Construction projects rely on contractors completing the work they started and meeting the design intent. In an attempt to hold contractors accountable, many projects use retention holdbacks, also known as retainage. These holdbacks need to be accounted for by every party to a project: owner, general contractor, and subcontractor. Tracking these amounts ensures that everyone gets paid the money they are due when the project is completed. Read on to see how to record retention receivable and payable, and why it can be essential for your business.

What is retention?

Retention, also called retainage, is money held back from each payment to ensure that a contractor or subcontractor completes a project. It provides a financial incentive to ensure that the work is of appropriate quality and meets the plans and specifications. It is intended to cover additional expenses if the contractor or subcontractor doesn’t finish the work or there is a quality issue.

The rate of retention is stipulated in the construction contract and can often be negotiated. Some states even have a statutory limit on retention for projects within the state boundaries. 

Retention can be withheld on residential or commercial projects and on both public and private projects. The project owner usually holds retention from the general contractor’s payments, and the GC in turn holds it on their subcontractors. Retention doesn’t usually apply to material suppliers.

Because retention is withheld from each payment and paid at a later date, the unpaid funds have to be recorded and tracked accurately. It can significantly impact the financial standing of contractors, especially when working on projects with a small profit margin.

Retention receivable and payable is different from accounts receivable and payable. According to Steven J. Peterson, a construction finance educator and author, “The retention in the retention receivable account is not collectible yet because the contractor has not earned the right to receive it.”

“When tracking and collecting accounts receivable, we only want to track those that are collectible. Therefore, they must be kept separate from the uncollectible,” Peterson says.

Steven Peterson

Steven Peterson 

Retention receivable is recorded by general contractors and subcontractors and is the number of funds due from a contractor’s customer for retention. Because these funds aren’t due until the project is completed, they are recorded in a separate account on the general ledger.

Retention payable is recorded by owners and general contractors and is the amount owing to contractors or subcontractors for retention. Since these funds aren’t due until the project is completed, they are recorded in a separate account on the general ledger.

“When the retention for a project is moved from retention receivable to accounts receivable, the project’s retention due to suppliers and subcontractors is moved from Accounts Payable-retention to Accounts Payable-trade,” Peterson recommends.

Both retention accounts are shown as current assets and current liabilities, respectively. Even though those funds may not be collected within the “current” timeframe, which is 12 months, they are shown on the balance sheet as current.

“There’s always a paragraph in any construction company’s financial statement that says, ‘Even though retention receivable may not be collected in the short-term period, it’s still classified as a current asset or liability,” says Californian CPA Fariba Mehdian.

Fariba Mehdian

Fariba Mehdian 

The pitfalls of not recording retention

According to Mehdian, a lot of contractors don’t record retention receivable or payable, especially those using Quickbooks accounting software. These contractors have no way of knowing or verifying the amount owed and payable for retention, leaving them dependent on others’ recordkeeping.

Not recording retention receivable leads to the underreporting of revenue, which can affect the amount owed for taxes. In states that charge sales tax, the tax is supposed to be calculated on the gross amount billed, not the net payment after retention is withheld.

Plus, not recording retention payable leads to the understating of a company’s liabilities. This means that companies could be reporting false information on their financial statements, which could lead to penalties and interest owed if they are subject to a tax audit.

Since some accounting software packages, like Quickbooks, don’t track retention on either the receivable or payable side, companies either don’t track it or use other tools, like Excel, to track these amounts. This can lead to mistakes and takes additional time and effort.

Mehdian recommends companies use software specifically designed to track retention. If you can’t afford software with this capability, do what you can to record retention receivable and payable with each transaction.

Next, let’s look at how retention is recorded from an accounting perspective.

How to record retention receivable

Retention receivable is similar to accounts receivable. Accounts receivable are monies invoiced and due from your customers. When retention is subtracted from the invoice, the amount held is recorded as retention receivable.

Once the project is complete and you’re billing your customer for the retention that was held throughout the project, the amount then moves from retention receivable to accounts receivable.

Let’s look at an example of how retention receivable is recorded.

ABC Contractor is billing a project owner for $100,000 with 10% retention. The invoice is recorded in the chart of accounts with a credit to the income account for $100,000, a debit of $90,000 to accounts receivable, and a debit of $10,000 to retention receivable.

Debit Credit
Income $100,000
Accounts receivable $90,000
Retention receivable $10,000

When the $90,000 is paid, it is posted with a debit to the bank or cash account and a credit to accounts receivable, clearing the account for that project.

Debit Credit
Bank or cash $90,000
Retention receivable $90,000

When ABC completes the project, they will invoice the customer for $10,000 in retention. This invoice is recorded in the chart of accounts as a credit of $10,000 to retention receivable and a debit of $10,000 to accounts receivable.

This clears the retention receivable account and moves the amount to accounts receivable, where it can then be paid.

Debit Credit
Bank or cash $10,000
Retention receivable $10,000

If your company is using QuickBooks, read up on recording retention receivable in QuickBooks.

How to record retention payable

Retention payable is similar to accounts payable, where you record your subcontractor and vendor invoices that need to be paid. Accounts payable amounts are to be paid within the payment terms, while retention payable is held until the project is complete and the owner or GC pays it.

Let’s look at an example of recording and paying retention payable.

Paul’s Masonry is a subcontractor working on a project with ABC Contractor as the general contractor. Paul’s Masonry invoices ABC $50,000 with 10% retention. ABC records the transaction as a debit of $50,000 to cost of goods sold, a credit of $45,000 to accounts payable, and a credit of $5,000 to retention payable.

Debit Credit
Cost of goods sold $50,000
Accounts payable $45,000
Retention payable $5,000

When ABC writes a check, it is recorded with a debit to accounts payable to clear the amount there.

Debit Credit
Bank or cash $45,000
Accounts payable $45,000

When the project is complete, Paul’s invoices ABC for $5,000 in retention. This is recorded as a debit to the retention payable account and a credit to accounts payable. This clears the retention payable account.

Debit Credit
Retention payable $5,000
Accounts payable $5,000

When the retention payment is made, it is posted against accounts payable to clear the amount owing.

Managing slow payment cycles

Because retention is often held for a long period of time, it can create cash flow problems for contractors. Contractors must weigh whether to use a mechanics lien to protect their payment rights. This gets sticky because it often takes longer to get paid retention than the lien deadline allows.

By tracking the amounts owed for retention, companies can make plans on how to collect overdue payments based on the amount of risk involved.

Learn more with The Ultimate Guide to Construction Accounting.

The post Accounting for Retention Receivable & Payable: A Contractor’s Guide appeared first on Levelset.