A customer is not paying, or is paying less than the invoice says. Three mechanisms are available and they are not interchangeable, but in most of the books we inherit they are being used as if they were.
A credit note reduces the invoice, so it reduces revenue and reverses the tax charged. A refund returns cash against an existing credit, so it moves money without changing revenue again. A write-off accepts the invoice was correct but will not be collected, so revenue and tax stay as billed and the loss sits in bad debt expense. Choosing wrongly misstates revenue, tax, or both.
Not sure which one your situation calls for? WhatsApp us the details and we will tell you which entry is correct.
Quick Summary
| Mechanism | What it says | Revenue | Indirect tax | Cash |
| Credit note | The invoice was wrong, or the supply was reduced | Reduced | Reversed, in the period of the credit | Unchanged unless refunded |
| Refund | Money is being returned against a credit already raised | Unchanged | Unchanged | Out |
| Write-off (bad debt) | The invoice was right but will not be collected | Unchanged | Generally unchanged | Never received |
| Discount at settlement | Agreed reduction for early or prompt payment | Reduced | Depends on terms and jurisdiction | Reduced inflow |
| Allowance / provision | Collection is doubtful, not yet certain | Unchanged | Unchanged | Unchanged |
💡 TaxKitab Tip The question to ask is not “how do I clear this balance” but “was the invoice correct when it was raised?” If the answer is no, it is a credit note. If the answer is yes, it is a write-off or a provision. We have never seen that test give the wrong answer, and it takes the decision out of whoever happens to be in the ledger that day.
Credit Note — the Invoice Itself Was Wrong
Use a credit note when the amount billed should not have been billed. Goods returned, services not delivered, a quantity or rate keyed incorrectly, a duplicate invoice, a post-sale price adjustment agreed with the customer.
The credit note reduces revenue in the period it is issued and reverses the indirect tax that was charged on the original invoice. That tax reversal is the part people miss. Clearing an incorrect invoice by any other route leaves tax declared on a supply that did not happen.
Credit notes should reference the original invoice. Both QuickBooks and Xero support this, and it is what makes the receivables ledger auditable later.
Refund — Cash Going Back Out
A refund is a cash movement, not a revenue event. It follows a credit note, or it follows a customer overpayment or a deposit that is being returned.
The order matters. Raise the credit note first, then record the refund against it. Recording the refund as a standalone payment leaves the original invoice outstanding and the credit unapplied, which is how a receivables ledger ends up with offsetting balances against the same customer.
Where a deposit or advance is being returned and no supply ever took place, check the tax treatment of the original receipt. In several jurisdictions tax falls due on an advance; if it did, returning the advance requires a credit, not just a bank payment.
Write-Off — the Invoice Was Right, the Money Is Gone
Use a bad debt write-off when the supply happened, the invoice was correct, and collection has failed. The customer has gone into liquidation, is uncontactable, or the cost of pursuing exceeds the balance.
Revenue stays as originally recognised. The receivable is removed and the matching debit goes to bad debt expense. This is the correct treatment and it is also the honest one: it shows in the accounts that the business billed work it did not get paid for, which a credit note conceals.
On the tax side, treatment differs by jurisdiction. Some regimes allow indirect tax relief on a bad debt after a specified period and subject to conditions; others do not. For direct tax, deductibility usually depends on the debt having been genuinely written off rather than merely provided for. Neither is a decision to make from the bookkeeping side alone.
Provision or Allowance — Doubtful, Not Dead
When collection looks unlikely but is not yet settled, the right entry is a provision against receivables, not a write-off. Gross receivables stay intact, a contra account carries the estimate, and the net figure on the balance sheet reflects what is realistically collectable.
This also keeps the collection effort alive. A written-off invoice stops being chased; a provided-for invoice stays on the ledger and in the statement. Convert the provision to a write-off only when the outcome is known.
Settlement Discounts Are a Separate Thing Again
A reduction agreed as part of getting paid — two percent for payment within ten days, or a round-down to close the account — is a discount, and it belongs on the invoice or as a credit referencing it, with the tax consequence considered.
Posting it as a write-off makes the business look worse at collection than it is, and posting it to a miscellaneous expense account makes revenue look better than it is.
Six Situations and the Right Answer
| Situation | Use |
| Customer returned goods | Credit note, then refund if cash was received |
| Invoiced twice for the same job | Credit note against the duplicate |
| Customer in liquidation, invoice correct | Write-off, with the indirect tax position checked locally |
| Customer disputing scope, outcome unknown | Provision now; credit note or write-off once settled |
| Deposit returned, no work done | Credit note, then refund; check tax on the advance |
| Agreed to take 90% to close it out | Credit note for the 10%, referencing the invoice |
Credit notes and write-offs both touch indirect tax, which is why they are worth reviewing alongside the VAT and sales tax coding checks — a credit with the wrong tax code does the same damage as an invoice with one. For product businesses, returns feed straight back into stock, so the inventory valuation checks belong in the same routine. And if receivables ageing is the actual concern rather than the accounting entry, the financial metrics worth tracking covers collection days and why the trend matters more than the balance.
Frequently Asked Questions
Can I use a credit note to write off a bad debt? You can, and the balance will clear, but it misstates both revenue and tax. Revenue you genuinely earned disappears, and indirect tax is reversed on a supply that actually took place. Use a write-off.
Does a credit note need to reference the original invoice? Not always as a legal matter, but always as a practical one. In several jurisdictions a tax credit note has prescribed content requirements that include the original invoice reference — confirm the local rule. Even where it is optional, an unreferenced credit is unauditable.
What period does the tax reversal fall in? Generally the period in which the credit note is issued, not the period of the original invoice. This is why a credit note raised after a return has been filed does not require amending that return in most regimes — but confirm the local position.
Can I recover indirect tax already paid on an unpaid invoice? Sometimes. Several regimes allow bad debt relief after a waiting period and subject to conditions such as the debt having been written off in the books. Others have no such relief. This is a jurisdiction-specific question for your local tax agent.
Provision or write-off, if I am not sure? Provision. It is reversible, it keeps the receivable visible, and it does not pre-empt a collection outcome you do not yet know.
Who decides — bookkeeper or management? Credit notes for keying errors and returns are a bookkeeping matter. Write-offs are a management decision, because they accept a loss and in most jurisdictions carry a tax consequence. Agree a threshold above which write-offs need sign-off, and keep the approval with the entry.
References
- Indirect tax treatment of credit notes and bad debt relief is set out in each jurisdiction’s own VAT or sales tax law
- Direct tax deductibility of bad debts generally requires an actual write-off rather than a provision, with the test varying by jurisdiction
- QuickBooks Online and Xero documentation on credit notes referenced to an invoice, and refunds applied against a credit
⚠️ Tax treatment of credits and bad debts differs by country and changes. Verify your own position with your local tax agent before applying any treatment described here.
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