construction retainage accounting

In this guide, we’ll explain the basic rules of retainage and how to ensure you bring home 100% of what you’re owed. Preliminary notices are a common requirement in the majority of states for a potential lien claimant to remain in a protected position and retain the ability to file a valid and enforceable mechanics lien. With a proper dispute resolution clause in place, unearned revenue contractors, subs, and suppliers can avoid taking their disputes into litigation. Retainage is an additional layer of complexity that contractors must learn to navigate. Having a clear understanding of what’s considered acceptable—as well as what’s not—will help you set boundaries and protect your interests. The process to create a retainage invoice is the same as creating any other, except that in this case you will enter the Rate as a positive number.

  • If they decide to pursue this avenue, subcontractors should find out how long they have to file and then make sure to file for the lien before the deadline.
  • Yet, even with all of these potential problems, retention clauses in construction contracts are rarely questioned or even thought about very much, at all.
  • When you’re entering into a contract for a project where there will be money withheld, make sure you examine the terms to find out everything you possibly can about how the retainage will work.
  • This is especially true if your accounting software isn’t tailor-made for construction companies (like QuickBooks).
  • When you submit an invoice or pay application, you subtract retainage from the total currently due.
  • A project-heavy period could mean you have to employ a larger workforce (or pay more in overtime) just to stay on top of project timelines.

Time and materials method

Every state has a specific deadline by which contractors must file a lien claim for retainage, often based on the day it was due. This is because, under most construction contracts, you won’t be able to collect it yet. When you submit an invoice or pay application, you subtract retainage from the total currently due. At the end of the project, or whenever it becomes due under your contract, you will bill for retainage in its own invoice.

  • So that their investment is protected until the project meets contractual requirements.
  • Retainage, or retention, is the portion of a contract payment withheld until project milestones are met.
  • Retainage accounting involves key elements that streamline your financial management.
  • Contract parties must also remain alert to any changes in laws that can affect their contractual rights and obligations, adapting their agreements to reflect those changes.
  • To calculate your expected holdback, simply multiply the scheduled payment amount by the retainage rate.

Defining „Completion“ and „Substantial Completion“

construction retainage accounting

All this to say, it’s not hard to see just how important managing retainage receivables and payables is – not just for your construction company, but for everyone under you as well. In summary, retainage in construction accounting is critical in maintaining the balance between ensuring project completion and managing cash flows effectively. It acts as a financial safeguard for project owners while posing challenges for contractors regarding cash flow management.

construction retainage accounting

Retainage as a Financial Incentive and Risk Control Tool

construction retainage accounting

Effective management of retainage receivable is crucial for construction businesses to maintain healthy cash flow and accurate financial reporting. This section explores how contractors should handle this component in their accounting practices. Retainage is a portion of a contract’s payment that is withheld by project owners until completion or fulfillment of the contract terms, often ranging from 5% to 10%. This policy helps ensure subcontractor compliance with quality and project timelines but requires careful handling to maintain trust. Retainage, also called “retention,” is an amount of money “held back” from a contractor or subcontractor during the term of a construction project.

construction retainage accounting

Should You Include Legally Withheld Money in a Mechanics Lien Claim?

This invoice is recorded Partnership Accounting in the chart of accounts as a credit of $10,000 to retention receivable and a debit of $10,000 to accounts receivable. Project owners, on the other hand, must consider the deductibility of retainage payable. While the full contract amount is an expense, the retainage portion is not immediately deductible since it has not been paid out. This delay in deductibility can affect the owner’s taxable income and, consequently, their tax liability for the year.

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In some cases, a portion of the retention may be released earlier, such as at the end of substantial completion. Retention serves as a financial safety net for project owners in case contractors default on their responsibilities or abandon the project. By holding back a percentage of the payments, project owners can reduce their exposure to financial loss and have retainage in construction a fallback to fund necessary corrective actions. This measure is especially important for large and complex projects where unforeseen challenges can arise. Effectively managing retainage ensures financial stability and smooth project completion. Focus on clear contractual terms and regular communication to manage retainage efficiently.

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