# Credit note accounting: how does it work?

The credit note process saves time for both service providers and clients, which is why it’s a popular method of issuing adjustments. However, a credit note must also be properly recorded in the financial statements. In this guide, you’ll learn how to record a credit note correctly in your accounts.

## How to record a credit note

Credit notes are an essential part of the billing process and must be recorded accurately in your financial statements. A credit note is typically issued by the **seller** to reduce the amount owed by a customer. In some cases, a **buyer may issue the credit note** under a **self-billing arrangement** — often used in long-term business relationships to simplify [invoicing](https://www.ionos.co.uk/digitalguide/startup/grow-your-business/creating-an-invoice-tips-for-businesses/).

Regardless of who issues the credit note, accurate [record-keeping](https://www.ionos.co.uk/digitalguide/startup/grow-your-business/accounting-standards/) is essential to maintaining clear financial records and complying with [VAT](https://www.ionos.co.uk/digitalguide/startup/grow-your-business/value-added-tax-vat/) regulations.

Simply follow these steps to record your credit note journal entry:

1. **Receive or issue the credit note**
Confirm that the credit note is accurate and complete.
2. **Assign a reference number**
Allocate a unique document number for traceability in your accounting system.
3. **Enter the credit note into your [accounting software](https://www.ionos.co.uk/digitalguide/startup/grow-your-business/bookkeeping-software-for-online-accounting/)**
Record it in the same way as an invoice — but with values that reduce revenue or accounts receivable.
4. **Link the credit note to the original invoice**
Match the credit note to the corresponding invoice to maintain a clear audit trail.
5. **Adjust VAT if applicable**
If VAT was included in the original transaction, make sure the credit note reflects the correct adjustment.
6. **Keep proper records**
Store the credit note and related entries in accordance with your document retention policy and HMRC requirements. Good documentation is essential in case of an audit.

Note This article refers to credit notes used to [adjust or cancel an invoice](https://www.ionos.co.uk/digitalguide/startup/grow-your-business/creating-correction-and-cancellation-invoices/). If you are correcting a previously issued invoice, the document should clearly indicate it is a **corrected invoice** or **invoice adjustment** — not a credit note — to avoid confusion.

## Credit note journal entry example

Let’s say you’re a freelance graphic designer working with an agency. Typically, as the service provider, you would issue invoices. However, in some cases, a **self-billing agreement** may be used — where the agency issues credit notes on your behalf, in line with HMRC guidance.

In this example, your agreed compensation for Q1 is **£5,000**, plus **VAT at 20% (£1,000)**. Here’s how you, as the freelancer (seller), would record the journal entry upon receiving the credit note and payment:

<table>
  <thead>
    <tr>
      <th>Credit note</th>
      <th>Journal entry</th>
    </tr>
  </thead>
  <tbody>
    <tr>
      <td><strong>Bank:</strong> £6,000</td>
      <td><strong>To Sales Revenue:</strong> £5,000</td>
    </tr>
    <tr>
      <td></td>
      <td><strong>To VAT Payable (20%):</strong> £1,000</td>
    </tr>
  </tbody>
</table>

As the **agency (buyer)**, assuming they are the end user (not a VAT-exempt organisation), they would typically record:

<table>
  <thead>
    <tr>
      <th>Journal entry</th>
      <th>Credit note</th>
    </tr>
  </thead>
  <tbody>
    <tr>
      <td><strong>Subcontractor/Service Costs:</strong> £5,000</td>
      <td></td>
    </tr>
    <tr>
      <td><strong>Input VAT:</strong> £1,000</td>
      <td><strong>To Bank:</strong> £6,000</td>
    </tr>
  </tbody>
</table>

To ensure the credit note is legally valid and properly recorded, it should include:

- Full names and addresses of both parties
- A clear description of the goods or services provided
- Itemised amounts, applicable VAT, and total credit
- The reason for the credit (e.g. return, overcharge, discount)
- A reference to the original invoice
- The term **‘Credit Note’** clearly displayed on the document

Please note the [legal disclaimer](https://www.ionos.co.uk/digitalguide/startup/disclaimer/) for this article.


This is a markdown version of: [https://www.ionos.co.uk/digitalguide/startup/grow-your-business/credit-note-accounting/](https://www.ionos.co.uk/digitalguide/startup/grow-your-business/credit-note-accounting/) for AI/LLM consumption.