Credit Note vs Invoice: Key Differences Explained

When comparing a credit note vs invoice, the distinction is direct: an invoice requests payment for goods or services delivered, while a credit note reduces the amount owed on a previous invoice. Credit notes typically follow returns, pricing errors, or damaged goods, and always reference the original invoice.

This article covers everything AP professionals, accountants, and business owners need to handle credit notes with confidence:

Definitions and structural comparison of credit notes and invoices
When to issue a credit note instead of generating a new invoice
Accounting journal entries showing how both parties record credit notes and invoices
A three-way comparison of credit notes, debit notes, and invoices
AP processing workflow for matching and applying incoming credit notes
International VAT and tax rules governing credit note compliance
Common mistakes that lead to reconciliation errors and audit exposure

The next section starts with clear definitions of both documents and a side-by-side look at how they compare structurally.

What Is a Credit Note and What Is an Invoice?

An invoice is a document issued by a seller to request payment for goods or services delivered. It establishes an accounts receivable on the seller's books and a corresponding accounts payable on the buyer's books. The invoice specifies the amount owed, payment terms, and a detailed breakdown of line items, serving as the formal demand for payment in any business transaction.

A credit note (often called a credit memo in the United States) is a document issued by a seller that reduces or cancels the amount owed on a previous invoice. Every credit note references a specific original invoice, and it can never exist in isolation. Whether the credit note partially adjusts an invoice or voids it entirely, its sole function is to reverse some or all of the charges that the original invoice created.

The fundamental difference between a credit note and an invoice is directional. An invoice increases what the buyer owes the seller. A credit note decreases it. One creates a financial obligation; the other reduces or eliminates one.

The table below breaks down the core distinctions across six dimensions:

Feature	Invoice	Credit Note
Purpose	Request payment for goods or services delivered	Reduce or cancel an amount previously invoiced
Effect on buyer's balance	Increases accounts payable	Decreases accounts payable
Who issues it	Seller/supplier	Seller/supplier (same party that issued the original invoice)
Typical triggers	Delivery of goods, completion of services, milestone billing	Returns, pricing errors, agreed discounts, damaged goods, order cancellations
Numbering convention	Sequential invoice numbers (e.g., INV-2024-0051)	Separate sequential series (e.g., CN-2024-0012)
Key reference field	Purchase order number or contract reference	Original invoice number being adjusted

The two documents also differ in their required fields:

Field	Invoice	Credit Note
Document number	Invoice number (e.g., INV-2024-0051)	Credit note number (e.g., CN-2024-0012)
Date	Issue date	Issue date
Parties	Seller and buyer names and addresses	Same seller and buyer as original invoice
Reference	Purchase order or contract number	Original invoice number (mandatory)
Line items	Goods/services with quantities and prices	Items being credited with quantities and amounts
Tax	Tax rate and amount charged	Tax adjustment (reduction)
Total	Amount due from buyer	Amount credited to buyer
Payment terms	Due date and payment method	Not applicable (adjusts existing obligation)

Credit notes are one of several related financial document types that businesses encounter regularly. For a broader view of the full document landscape, see our complete guide to invoice types in business, which covers proforma invoices, recurring invoices, and other variants alongside credit notes.

When to Issue a Credit Note Instead of a New Invoice

The core principle is straightforward: a credit note adjusts an existing transaction, while a new invoice creates a new one. When a sale has already been invoiced and something about that specific sale changes, a credit note is the correct document. A new invoice is only appropriate when there is a genuinely new sale or service being billed.

Here are the six most common scenarios where a credit note is the right choice.

1. Product returns (full or partial)

The buyer returns goods, and the seller issues a credit note reducing the original invoice amount by the value of the returned items. This applies to both purchase returns on the buyer's side and sales returns on the seller's side.

Example: Original invoice was $5,000 for 100 units at $50 each. The buyer returns 10 units. The seller issues a credit note for $500, reducing the outstanding balance to $4,500.

