Definition: A credit memo is a contraction of the term "credit memorandum," which is a document issued by the seller of goods or services to the buyer, reducing the amount that the buyer owes to the seller under the terms of an earlier invoice. The credit memo usually includes details of exactly why the amount stated on the memo has been issued, which can be used later to aggregate information about credit memos to determine why the seller is issuing them.
A credit memo may be issued because the buyer returned goods to the seller, or there is a pricing dispute, or a marketing allowance, or other reasons under which the buyer will not pay the seller the full amount of the invoice. The seller records the credit memo as a reduction of its accounts receivable balance, while the buyer records it as a reduction in its accounts payable balance.
The seller should always review its open credit memos at the end of each reporting
period to see if they can be linked to open accounts receivable. If this is allowed by the accounting software, it reduces the aggregate dollar amount of invoices outstanding, and can be used to reduce payments to suppliers.
If the buyer has not yet paid the seller, the buyer can use the credit memo as a partial offset to its invoice-based payment to the seller. If the buyer has already paid the full amount of the invoice, the buyer has the option of either using the credit memo to offset a future payment to the seller, or as the basis for demanding a cash payment in exchange for the credit memo.
A credit memo may be considered an internal credit memo. in which case no copy is sent to the customer. This approach is typically used when the company is writing off an outstanding receivable balance.
A credit memo is also known as a credit memorandum or a credit note .Source: www.accountingtools.com