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In line with my construction accounting experience, construction entrepreneurs truly fear when talking about retention accounting.  It’s a concept that creates fear and headaches among construction professionals.

So, I decided to explain the concept in easy words and tone. So, you really don’t make a mistake when it comes to recording and tracking the retention. Let’s get started.

Definition

Retainage in construction accounting can be defined in any of the ways given below.

• Retainage is a portion of the total construction cost that is to be paid upon successful completion of the construction project.
• Retainage is security withheld by the customer and is to be paid at the end of the project completion.
• Retainage is an asset for the general contractor that is to be realized when they successfully end the project. Similarly, it’s a liability for the owner that is to be settled on agreed time like substantial completion or full completion of the project.

Please be advised that for general contractor – retention receivable/retainage is the revenue. However, it is to be received at agreed time (fully project completion or substantial completion). Let’s go through detailed accounting.

Journal entries for retention/retainage

For instance, the general contractor calculates the gross bill for the month of January amounts to $10,000. And the agreed retention rate is 5%. In this case, the contractor can record $10k revenue in full. However, they are entitled to receive $500 ($10,000 x 5%) after the project is fully completed.

Following is the journal entry for retention accounting is to be posted from the contractor’s perspective.

Description	Debit	Credit
Retention receivable (asset)	$500
Revenue (profit and loss)		$500

The debit impact of the given transaction records receivable as this amount is to be received when the project gets completed. Please note it’s different from accounts receivable because accounts receivable can be received at any time but this balance is to be only received at agreed time.

So, please do not make a mistake by treating retention receivable as accounts receivable or it can be really challenging to sort out the things later.

As you keep on sending invoices on the specific project, the retention receivable keeps accumulating and remains as asset in the accounting books until project is completed and the customer is satisfied with work quality of the constructed project.  So, following journal entry is posted when project is completed and contractor receives the cash.

Description	Debit	Credit
Cash / Bank (asset)	$500
Retention receivable (asset)		$500

The debit impact of the given transaction records cash as it’s received in the bank. And credit impact removes retainage/retention because it’s finally realized.

Further, please note that the owner of the construction site needs to record retention payable while doing the accounting.

Purpose of keeping retention in the AIA contract

Following is the purpose of embedding retainage in the AIA contract.

• Prime incentive for contractor– Retention receivable encourages contractor to promptly complete the project while meeting quality standards. Contractors understand realization of this amount is subject to successful completion of the project.
• Keeps the buyer safe side– This balance helps to reduce the risk of contractor’s abandonment. It may not be feasible for the contractor to leave unfinished project as retainage lies in the hands of owner.
• A great way to ensure quality construction– The construction owner may not fully release the retainage if project does not meet quality standard.

Why do things often go wrong for retainage?

Retainage is often one of the most disputed areas of construction accounting. It’s a common ground of disputes. So, it’s essential to ensure appropriate accounting treatment. In my person experience, here is a list what goes wrong.

• Contractors mismatch receivable with retention receivable. And get confused how much they exactly need to receive now and at the time of project completion.
• Contractors often think retention is a liability ending up with messy books.
• Contractors do not record retainage at all.
• Terms of the contract are often vague.
• The scope of the work falling under retention is not adequately defined.
• Contractors often perceive this amount as a financial strain in terms of compromised liquidity.
• Project-specific tracking for retainage is often challenging.
• Contractor may opt to inflate overall project price to offset the retention, it can be a root cause of tension and disagreement.

My personal experience with retention disputes and how we resolved them?

One of my remote clients based in Florida had the messy books. They were working on 7 projects and did not have retention receivable in their QuickBooks online. They recorded full revenue and receivables and no retention. So, how did I resolve it?

For each project, completion percentage was re-assessed and 5% of the total constructed cost was transferred to retainage via following JE.

Description	Debit	Credit
Retention receivable	XXX
Accounts receivable		XXX

Further, we compiled an Excel sheet enlisting retainage for each project, and the total tied with QBO!

Here is the workflow that we followed! (for contractors that didn’t record retention yet).

• Calculate the completion percentage for each project.
• Apply the completion percentage to the total estimated construction cost for each project.
• Apply the rate of retention (copy from AIA agreement) on the completed project value.
• Sum the total calculated for each project.
• Post this total in the QBO by debiting the retainage and crediting the receivable.

An alternate workflow can be followed.

1. Get all the invoices sent to the customer to date.
2. Apply rate of retention.
3. Sum the total for each project.
4. Post this total in the QBO by debiting the retainage and crediting the receivable.

Best practices for retainage accounting

• Ensure the contract’s scope and rate are clearly defined for retention purposes.
• Create a separate chart of accounts for retention in the liability section.
• Ensure monthly reconciliation of “Retention Excel listing” with the accounting books.
• Measure and track the balance using reliable accounting software like QuickBooks online.

Conclusion

Retainage refers to certain amount/balance withheld by owner during construction project. This amount remains as payable in the books of customer and receivable in the books of contractor.

The prime purpose of embedding retention in the contract is to manage the owner’s risk in terms of sustained quality and project completion.

It’s the most common ground of disputes in construction projects and need to be managed in line with best practices.

Frequently asked questions

Is there a regulatory cap on applying retention?

It depends on your state. For instance, in California, the cap is 5% and this balance has to be settled within 60 days of substantial completion. Similarly, in Mexico, no retainage is allowed. (Source)

Is the release of retention often delayed?

It’s true release of retainage is often delayed because owner may be confused about construction quality and administrative aspects to track the balance. For instance, survey conducted by King college London revealed that 50% of individuals reported dispute in construction project was due to in-efficient administration.

What are the alternatives to using retainage in the construction contract?

The alternatives include performance bonds, lien rights, liquidated damages, etc.