supplier) after issue credit note.

Account Debit Credit
Accounting Service Income $ 10,000
Accounts Receivable $ 10,000

Journal for XYZ company (Customer)

Account Debit Credit
Accounting Service Expense $ 10,000
Accounts Payable $ 10,000

Journal of XYZ (Customer) after receive a credit note.

Account Debit Credit
Accounts Payable $ 10,000
Accounting Service Expense $ 10,000

Note: both companies will record AR and AP when the supplier issues the correct invoice which we do not mention here.

Debit Note

Debit Note is the letter that sends from seller to buyer to inform or remind of the outstanding invoice which is not yet settled.

It is also used by the buyer to supplier to ask for a refund due to overbilling, product damage, goods return or other reasons. It is the commercial document which sends from the buyer to ask for the credit.

Debit note is treated as a credit note but it was sent from buyer to seller to clear the accounts payable amount due to various reasons. It is the formal request from a buyer to seller to issue a credit note.  It will cancel the previous invoice which both parties have agree and record into accounting system.

Reason for using Debit Note:

There are some reasons which enable the customer issue debit note to suppliers:

  • The products are defective
  • Supplier issue a wrong invoice which overcharge customer
  • The price on invoice higher than agreed price in the purchase order=

Debit Note Example

Company ABC purchases equipment from its supplier and the package arrive on 01 Jan 202X with the invoice amount $ 20,000.  One week later, they found out that 20% of the product has a technical issue which needs to adjust by the factory. Due to the warranty, ABC decides to send the products back to the supplier on 10 Jan 202X. At the same time, ABC also issues the Debit Note amount of $ 4,000. The supplier has checked their product and accept the sale return.

Please prepare the journal entries for the debit note.

Journal entries for ABC on 01 Jan 202X:

Account Debit Credit
Equipment $ 20,000
Accounts Payable $ 20,000

After issue Debit Note:

Account Debit Credit
Accounts Payable $ 10,000
Equipment $ 10,000