How to create and approve a credit note in XERO

If you need to reduce the amount on an invoice you have already sent, or your supplier has issued you with a credit, you need to create a credit note in Xero. This is a legal document that cancels or adjusts an original invoice - and it’s essential for maintaining an accurate audit trail in your accounting records.

Common reasons for raising a credit note include damaged goods, returned items, a pricing error on the original invoice, service cancellations, or an early-payment discount. This guide covers every method available in Xero, including sales and purchase (supplier) credit notes, VAT implications for UK businesses, and the most common mistakes to avoid.

What Is a Credit Note in Xero?

A credit note is a document that reduces or cancels the amount owed on an original invoice. In Xero, credit notes can be raised for:

• Sales credit notes (customer): To reduce or cancel an amount owed to you by a customer.
• Purchase credit notes (supplier): To reduce or cancel an amount you owe to a supplier.

Once created and approved, a credit note:

Note: Credit notes have their own separate numbering sequence in Xero. Any changes made to a credit note after saving will be recorded automatically in the History & Notes section.

When Should You Create a Credit Note in Xero?

Use the table below to decide whether a credit note is the right approach for your situation:

 

Situation	What to Do	Why
Invoice sent but customer hasn't paid	Create a credit note	Provides a formal audit trail and adjusts the outstanding balance.
Invoice sent and customer has paid	Create a credit note + refund	The credit note offsets the overpayment. Process a cash refund from the credit note.
Invoice not yet sent, error found	Edit the invoice	No credit note needed — simply correct the draft invoice.
Received more than invoiced amount	Create an overpayment	Use Xero's overpayment feature, not a credit note.
Payment received in advance	Create a prepayment	Prepayments handle advance payments; credit notes are for invoice adjustments.
Supplier has overcharged you	Create a supplier credit note	Reduces the amount owed to your supplier against their bill.
Damaged or returned goods	Create a credit note	Documents the reduction and maintains accurate stock/cost records.

Before You Start: User Roles Required

To create and approve credit notes in Xero, you must have one of the following user roles:

Important: You can only credit an awaiting payment invoice if it is in the same currency as the credit note. Multi-currency credit notes must match the original transaction's currency.

Method 1: Create a Credit Note Directly from an Invoice

This is the recommended method when you have a specific awaiting payment invoice to credit. The credit note can be for some or all of the outstanding amount.

• In the Business menu, select Invoices.
• Click the Awaiting Payment tab, then find and open your invoice.
• (Optional) If the invoice opens in classic invoicing, click Switch to new invoicing at the bottom of the screen.
• Click the menu icon (⋯) and select Create and apply credit. This pre-populates the credit note with details from the original invoice.
• Check the details on the credit note and make any changes needed — for example, adjusting the quantity or amount if issuing a partial credit.
• Click Approve. You will be returned to the original invoice, which will now show the amount credited and any remaining balance.

Tip: If you have not yet sent the invoice to your customer and need to correct an error, edit the invoice directly instead of raising a credit note. This avoids unnecessary documents in your records.

Method 2: Add a Credit Note from Your Sales Overview

Use this method when you need to raise a standalone customer credit note that is not tied to a specific existing invoice.

• In the Business menu, select Sales Overview.
• From New, click the arrow and select Credit Note. The credit note form opens.
• Enter the credit note details. The fields are similar to entering an invoice select the customer, the date, the account, tax rate, and description.
• (Optional) Click the file icon to upload supporting documents such as a returns note or correspondence.
• Click one of the following: Approve saves the credit note as awaiting payment (ready to allocate) • Save saves it as a draft • Save & Submit for Approval sends the credit note for review by another user
• If you approve the credit note and there is an awaiting payment invoice for the same customer, you will be prompted to apply the credit. Enter the amount to credit and click Allocate Credit, or click Cancel to allocate it later.

Method 3: Copy an Existing Credit Note

Useful when you need to raise a similar credit note to one you have already created- for example, for a recurring return or a repeated transaction.

1. In the Business menu, select Invoices.
2. Click a status tab, then find and open the credit note you want to copy. To search for deleted or voided credit notes, use the All tab in Sales.
3. Under Credit Note Options, select Copy.
4. Confirm the credit note details and edit them as required- update the date, reference, or amounts.
5. (Optional) Add or edit line items. You can drag and drop the item lines to reorder them.
6. Click Approve to approve the credit note, or click Save to save a draft.

How to Add a Supplier (Purchase) Credit Note in Xero

If your supplier has sent you a credit note- for example, following a return, overpayment, or pricing dispute- you must record it in Xero against the relevant bill.