2. Pricing errors

The original invoice contained an incorrect price, and the buyer was overcharged. Rather than voiding and reissuing the entire invoice, a credit note corrects the difference.

Example: An invoice billed 50 units at $120 each ($6,000), but the agreed price was $100 per unit. The seller issues a credit note for $1,000 to correct the $20-per-unit overcharge.

3. Damaged or defective goods

Goods arrived damaged or failed to meet specifications. The credit note compensates the buyer for the affected portion without requiring a physical return of the goods.

Example: A shipment of 200 items worth $8,000 arrives with 25 items damaged beyond use. The seller issues a credit note for $1,000 covering the defective units.

4. Early payment discounts

The buyer paid before the discount deadline and qualifies for a reduction that was not reflected on the original invoice. A credit note formalizes the discount after the fact.

Example: An invoice for $10,000 offers 2/10 net 30 terms. The buyer pays within 10 days. The seller issues a credit note for $200 to apply the 2% early payment discount.

5. Volume rebates or retrospective discounts

The buyer reached a volume threshold over a period of time, entitling them to a retroactive discount that may span multiple invoices. A credit note captures the earned rebate.

Example: A supplier agreement grants a 5% rebate once quarterly purchases exceed $50,000. The buyer's Q3 purchases total $62,000 across eight invoices. The seller issues a credit note for $3,100.

6. Partial delivery shortfalls

The seller shipped fewer units than were invoiced. A credit note adjusts the invoice to match the actual delivered quantity rather than requiring a new invoice for the correct amount.

Example: An invoice covers 500 units at $30 each ($15,000), but only 475 units were delivered. The seller issues a credit note for $750 to account for the 25 missing units.

In every scenario above, the adjustment ties back to a sale that was already invoiced. That linkage is what makes a credit note the correct document. If the buyer places a separate order for different goods or services, that transaction gets its own invoice.

How Credit Notes and Invoices Are Recorded in Accounting

Credit notes affect the books of both the seller who issues them and the buyer who receives them. Understanding the accounting treatment on each side prevents reconciliation errors and keeps your ledgers aligned during month-end close.

Seller/Issuer Side

Consider this scenario: A seller issues invoice INV-100 for $2,000 worth of goods. The buyer later returns $500 worth of those goods, and the seller issues credit note CN-001 referencing INV-100.

Original invoice journal entry:

Account	Debit	Credit
Accounts Receivable	$2,000
Revenue		$2,000

Credit note journal entry (CN-001):

Account	Debit	Credit
Sales Returns and Allowances	$500
Accounts Receivable		$500

The credit note reduces both recognized revenue and the outstanding receivable. After posting CN-001, the seller's accounts receivable balance for this customer drops from $2,000 to $1,500, and the sales returns account reflects the $500 adjustment against gross revenue.

Buyer/Recipient Side

On the AP side, the buyer originally recorded the same transaction as follows:

Original invoice journal entry:

Account	Debit	Credit
Purchases (or Inventory)	$2,000
Accounts Payable		$2,000

Credit note journal entry (CN-001):

Account	Debit	Credit
Accounts Payable	$500
Purchase Returns		$500

Applying the credit note reduces both what the buyer owes and the recorded cost of goods purchased. The accounts payable balance for this vendor drops from $2,000 to $1,500, and the purchase returns account captures the $500 reversal.

Summary of Journal Entries

Transaction	Seller Journal Entry	Buyer Journal Entry
Original Invoice (INV-100)	Dr. Accounts Receivable $2,000 / Cr. Revenue $2,000	Dr. Purchases $2,000 / Cr. Accounts Payable $2,000
Credit Note (CN-001)	Dr. Sales Returns & Allowances $500 / Cr. Accounts Receivable $500	Dr. Accounts Payable $500 / Cr. Purchase Returns $500

One detail that matters for audit readiness: the credit note entry in your accounting system must reference the original invoice number. Linking CN-001 to INV-100 in the transaction record creates the audit trail that auditors and reconciliation workflows depend on. Without that reference, matching credit notes to their source invoices becomes a manual, error-prone process.

