What is a Memorandum in Accounting? (Definition, Explanation, and More)

Background

Authorized and approved supports must support accounting entries. This procedural formality is implemented to bring an element of reliability for the users of financial statements.

When the business performs some activity, some documents are generated to support the transaction. These documents may be internal/external depending on the nature of the transaction posted in the accounting system.

However, sometimes things do not work as planned, and some corrections need to be made in the books of accounts that need some form of evidence/memorandum to ensure compliance with the internal controls and the accounting principle of full disclosure (especially if some material adjustment is to be made).

Attachment of memorandum with some correction/update in the ledger helps document the cause of the update and can be traced when the accountant proceeds to prepare the financial statement.

Further, an accountant may need to disclose the facts/impacts of the memorandum in the notes to the financial statement if they perceive details of the memorandum impact on the user of the financial statement (Principle of materiality).

Definition:

A memorandum in accounting refers to a document with the short message to be entered in the general journal and the general ledger account. The message in the memorandum is entered in the ledger for tracking purposes of the updates made in the accounting record.

Even though there may not be any update in the accounting ledger, the memorandum is one of the essential documents and needs to be recorded as notes in the ledger for better record-keeping and control purposes.

Explanation of memorandum

Suppose the Company’s current share price is $120 and the Company announces a stock split of 4 for 1. The Company needs to update its internal record to reflect the stock split.

However, there is no involvement of the cash/liability/asset or any other aspect of the accounting in the announcement as there is no impact on the valuation of the equity in the financial statement.

Hence, no supporting evidence like Invoice/GRN can be generated. So, there is a need to generate some memorandum that contains information regarding updates in the number of shares due to the stock split.

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So, an accountant attaches details of the memorandum with the details for a stock split. It helps to strengthen internal controls and ensure comprehensive financial records.

Further, it’s important to note that the memorandum might be internal or external as it may be issued by some department of the Company or external stakeholders like suppliers, customers, etc.

In addition to this, the companies need to ensure proper filing and tracking of the memorandums as these are essential documents and are expected to have material information that the accountant needs to adjust before closing the accounts.

Overall, the memorandum adds gaps in the accounting record, leading to an enhanced control environment and comprehensive documentation.

Memos are also exchanged between the businesses when normal business documents cannot be used. So, they draft the message and exchange memos to ensure the accuracy of communication. It’s mostly when some adjustment is made in the account balance of some other party. However, a business can also exchange memorandum in any other situation.

For instance, the supplier receives a purchase order from the buyer, but the last bills of the buyers are already overdue. So, the supplier can send a memo to the buyer highlighting the fact that they have an overdue balance with them. Hence, there can be multiple uses of memorandum in business and accounting.

Following are some of the types of memorandum frequently used in the accounting function.

General memorandum

As the name suggests, it’s a general memorandum and does not contain debit or credit. These memoranda are created to remind something within an organization and documented to ensure completeness of the accounting record.

The Company’s accountant can also request an internal memorandum from any company department when they feel there is a need to do so. It’s because an accountant needs to provide evidence of items in the general ledger (especially if they update something).

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Even if there is no debit/credit, but activity has an impact on the general ledger in any form, an accountant can obtain a general memorandum for completeness of the accounting record and ensure compliance with the Company’s internal controls.

The facts reported in the memorandum are noted in the ledger that helps an accountant to track the updates and explain the reason for the updates in the accounting record.

If a memorandum is from an outside organization, it’s called a letter and can be recorded as notes in the ledger if some update is made based on it or it adds certain value in the record keeping. In accounting, as a ritual, we term a memorandum as a memo.

Credit memorandum

A seller issues a credit memorandum to the buyer for reducing the balance buyer has to pay.  In simple words, the buyer does not pay an agreed amount that was fixed at the time of invoicing. The most common reasons the seller issues a credit memorandum include a dispute with the buyer, a return of goods from the buyer (before making payment), and marketing allowances offered by the seller (after an invoice is issued).

An accounting impact of credit memo is that seller reduces accounts receivable in their books of accounts. On the other hand, the buyer reduces the payable amount in their books of accounts with the same amount.

Debit memorandum

 A buyer issues the debit memorandum to the seller for reducing the balance the buyer has to pay. In simple words, the buyer does not want to pay an amount that was invoiced. This can be due to damaged goods received from a supplier, inferior quality of goods received from the supplier, or any other reasons the buyer does not intend to pay a complete amount as in the original invoice.

Further, the debit memorandum is a formal request from a customer to seller for decreasing the total payable amount. If the seller agrees to the debit note received from the customer, it sends back a credit note as a confirmation for acceptance of their request.

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An accounting impact of debit note is that the customer decreases/debits accounts payable and credits/increase purchase returns and allowance, which is contra account for the purchases.

Example of memorandum

  1. Afoca computers find that ten hard drives amounting to $1,500 received from Jessica traders were not operational. So, they decided to return and issue a debit note for the ten hard drives. The memorandum, in this case, is called a debit memo because the sender of the memo (customer) debits the balance of accounts payable.
  2. Banks charges are deducted from a business bank account and reflected in the bank statement. However, at the end of the period, the bank sends a debit memorandum to summarize transactions that have been debited in the account.

Frequently asked questions

What is an entry of a memorandum?

Entry of memorandum refers to the process of entering the message of the memorandum in a general ledger. There may/may not be debit/credit to be entered in the accounting system, yet the detail of the memorandum is entered to ensure completeness of the accounting record.

Does Company have to publish a memorandum in their note to the financial statements?

The memo is a basic document in accounting that does not need to be published in the financial statement. However, if details of the memorandum are material and can impact the user of financial statements, the Company needs to disclose the details in the notes to the accounts.

What is the purpose of a memorandum in accounting?

The purpose of a memorandum in accounting is to ensure the completeness of accounting records and initiate some requests for the performance of the activity. For instance, requesting an increase/decrease in the balance of accounts payable.

Why is a memorandum created in accounting?

Usually, a memorandum is created for the following reasons,

  1. Keeping an official record of some event/activity/decision.
  2. To remind something.
  3. Acts as evidence if there is some dispute on a specific business transaction.         
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