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Credit Note Insights: Understanding Its Function and Benefits

Summary: Credit Note: Learn how to use credit notes to acquire goods without immediate payment and the difference with debit notes.

17 Jun 2022 by Team FinFIRST

Credit note meaning

A credit note helps you purchase goods from a supplier in the future without making a payment

How does a business entity account for goods that the customer returns after purchasing them? An item can be returned for quality/quantity issues, packaging defects, or maybe because customers were overcharged and the tax invoice didn’t reflect their payment. It warrants accounting, both by the buyer and the supplier. The issuance of a credit note allows a supplier to account for this returned item in their ledger.

This article will explain credit note meaning, what is debit note and credit note, and the reason for issuing credit note.

What is a credit note?

Credit and debit notes are best understood with an example. Imagine heading to your local grocery store to buy some groceries worth ₹2000. When you get back home, you realise that the bread you bought is stale and the milk is spoilt. They together amount to ₹ 80. You immediately head back to the store, return them, and ask for a replacement. The shopkeeper obliges, only to regretfully inform you that his stock for both bread and milk is depleted.

Instead of returning you the ₹80, he issues you a credit note, telling you that you could come to his store and buy the bread and milk at any point in the future or make a purchase worth ₹ 80. This is the primary function of a credit note.

In a supplier and buyer transaction, the supplier issues a "credit note" as a sales return. By doing so, the supplier informs the buyer that the purchase returns are accepted. A credit note, also called a "sales return credit note", is given by the supplier in exchange for a debit note.

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Who provides the debit note?

The customer returning the goods provides the debit note. In our example, you give a debit note to the shopkeeper mentioning the details of what you intended to purchase with the ₹80. In return, you receive a credit note from the shopkeeper.

Why is a credit note important?

A credit note enables a buyer to purchase goods later without paying for them. While quality issues can be one reason for issuing credit notes, here are a few more reasons why suppliers may issue them:

In case the supplier has erroneously collected higher charges from the buyer.
As a goodwill gesture on the supplier's part, to help the buyer avail of a post-sale discount.
If the supplier wants to cancel any pending payments against invoices.
If the quantity of a product received by the customer is worse than what is mentioned on the invoice.

Hence, the process of issuing a credit note to a customer is as follows:

The supplier sells goods to the buyer and provides a tax invoice.
After noticing some quality/quantity issues, the buyer returns the goods and provides a debit note.
The supplier issues a credit note to the customer as an acknowledgement.

Section 34 of the Central Goods and Services (CGST) Act, 2017 mandates the issuance of one or more credit notes in any such event.

What does a credit note contain?

A credit note contains HSN SAC codes (Harmonized System Nomenclature Service Accounting Code) for the goods involved, the name of the product/service, quantity, rate, taxable value, the Integrated Goods and Services Tax (IGST), and a calculation of the total amount after tax. It also contains the buyer's bank details, who has already made the payment.

Additionally, it may also include:

The date of issue
GST identification number of supplier and buyer
Name and address of the buyer
Serial number and date of the corresponding tax invoice
Nature of the document

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject Metra Trust or its affiliates to any licensing or registration requirements. Metra Trust shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.

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