For readers who want foundational context on how invoices are recorded before working through credit note adjustments, understanding what invoices are and how they work provides that background.

Credit Note vs Debit Note vs Invoice: A Three-Way Comparison

Credit notes and invoices are seller-issued documents, but a third document enters the picture when the buyer initiates a correction: the debit note. Confusion between credit notes and debit notes is common, so a direct three-way comparison clarifies each document's role.

A debit note is a formal document issued by the buyer to the seller. It serves as written notification that the buyer has reduced their accounts payable balance due to an identified issue, such as an overcharge, defective goods, or a pricing discrepancy. In practice, the debit note is the buyer's way of requesting or triggering a credit note from the seller. In some jurisdictions, particularly in parts of South Asia and the Middle East, "debit note" also describes a seller-issued document that increases the amount owed. However, the buyer-initiated usage is far more common in Western AP and procurement workflows.

The directional flow is the clearest way to keep these three documents straight:

Invoice: Issued by the seller to the buyer. Creates a new amount owed.
Credit note: Issued by the seller to the buyer. Reduces an existing amount owed.
Debit note: Issued by the buyer to the seller (typically). Requests or formally notifies of a reduction in what the buyer owes.

Feature	Invoice	Credit Note	Debit Note
Issued by	Seller	Seller	Buyer (typically)
Direction	Seller to buyer	Seller to buyer	Buyer to seller
Effect on buyer's balance	Increases accounts payable	Decreases accounts payable	Decreases accounts payable (reflects buyer's adjustment)
Typical trigger	Sale of goods or services	Return, overcharge, pricing error, or cancellation	Buyer identifies defect, overcharge, or shortfall
References	Purchase order or contract	Original invoice number	Original invoice number and reason for adjustment

A worked scenario showing all three documents in sequence:

Company A sells 500 units of packaging material to Company B at $4.00 per unit and issues Invoice #801 for $2,000. When Company B inspects the shipment, 60 units are defective. Company B prepares Debit Note #DN-45, referencing Invoice #801, stating that 60 defective units at $4.00 each ($240) have been identified and that Company B's payable balance has been reduced accordingly. Company A reviews the debit note, confirms the defect, and issues Credit Note #CN-801 for $240 against Invoice #801. The chain is complete: the invoice created the obligation, the debit note flagged the problem from the buyer's side, and the credit note formalized the seller's agreement to reduce the amount owed.

This three-document sequence is standard in B2B transactions where formal paper trails matter for audit and compliance. On a related note, the distinction between invoices and receipts is another area that causes frequent mix-ups. You can read more about how invoices differ from receipts for a breakdown of when each document applies.

With the document types and their relationships clarified, the next section walks through the practical workflow AP teams should follow when a credit note arrives.

How AP Teams Should Process Incoming Credit Notes

Most guidance on credit notes is written from the issuer's perspective, walking sellers through when and how to generate one. But AP teams on the receiving end need their own clear process. An incoming credit note that is not properly matched, validated, and applied creates confusion in your payables ledger and distorts your cash flow reporting.

Follow this credit note processing workflow to handle incoming credit notes consistently:

