@denisemoe
IMO, the advice given by @RogelioL isn't good. You don't want to set up an inventory item for this as suggested. If you did, you would be putting this item into inventory when you issued the Credit Memo. You can use a service or non-inventory item and call it whatever makes the most sense to you - Customer Credit, Damaged Product Credit, whatever. When setting up the item, select the appropriate income/expense account under the 'Account' drop down. If you want to see this account separately on reports, use a dedicated income/expense account or use the same income account that was used on the original sales receipt/invoice for the sale of the damaged item. Mark the item as taxable/non-taxable as needed. Then, issue a Credit Memo to the customer using this newly-created item.
