How to create a credit memo and Customer Refund in QuickBooks Online

Understanding credit memos

A credit memo is a type of posting transaction that can be applied to fulfill partial or full payment for a customer's invoice. It is important to note that a credit memo does not constitute a refund to the customer, and as such, is not classified as a money-out transaction. Instead, credit memos serve the purpose of reducing the total amount of Accounts Receivable (A/R) owed to the company, without affecting the cash balance. It is a vital tool for businesses to manage their financial records and maintain an accurate account of their transactions.

If your client is seeking clarification on credit memos, it is important to address some of the most frequently asked questions. By doing so, you can ensure that they have a clear understanding of the process and any potential implications. Therefore, it is crucial to be well-versed in the commonly asked questions regarding credit memos, which can help you provide a comprehensive explanation to your clients. 

 

1.     Why we use credit memo instead of just editing the original Transaction?

It may occur to a client that if they complete a job faster and at a lower cost than anticipated, the optimal solution would be to modify the initial invoice accordingly. However, it is not considered to be a good practice to alter transactions once they have been issued to the customer. Amending an existing transaction can create misunderstandings and adversely impact record-keeping. This is especially relevant when the original invoice is from a previous period, as any alterations would cause the books to be out of sync with the tax return and alter previously reported amounts. Therefore, it is advisable to avoid changing invoices after they have been sent to the client and to keep a record of any changes that occur after the initial invoice has been issued. This helps to ensure accurate financial reporting and avoids any potential discrepancies.

2.     Why not just bill for less on next invoice?

 Most businesses utilizing QuickBooks Online have established prices and costs for their products and services. However, in certain situations where a customer is charged less for a particular invoice than another, the client must either modify the cost/price of the item or invoice the customer for less than the originally agreed upon price. Nevertheless, both options can have severe consequences on the company's financial records in the future.

It is also crucial to record a new transaction in QuickBooks Online for any exchange between the client and the customer. This helps to establish the timing and sequence of events with a customer and can impact the timing and balances of sales tax liabilities and inventory movement in and out of the company. By doing so, the company can better keep track of its financial transactions and maintain accurate records for bookkeeping purposes.

In summary, businesses using QuickBooks Online must ensure that their prices and costs are appropriately set and that each transaction with their customers is recorded as a separate entry. Failure to do so could result in significant financial inaccuracies that can harm the company's financial stability and reputation. Therefore, it is essential to maintain meticulous records and stay on top of any changes to prices or costs.

3.     Why not just refund in cash and not record the credit memo?

It is of utmost significance to meticulously document all transactions, whether they are in cash or not, to guarantee the completeness of the client's records. Failure to record a cash transaction between a client and their customer can result in the client paying sales and income taxes on the sales transaction, while receiving no advantage from the return transaction deduction. Hence, it is crucial for clients to ensure that all transactions are duly recorded to avoid any unfavorable tax implications.

4.     What else can we use credit memo for?

 So far, we have discussed credit memos in the context of products or services that have already been invoiced to a customer. However, it is important to note that clients have the ability to issue credit memos at any point in time. This can include instances such as loyalty reward programs or referral incentives, as well as goodwill gestures extended to the customer.

If clients are interested in establishing a referral program, they can do so by creating a new Service item under the name of "Thank you for referring us." This item should be mapped to a Discounts income account. Once this item has been created, it can be utilized by the client when generating the credit memo. By doing so, the client is able to successfully incorporate the referral program into their credit memo system.

                              

 

We’ll look at how to create a credit memo next.

Creating a credit memo

To proceed with the remediation of a defective item, it is necessary to document a credit memo. Once this essential step has been taken, you will gain insight into the process of applying the credit memo to an invoice. By following this procedure, you will be able to effectively manage and resolve issues arising from faulty transactions.

1.     Select +New, then Credit memo

2.     Alternatively, your client can create a credit memo through the Sales center by selecting All Sales, then New transaction and Credit Memo  

3.     Fill in the sections, including the Customer, the Product/Service, the Quantity, and the Amount

 4.     Then select Save and close

 

Clients can now apply this credit memo to an invoice for the customer. Let’s see how to do it next. 

 

How are Credit memos applied?

By default, the accounting software QuickBooks Online has a feature that applies the value of any Credit memos automatically to existing or new customer invoices. This feature is controlled by the automatically apply credits setting, which is located in the Advanced tab of Account and Settings. For clients with simple Accounts Receivable, this setting proves to be very useful, especially those who only have a few invoices per customer. However, clients with complex accounts receivable workflows or higher-volume accounts should use this feature with caution. If clients want to apply credits manually, they can disable the slider, and the feature will be turned off. It is important to note that the settings in QuickBooks Online should be reviewed carefully to ensure that the software is working optimally for the business's unique needs.

 

Applying a credit memo to an invoice

Now let’s apply the credit memo to an invoice for the customer.

1.     From the + New button, select Invoice 

2.     Select the customer from the Customer dropdown 

3.     In our case, we replaced the faulty item with a new product, so in the Product/Service column, we add the new item 

4.     For the sales price rate, enter the value of the new item. In our case, it’s the same as the replaced item 

5.     Then select Save and close

If your client has the Automatically apply credits option switched on in Account and Settings, QuickBooks Online will prompt them to apply the existing credit memo to the new invoice. Otherwise, they would have to do it manually.  

Let’s apply the credit to a new invoice manually.

1.     Select the + New button, then Receive payment 

2.     From the Customer dropdown, select the same customer 

3.     In the Outstanding Transactions section, check the box next to the Invoice 

4.     In the Credits section, check the box next to the Credit Memo

5.     Finally, select Save and close

Customer refunds

There may arise certain situations where a credit memo may not be the most appropriate solution for a client to refund money to their customer. Such instances may occur due to various reasons, such as faulty goods or a one-time job that was completed under budget. In such scenarios, clients can opt to issue a customer refund using QuickBooks Online, which involves creating a Refund receipt. This refers to a money-out transaction that is initiated from the specified payment account and enables the clients to ensure that the customer receives a refund in a seamless and efficient manner. By leveraging this functionality, clients can not only enhance their customer experience but also streamline their internal processes and promote operational efficiency. It is important to note that clients should exercise due diligence while using this functionality and ensure that all relevant guidelines and regulations are adhered to in order to maintain compliance and avoid any potential legal or financial implications.

To create a Refund receipt:

1.     Select + New, then Refund receipt 

2.     Choose the Customer from the dropdown

3.     Use the Refund From dropdown to select the bank account to issue the refund from

4.     Enter the appropriate product/service information. Make sure to fill in the other required fields accordingly

5.     When done, select Save and close

 

What happens next?

The monetary transaction is recorded by the Refund receipt, yet the refund itself is not dispensed. The refund must continue to be handled through an alternative payment method, such as a check or electronic transaction. It is important to note that the Refund receipt solely documents the money-out-transaction and does not finalize the refund process.