A credit note is a formal document that reduces or cancels part or all of a previous tax invoice, usually because goods were returned, services were not supplied as expected, pricing changed or an error occurred. In Australia the term credit note often appears as adjustment note when the transaction involves Goods and Services Tax, and issuing it allows the seller to lower the GST that was originally reported while telling the buyer to increase the GST previously claimed. Correct use of a credit note protects both parties, keeps accounting records clean and satisfies Australian Taxation Office record keeping rules.
What is a credit note
A credit note is a follow up document that reverses or corrects an earlier tax invoice without deleting that invoice from the accounting records. The supplier creates the document, references the original invoice, explains why the amount has changed and shows any adjustment to GST. Once issued the credit note either lowers the customer’s outstanding balance or turns into a credit that can be applied to a new invoice. In GST language the paper or electronic form that performs this task is an adjustment note because it adjusts the taxable supply already on record.
Credit notes differ from simple receipts or statements because they carry specific tax consequences. The seller may claim a decreasing GST adjustment and the buyer may need to make an increasing GST adjustment. Because of that both sides must archive the document for at least five years in case the ATO reviews the transaction.
When should a business issue a credit note
Several day to day events create the need for a credit note. Goods might arrive damaged or in a smaller quantity than ordered so the customer sends them back. A professional service agreement could be cancelled before all work is finished and both parties agree that the unused portion will not be billed. An invoice might contain a typographical error that shows one extra zero. Sometimes a volume rebate or retrospective discount is negotiated after the invoice date. All these cases represent adjustment events under the A New Tax System Goods and Services Tax Act 1999. Rather than voiding or changing the original invoice the seller keeps the permanent record intact and produces a credit note so the accounting trail remains transparent.
The supplier should not issue a brand new invoice with a lower total when something has already been delivered and invoiced because that destroys the audit trail. In the same way it is poor practice to delete or overwrite the original tax invoice inside software. The correct approach is always to raise a separate credit note.
Credit note example
The example below shows how a supplier credits part of an earlier sale when a customer returns half of the items originally purchased. All figures are Australian dollars and include GST where applicable.
| Description | Amount |
|---|---|
| Original invoice total | 1,100 |
| GST within original invoice | 100 |
| Portion of goods returned | 550 |
| GST reduction on returned goods | 50 |
| Revised balance owing | 550 |
In this scenario the business previously reported one hundred dollars of GST on the full sale. Once the credit note is issued it may claim fifty dollars as a decreasing adjustment on the next Business Activity Statement. The customer on the other hand previously claimed one hundred dollars of input tax credits but now needs to increase GST payable by fifty dollars, usually by reducing the credits claimed.
How GST applies to a credit note in Australia
GST only attaches where the original supply was taxable. If the first invoice carried GST, then any subsequent credit note must reflect the change in the GST amount. The supplier can only claim that GST back after it has created a valid adjustment note, and the buyer must have a copy before adjusting its own records.
If the original supply was GST free, such as many basic food items, or input taxed, such as certain financial services or residential rent, no GST appears on either the invoice or the credit note. The figures on the credit note therefore show zero GST even though the dollar value of the credit can still be significant.
Timing matters as well. A business that reports GST on an accrual basis records the GST adjustment in the tax period when the credit note is issued, not when the original money flows in or out of the bank. Cash basis reporters adjust GST in the period when the credit is actually applied or refunded. Either way the supplier and customer must use the same GST inclusive or exclusive amounts and keep matching adjustment notes in their files.
Credit note versus refund
A credit note and a refund can work together yet they mean different things. The credit note documents the reduction in the amount owed. A refund represents the payment that returns cash to the customer. A business might issue a credit note first, then decide whether to leave the credit on the account for future purchases or to pay cash back. Without a credit note the accounting system has no formal record showing why the refund happened, which could cause confusion during audit.
| Aspect | Credit note | Refund |
|---|---|---|
| Impact on accounts receivable or payable | Decreases outstanding balance or creates credit | Settles balance through cash movement |
| Form | Document within the accounting system | Bank transfer or cash payment |
| GST treatment | Creates GST adjustment if original sale was taxable | GST already adjusted through the credit note so refund itself has no new GST effect |
Credit note versus debit note
In everyday language a debit note is the opposite of a credit note. Where a credit note reduces what the customer owes, a debit note raises or records an additional amount payable. For example a supplier might discover that freight was left off an invoice and needs to bill the difference. Rather than creating an entirely new invoice some businesses issue a debit note. In Australia both documents should follow the tax invoice content rules if they affect GST, and accounting software normally allows users to select credit or debit as separate document types. The pair ensures that either party can adjust the original transaction up or down without tampering with the past records.
How to record a credit note in accounting software
Modern cloud accounting platforms such as Xero, MYOB Business or QuickBooks Online provide a dedicated credit note or adjustment note feature. The accountant or bookkeeper opens the original invoice inside the program, selects the add credit function, confirms the items being reversed, checks that the GST codes match the original lines and saves the credit note. The system then prompts whether to allocate the credit against the same invoice, leave it awaiting allocation to future sales or process an immediate refund. Once the bank payment occurs, the user reconciles the outgoing or incoming money against the credit note. This workflow preserves the link between the two documents so any later reviewer can see the sequence of events.