Receive and log the credit note. Record the incoming credit note (or credit memo, as it is often called in the US) in your AP system as soon as it arrives. Capture its unique reference number, issue date, and the original invoice number it references. Treat this step the same way you would treat logging a new invoice: assign it a receipt date and route it for processing.
Match to the original invoice. Locate the original invoice in your system using the referenced invoice number. Verify that the credit note matches the correct vendor, invoice number, and line items. If your team also handles PO-based workflows, this matching step parallels the three-way match described in our guide comparing purchase orders and invoices.
Validate the amounts. Confirm that the credit note amount aligns with the agreed adjustment. For a goods return, multiply the returned quantity by the unit price on the original invoice and check that the credit note reflects that total, including any applicable tax. Flag any discrepancies and send them back to the vendor before processing further.
Update the open invoice balance. Reduce the outstanding payable by the credit note amount. If the credit note fully offsets the invoice, mark that invoice as settled in your system. If it partially offsets the invoice, update the remaining balance so your aging reports stay accurate.
Apply to payment. If the original invoice has not yet been paid, deduct the credit note amount from the next payment run for that vendor. If the invoice was already paid, apply the credit to a future invoice from the same vendor. When no future invoices are expected, request a cash refund from the vendor and track the receivable until it is collected. If the credit note amount exceeds the remaining invoice balance, apply the excess as a credit on the vendor's account to offset future invoices.
Record the journal entry. Post the accounting entry as described earlier in this article: debit Accounts Payable to reduce your obligation, and credit Inventory or Purchases to reflect the value returned or adjusted. Attach the credit note reference number to the journal entry for traceability.
File and archive. Store the credit note linked to the original invoice so both documents are retrievable together. Auditors will expect to see the credit note alongside the invoice it modifies, and a broken link between the two creates unnecessary questions during year-end reviews.

The critical step in this workflow is matching. An unmatched credit note sitting in the AP queue creates a phantom liability on your books. Your payables balance appears higher than it actually is, vendor statements will not reconcile, and duplicate payments become a real risk when the team does not realize a credit was already issued.

Organizations processing high volumes of invoices and credit notes benefit from tools for extracting and processing invoice data that automate the matching and data capture steps, reducing the manual effort at steps one through three and cutting down on the unmatched items that clog reconciliation.

VAT and Tax Requirements for Credit Notes

Credit notes are not purely internal accounting documents. They carry specific legal and tax obligations that differ depending on where your business operates and where your trading partners are located. Getting the VAT or sales tax treatment wrong on a credit note can trigger audit flags, penalties, or incorrect tax filings on both sides of the transaction.

EU: VAT Directive Rules

Under the EU VAT Directive, a credit note must adjust the VAT liability recorded on the original transaction. When a supplier issues a credit note, they reduce their output VAT for the period. The buyer, in turn, must reduce the input VAT they previously claimed. Both parties adjust their VAT returns to reflect the change.

Every VAT credit note issued within the EU must reference the original invoice number and clearly state the VAT amount being adjusted. Failing to link the credit note back to its source invoice can invalidate the adjustment, leaving the seller liable for VAT they should no longer owe and the buyer claiming input VAT they are no longer entitled to.

UK: HMRC Requirements

The UK applies particularly strict rules to credit notes. According to HMRC's guidance on VAT credit note requirements, suppliers must issue a credit note within 14 days of making a refund, and each credit note must include eight mandatory fields linking it back to the original VAT invoice, including the identifying number and date of the original invoice, a description of the goods or services, the amount of the price decrease excluding VAT, and the rate and amount of VAT credited.

Missing any of these fields means the credit note does not satisfy HMRC's requirements, which can complicate VAT recovery for the buyer and create compliance exposure for the seller.

US: State Sales Tax Rules

The US does not have a federal VAT system, so credit notes, more commonly called credit memos, are governed by state sales tax rules. If the original invoice included sales tax, the credit memo should reflect the corresponding tax adjustment. Sellers can typically claim a sales tax credit or refund from their state's department of revenue for returned goods, but the specific rules, deadlines, and documentation requirements vary by state.

Businesses operating across multiple states should consult each relevant state's department of revenue rather than assuming uniform treatment.

