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.

Re­gard­less of who issues the credit note, accurate record-keeping is essential to main­tain­ing clear financial records and complying with 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
   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.

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:

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

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 for this article.