If the credit relates to a supplier bill rather than an outgoing sale, the operator chooses create supplier credit or bill credit depending on the software terminology. The logic is identical. The entry lowers accounts payable, adjusts the expense or asset account and reverses GST previously claimed.
Businesses that still rely on spreadsheets or manual ledgers must replicate the same process by entering a new transaction dated appropriately, referencing the earlier invoice number within the description and posting the debit and credit sides to the correct accounts.
Credit note accounting entries
The journal for a seller that issues a credit note looks different from the journal for a buyer who receives that document. Below are typical double entry movements when the seller uses an accrual system and the original transaction attracted GST.
| Seller account | Debit | Credit |
|---|---|---|
| Sales returns or revenue adjustment | 1,000 | |
| GST payable | 100 | |
| Accounts receivable | 1,100 |
These postings reduce revenue and lower GST payable. The accounts receivable credit cancels part or all of the customer balance. If the customer has already paid, the entry may credit a clearing account until cash is refunded.
For the customer, the mirror image happens.
| Buyer account | Debit | Credit |
|---|---|---|
| Accounts payable | 1,100 | |
| Expense, inventory or asset account | 1,000 | |
| GST receivable | 100 |
The buyer lowers the amount owed to the supplier and reverses the expense or inventory value together with the GST credit.
What a credit note should include
A valid credit note must carry enough information to satisfy the ATO that it accurately adjusts the earlier taxable supply. Mandatory elements include the words credit note or adjustment note in a prominent position, the seller’s identity and ABN, the issue date, a unique document number, a clear link to the original invoice through its number and date, a description of what is being adjusted, the amount of the adjustment, the GST component if any and the reason the adjustment happened. Many businesses also include payment terms or instructions about how the credit will be applied though these parts are commercial rather than legal requirements.
Maintaining the same style and layout as the primary tax invoice helps users understand the document quickly and reduces the chance that someone will mistake it for a new invoice.
Common credit note mistakes
Businesses can stumble when preparing or processing credit notes. One frequent error is raising a brand new negative invoice rather than a linked credit note. Another mistake is using the wrong GST code, often because the accounting software defaults to a standard code and the user forgets to override it. Some operators issue the credit but never apply it against the invoice, leaving both documents open and distorting aged receivable or payable reports. Others reverse too much GST by crediting the full tax component when only part of the sale is being returned. Editing the original invoice after a credit note exists is also a trap because it breaks the audit trail and can produce inconsistent GST figures during lodgement.
Credit note checklist
Before sending a credit note, the issuer should confirm that the quantity and value match the items or services being adjusted, the GST code aligns with the original tax classification, the description explains the reason, the customer details are correct and the document references the earlier invoice. After sending, the business must lodge the decreasing GST adjustment in the appropriate BAS period, apply or refund the credit and store the adjustment note with supporting documents such as emails approving the return or photographs of damaged stock. Following these steps every time creates a dependable internal process and protects the business if the ATO ever queries the adjustment.
Frequently asked questions
What is a credit note
A credit note is a document that reduces or cancels part or all of a previous invoice while preserving the original record and showing any GST reversal needed.
Is a credit note the same as a refund
Not exactly. The credit note records the accounting adjustment and GST change. A refund is the cash or bank payment that settles the credit if the supplier decides not to leave the amount on the customer’s account.
Does a credit note always include GST
Only if the original sale included GST. GST free and input taxed supplies do not carry GST on either the invoice or the credit note.
Does a credit note affect the BAS
Yes when the original transaction was taxable. The seller claims a decreasing GST adjustment and the buyer makes an increasing adjustment during the BAS period that covers the credit note date.
Can a credit note correct an invoice error
Yes. Issuing a credit note is the preferred method to correct an overstated invoice, as it leaves an auditable chain of documents rather than altering the historical invoice.
How do I record a credit note in Xero or MYOB
Open the original invoice or bill, choose the add credit or create credit function, complete the lines to be reversed, confirm the GST code, save the credit note and then allocate it against the invoice or process a refund before reconciling the bank entry.
Does a credit note expire
No universal expiry period exists under tax law but contractual terms or consumer protection rules may impose time limits on when a customer can use a credit balance.
Can I issue a credit note without an original invoice
In practice every credit note should point back to an earlier tax invoice because the goal is to adjust a specific taxable supply. Issuing a stand alone credit makes tracking and GST reporting difficult.
Should a credit note have negative amounts
Most accounting software shows amounts as positive numbers on the credit note screen but prints or displays the document with a negative balance. The key requirement is that the customer and accounts receivable both see a clear reduction.
How long should I keep credit note records
The ATO generally requires taxpayers to keep records for at least five years from when they prepared or obtained the documents. Keeping digital and backup copies of credit notes alongside invoices and bank statements satisfies this rule.
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This guide has explained what a credit note is, when to issue one, how GST applies, the difference between credit notes and refunds, the necessary accounting entries and the practical workflow for common Australian software. By following these principles and maintaining complete records small businesses can avoid GST errors, reduce compliance risk and give customers confidence that any adjustment is handled professionally.
