Credit Notes Explained: When to Issue One and How to Write It

You have sent an invoice and something about it is wrong: the price, the quantity, a line that should not be there, or work the client is not going to pay for. The instinct is to delete it and send a corrected one. In almost every accounting system, and under most tax rules, that is precisely what you must not do.

A credit note is the mechanism for correcting an issued invoice without breaking the record. This guide covers when to issue one, how it differs from a refund or a voided invoice, what it must show, how numbering works, the tax treatment, and how to apply it.

What a credit note is

A credit note — also called a credit memo — is a document that reduces the amount a customer owes on a previously issued invoice. It is effectively a negative invoice: same structure, same required fields, opposite direction.

It does not erase the original invoice. Both documents stay in your records, and the net position is the invoice minus the credit note. That is the entire point: an auditor, a tax authority or a client's accounts team can see exactly what was billed, what was credited, and why.

When to issue one

• You overcharged — wrong rate, wrong quantity, a duplicated line, or an agreed discount that was not applied.
• The scope reduced after invoicing — work was cancelled or descoped.
• Goods were returned or services were rejected.
• You agreed a settlement on a disputed invoice and are writing off part of it.
• You billed the wrong entity — credit the incorrect invoice in full and issue a fresh one to the right customer.
• A goodwill reduction after a service failure.

The common thread is that the invoice was validly issued and something later changed. If the invoice was never valid — issued in error, never sent, a test — that may be a candidate for voiding instead.

Credit note, refund, or void: which one

In practice: unpaid invoice and the amount was wrong, issue a credit note. Paid invoice and money must go back, issue a credit note and process the refund — the credit note is the document, the refund is the transaction. Invoice created by mistake and never sent, void it, keeping the number in the sequence marked as void.

Never simply delete. A gap in your invoice numbering is one of the first things an auditor queries, and in several jurisdictions deleting an issued invoice is an offence rather than an untidiness.

What a credit note must show

Essentially everything an invoice shows, plus a link back to what it is correcting.

CREDIT NOTE

Credit note number:  CN-2026-004
Date:                17 August 2026
Against invoice:     INV-2026-014, dated 15 July 2026

From: [Your business, address, VAT number]
To:   [Client business, address, VAT number]

Reason for credit: Phase 3 descoped by agreement 12 August 2026.

  Description                        Qty      Amount
  Phase 3 — implementation             1    1,200.00
  ------------------------------------------------
  Subtotal                                  1,200.00
  VAT @ 20%                                   240.00
  ------------------------------------------------
  Total credited                            1,440.00

This credit note reduces the balance outstanding on invoice INV-2026-014 to 1,560.00.

Numbering and sequence

Credit notes need their own unbroken sequence, separate from invoices. A common convention is a distinct prefix — CN-2026-001 alongside INV-2026-014 — so the two can never be confused at a glance or in a filename.

The same rules that govern invoice numbering apply: sequential, no gaps, never reused, and never renumbered after issue. If you cancel a credit note, mark it cancelled and keep the number.

VAT and GST treatment

A credit note reverses the tax as well as the net amount. Three points matter:

• Use the rate from the original invoice, not today's rate. If VAT was 20% when you invoiced and has since changed, the credit note carries 20%.
• Adjust in the period the credit note is issued, not by amending the earlier return — assuming the original period has been filed.
• Both sides must reflect it. Your output tax reduces; the customer's input tax reclaim reduces correspondingly. This is why they need a proper credit note document rather than an email saying "ignore the last one".

If you need a compliant tax document layout to work from, our VAT invoice template shows the required fields, and the same set applies to a credit note. Rules vary by jurisdiction — confirm the treatment with your accountant.

Applying a credit note against invoices

A credit note is not much use sitting on its own. It has to be allocated.

Where a credit is carried forward, show it explicitly on the next invoice — a line reading "Less credit note CN-2026-004" is far better than a total that quietly differs from the expected figure.

Common mistakes

1. Deleting the invoice instead. Breaks your number sequence and, in many places, the law.
2. Not referencing the original invoice number. The client's accounts team cannot match it, so it sits unprocessed.
3. Vague reasons. "Adjustment" tells nobody anything in twelve months' time. Be specific.
4. Crediting the wrong tax rate. Use the rate from the original invoice.
5. Issuing a credit note for a bad debt. A client refusing to pay is not a reason to credit the invoice — that is a write-off, handled differently, and crediting it can forfeit your right to pursue the debt.
6. Never allocating it. An unallocated credit distorts both parties' balances indefinitely.

The fifth is the one that costs real money. If a client will not pay, see our guide to overdue invoices — the invoice stands and you pursue it. Credit notes are for amounts that were never properly owed, not for amounts you have given up collecting.

Most credit notes start life as a disagreement — see our guide to invoice disputes for handling those before they get that far, and what to include in an invoice for the field set both documents share. You can create an invoice free and adapt the same layout for credit notes.