From a Supplier’s Bill (Recommended)

1. In the Purchases menu, select Bills.
2. Click the Awaiting Payment tab and open the bill you want to credit.
3. Under Bill Options, select Add Credit Note.
4. (Optional) Edit the pre-populated details. Add the reason for the credit in the Reference or Description field.
5. (Optional) Click the file icon to upload the supplier’s credit note document.
6. Click Approve to automatically allocate the credit note to the bill, or click Save to come back to it later.

From the Purchases Overview (Standalone Supplier Credit Note)

1. In the Purchases menu, select Bills.
2. Click New Bill, then select New Credit Note. Enter the supplier and credit note details.
3. (Optional) Upload the supplier’s credit note as supporting documentation.
4. Click Approve to approve and allocate, or Save to save as a draft.

How to Allocate a Credit Note to an Invoice or Bill

Once a credit note is approved in Xero, you can allocate it against an outstanding invoice or bill to reduce the amount due.

• For sales credit notes: Open the credit note and scroll to the Allocations section. Select the invoice you wish to apply the credit to, enter the amount, and click Allocate.
• For purchase credit notes: Open the credit note from Bills, scroll to Allocations, select the bill, enter the amount, and click Allocate.
• Cash refund: If there is no invoice to allocate against, you can apply a cash refund directly from the credit note by clicking Add Refund and entering the bank account and date.

Credit Notes and VAT: What UK Businesses Need to Know

For UK VAT-registered businesses, credit notes have important implications for your VAT return:

• VAT reduction: A credit note reduces the VAT you originally declared on the invoice. This lowers both your total sales and the VAT you owe to HMRC.
• VAT rate: The VAT rate on the credit note must match the rate used on the original invoice.
• Timing: Xero will include the credit note in the VAT return for the period in which it is dated. Make sure you date the credit note correctly.
• HMRC records: You are required to keep all credit notes for a minimum of six years as part of your VAT records.
• VAT invoice reference: A valid credit note must reference the original invoice number to satisfy HMRC requirements.

HMRC Compliance: A credit note is a legal VAT document. It must include your business name, address, VAT registration number, a unique credit note number, the original invoice reference, the amount credited (net and VAT), and the date. Xero populates most of these automatically always check the details before approving.

Common Mistakes to Avoid When Raising Credit Notes in Xero

 

Mistake	How to Avoid It
Raising a credit note instead of editing the invoice	If the invoice has not been sent to the customer, simply edit it. Only use a credit note once the invoice has been issued.
Wrong currency on credit note	The credit note must be in the same currency as the original invoice. Xero will not allow allocation across currencies.
Not referencing the original invoice	Always include the original invoice number in the Reference or Description field for a clear audit trail and HMRC compliance.
Incorrect VAT rate on the credit note	The VAT rate must match the original invoice. A mismatch will cause errors in your VAT return.
Approving without checking the amount	For partial credits, carefully review the amount before approving. An over-credit will create an unapplied balance on the account.
Forgetting to allocate the credit note	An approved but unallocated credit note will sit as an open balance. Always allocate or refund it promptly.
Using a credit note for advance payments	Advance payments should be entered as prepayments in Xero, not credit notes.

Frequently Asked Questions

What is a credit note in Xero?

A credit note in Xero is a document that reduces or cancels the amount owed on an original sales invoice (customer credit note) or purchase bill (supplier credit note). It creates a formal record of the adjustment and updates your financial reports automatically.

Can I create a credit note for a paid invoice in Xero?

Yes. If the invoice has already been paid, you can still raise a credit note in Xero. You will then have the option to either allocate the credit against a future invoice or process a cash refund directly from the credit note.

How do I find a deleted or voided credit note in Xero?

Go to Business → Invoices and click the All tab in Sales. From here, you can filter or search for deleted or voided credit notes.

Does a credit note in Xero affect my VAT return?

Yes. An approved credit note will be included in your Xero VAT return for the period it is dated in. It reduces the VAT output you declared on the original invoice, lowering the amount of VAT owed to HMRC.

Can I issue a partial credit note in Xero?

Yes. When creating a credit note from an invoice, you can adjust the quantities or amounts to issue a partial credit. The remaining balance on the invoice will remain as outstanding.

What is the difference between a credit note and an overpayment in Xero?

A credit note is used to adjust or cancel an invoice or bill. An overpayment is used when a customer or supplier has paid more than the invoiced amount. Use overpayments when the excess arises from a payment transaction, and credit notes when it arises from an invoice adjustment.

Can I add a credit note from a contact record in Xero?

Yes. You can navigate to a contact’s details page in Xero and create a credit note directly from there. This is useful when managing account credits for a specific customer or supplier.

Video Tutorial: For a quick visual walkthrough, watch our video guide: https://youtu.be/EExJlt9GixI