During the normal course of the business, there are a lot of transactions that require a certain explanation. Generally, things might not always go as planned, and therefore, organizations need to adjust in accordance with these activities. When such situations arise, accountants need to make the necessary amendments to their books, so that the books are able to comply with the accounting principle of full disclosure.
Memorandums are created in order to combat this particular issue. In this aspect, it can be seen that the primitive motif of the memorandum is to ensure that these transactions or ‘notes’ are mentioned alongside the financial statements so that the users of the financial statements have a complete understanding of the process in itself.
Definition of Memorandum
Memorandum is defined as a document, or a note, that goes alongside financial statements or general ledger entries. This note serves the purpose of ensuring that there is proper clarity pertaining to these transactions and all disclosures are fully made.
Memorandum also serves as a reminder, or a note in the general ledger entries, so that the accountants can revisit these statements and make the required amendments if any. Hence, a memorandum primarily serves to reiterate a certain transaction or a certain change in the financial statements.
It must be noted that the memorandum serves two main purposes, as far as companies are concerned. Firstly, they serve the purpose of ensuring that companies have internal records kept and maintained. In the same manner, it can be seen that it also serves the purpose of acting as a communicative tool between the organization, and third-party. From the perspective of internal control, memorandums tend to be extremely resourceful because they act as reminders of issues that need to be fixed because of the closing of the month-end (or year-end).
Types of Memorandum
Memorandums can broadly be classified into three different categories:
- Debit Memorandum: Debit Memorandum is a document that is created in order to record, and duly notify the customer of a debit adjustment that is made to their respective bank account. This mainly serves the purpose of ensuring that there is an internal record that is kept for the relevant entry, as well as the customer is duly notified of the given transaction.
- Debit Memorandum is also created as a reminder that a certain debit has been made to an account, and the relevant credit entry also needs to be made, at a later time. Mainly, debit memorandums are issued when companies pay their creditors, and via this document, they communicate to the creditor (their supplier) that they have settled the amount, and they are debiting the account with the similar amount.
- Credit Memorandum: Credit Memorandums serve a purpose entirely opposite to debit memorandum. A credit memorandum might be issued in order to notify a party of a liability being created in the books of the company that is purchasing goods and services. Similar to debit memorandum, credit memorandum are all resourceful in terms of reinstating changes in account activity. Again, the primary reason behind this is to ensure that there are proper internal records kept and maintained, the communication with external parties is also not compromised upon.
- General Memorandum: General Memorandums are mostly created for an internal understanding, and record-keeping. These are created for transactions that are not yet fulfilled, or are partially fulfilled. Similarly, they might also be created in cases where there is some information missing from the records, and that information needs to be completed in order for the transaction to be complete. Also referred to as a memorandum entry, this is mainly a short message that is entered into the general ledger as an explanation of a certain transaction. It does not always have relevant debit and credit entries.
Explanation of Memorandums
As mentioned earlier, memorandums are mostly un-official documents that do not need to be necessarily published in the year-end financial statements. However, there is a need to realize that memorandums should still be maintained since they might be used during the company’s audit process. In the same manner, they might also help the company maintain a relatively strict internal control policy since it marginally reduces the chances of error or mistakes caused as a result of the creation of memorandums.
It must also be noted that in certain cases, companies might opt to declare memorandums in the financial statements as ‘Notes to the Financial Statement’. This is because it might help the users of financial statements understand the financial statement in a better manner. For example, if there is a one-off transaction that might come off as unusual, memorandums can be used in order to communicate this to the users of the financial statements, in order to mitigate the chance of confusion, whatsoever.
Memorandums may, or may not exist within the company. Companies might have tens of memorandums one year, followed by no memorandums in the next year. This purely depends on the transactions, and the existing need to have memorandums in the first place. Either way, this is something that is quite subjective and is primarily contingent on the preexisting need to have memorandums in the first place. Also, having, or not having a memorandum is also not a reflection on the company and its operations.
Example of a Memorandum Entry
As mentioned earlier, memorandum entries are different from situation to situation. However, here are a few examples of memorandums created by accountants:
- Paxy Inc. had a 2-for-1 stock split on 6th April 2020. This was declared for all the common stockholders of the company, to be implemented on 30th June 2020. The stock split resulted in the number of outstanding common shares increasing from 200,000 shares to 400,000 shares.
In the scenario mentioned above, it can be seen that there was a stock split, which resulted in an increase in the number of shares. However, the issued share capital or the actual value of equity in the company did not change. Hence, in order to record this, and serve as a reminder for users of the financial statements, the accountants will create a memo that would explain and reiterate that the increased number of shares in the financial statements was owing to a stock split, and hence, the number of shares has increased without a change in the actual paid-up capital
- Another classic example of debit memorandum is related to banking transactions, that are sent to the account holder, indicating that the bank account of the company has been debited, as a result of cash withdrawal, or some other transaction that has resulted in bank balance decreasing of the company.
- Debit note from business to business: In certain cases, debit notes are also issued by businesses to other businesses in order to indicate changes in account activity. For example, in the case where a company has new sales or purchase related orders, with previous bills not yet settled, a debit memo can serve the purpose to show that the account has changed in the following manner, after the transaction was duly completed.
Therefore, it can be seen that memorandums essentially serve the purpose of facilitating better results and record-keeping that mitigate the risk of errors when it comes to basic bookkeeping.