Jurisdiction Comparison

Jurisdiction	Credit Note Term	VAT/Tax Adjustment Required	Key Compliance Rule
EU	Credit note	Yes, both seller (output VAT) and buyer (input VAT) must adjust	Must reference original invoice and state VAT adjustment amount
UK	Credit note	Yes, same bilateral adjustment as EU	Must be issued within 14 days of refund; eight mandatory fields required per HMRC
US	Credit memo	Depends on state; sales tax adjustment applies if original was taxed	Rules vary by state; consult the relevant department of revenue

Mishandling credit note VAT requirements carries consequences that go beyond regulatory compliance. The final section covers the most common mistakes businesses make with credit notes and how to avoid them.

Common Mistakes with Credit Notes and How to Avoid Them

Credit notes are straightforward in theory, but in practice they are one of the most frequently mishandled documents in accounts payable and receivable. Each mistake below carries real financial and compliance consequences.

1. Issuing a new invoice when a credit note is the correct document

Some businesses void the original invoice and reissue a corrected version rather than issuing a credit note against it. This breaks the audit trail. The original invoice, its payment records, and the correction no longer link together cleanly, making reconciliation difficult and audits time-consuming. In VAT jurisdictions, the problem is worse: the original invoice's VAT liability remains on record unless properly cancelled with a credit note, which can trigger compliance issues with tax authorities who expect a clear paper trail from invoice to adjustment.

How to avoid it: Treat the original invoice as permanent. When a correction is needed, issue a credit note that references the original invoice number and explains the reason for the adjustment.

2. Failing to match credit notes to original invoices

Credit notes that sit unmatched in the AP system create phantom liabilities. The accounts payable balance reflects more owed to the supplier than is actually due, distorting cash flow forecasts and potentially leading to overpayment. Over time, unmatched credit notes accumulate and become increasingly difficult to resolve, especially after the staff who handled the original transactions have moved on.

How to avoid it: Match every incoming credit note to its original invoice immediately upon receipt. Do not process supplier payments until all outstanding credit notes for that supplier have been applied.

3. Ignoring VAT/tax adjustments on credit notes

When a credit note is issued but neither the seller nor the buyer adjusts their VAT return, the numbers fall out of alignment. The seller continues to overpay output VAT on revenue that was reversed, and the buyer over-claims input VAT on a purchase that was partially or fully cancelled. Tax authorities cross-reference these figures, and discrepancies discovered during an audit can result in penalties, interest charges, and forced restatements. The fix is straightforward: treat every credit note as a trigger for a corresponding VAT adjustment, with the seller reducing output VAT and the buyer reducing input VAT in the period the credit note is dated.

4. Using credit notes to mask revenue or manipulate figures

Issuing credit notes without a genuine commercial reason, such as a product return, a pricing error, or a documented service shortfall, is a red flag for both auditors and tax authorities. Fraudulent credit notes are a well-known method for artificially deflating revenue or creating fictitious refunds. Even when the intent is not fraudulent, credit notes that lack clear justification invite scrutiny.

How to avoid it: Require documented justification for every credit note, tied to a specific original invoice and a verifiable reason. Implement an approval workflow so that no credit note is issued without a second set of eyes.

5. Delaying credit note issuance

Late credit notes complicate period-end close. If a product was returned in March but the credit note is not issued until May, both months' financial statements are affected. March overstates revenue and receivables, while May shows an adjustment that belongs to a prior period. This distorts monthly reporting and can trigger restatements if the amounts are material. The best practice is to issue credit notes within the same accounting period as the triggering event, and to include credit note issuance in your month-end close checklist so outstanding returns and disputes are resolved before the books close.

Credit note handling checklist:

Always reference the original invoice number on every credit note. This single practice prevents most matching and audit trail problems.
Issue credit notes in the same accounting period as the triggering event. Do not let returns, disputes, or pricing corrections carry over into the next period.
Adjust VAT returns to match issued or received credit notes. Both seller and buyer must update their tax filings in the period the credit note is dated.
Match every credit note to its original invoice before processing payment. No supplier payment should go out until all applicable credit notes have been applied to the balance.