This creates cash flow challenges in an already cash-poor industry, the practice is too frequently abused, and of course, it’s subject to complicated regulations that make it tricky to execute. Like we mentioned before, retainage in the construction industry generally ranges from 5-10%, which mirrors the profit margin many construction contractors expect from each job. Because contractors often need to make outlays for upfront costs on a job, waiting for retainage to be released can make a tough financial situation even more difficult. On the other side, subcontractors and suppliers are often made to wait until project completion or final approval to see their retainage payment, even if their portion of the project was finished early on. 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. Retainage is an amount of money withheld from payment to a contractor or subcontractor until the end of the construction project, or a time specified in the contract.
Why you can’t record retainage in Accounts Receivable
That way you can ensure that you get paid all of what you’ve earned. Each pay application is different, but generally speaking, they follow the same basic principles. We’ll take a look at two of the more commonly used standardized pay applications as examples. Although a controversial topic, retainage is commonplace in the construction industry. You can find retainage provisions in almost every modern construction contract. So you need to be sure to properly account for retainage throughout the project on each pay application to ensure it’s eventually paid out.
- Additionally, any changes to the original contract terms may impact how retainages are calculated and managed.
- On large projects this final payment can be quite substantial, so it is in the contractor’s best interest to finish the project quicklyso they can get paid.
- Perhaps you can offer a letter of credit or a surety bond to substitute for the retainage requirement.
- Your books must show your gross income, as well as your deductions and credits.
- This concept of holding back a portion of money until a job is signed off on is called retainage.
What is Overbilling? Construction Industry Accounting
By tracking the amounts owed for retention, companies can make plans on how to collect overdue payments based on the amount of risk involved. When the retention payment is made, it is posted against accounts payable to clear https://www.bookstime.com/ the amount owing. When ABC writes a check, it is recorded with a debit to accounts payable to clear the amount there. “When tracking and collecting accounts receivable, we only want to track those that are collectible.
Accounting for Retention Receivable & Payable: A Contractor’s Guide
This way, you can reallocate funds or schedule in a more labor-efficient manner. You can also look into and instigate financing options early so you can secure cash for job phases where you need it most. You must budget around the amount you’ll receive less retainage. For retainage accounting example, a $10,000 payment at 10% retainage will result in a $1,000 gap. The $1,000 withheld from this payment can be easily more than enough to cause serious cash flow issues, production delays, missed payroll, scheduling issues, or disruptions in material deliveries.
How retainage is structured in a construction contract
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You can view the laws and rules for your state by reviewing our 50-State Retainage Law Guide & FAQ Pages. Just like with federal projects, retainage can be withheld on state, municipal, and county projects. In fact, there are very few instances when the laws are in agreement in every state, but this is one of those instances. Every single one of the 50 states allows retention to be withheld on a public works project.
Some states have prompt payment laws that regulate how much can be withheld from contractors, while other states don’t. 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. Not recording retention receivable leads to understating of revenues, which can affect the amount owed for taxes. Not recording retention payable leads to the understating of a company’s liabilities. This means that companies could be reporting inaccurate information on their financial statements, which could lead to penalties and interest owed if they are subject to a tax audit.
- Retainage plays a big role in this – it’s money that you’ve earned but haven’t been paid.
- It is intended to cover additional expenses if the contractor or subcontractor doesn’t finish the work or there is a quality issue.
- Because these funds aren’t due until the project is completed, they are recorded in a separate account on the general ledger.
- What is a cost-plus contract and how is it used in the construction industry?
- The weighted average method of inventory costing is often used when inventory is not perishable but stock can still easily be rotated or intermingled.
- This is especially true because the rules are very specific and vary from state-to-state and job-to-job.
Factor it into your cash flow needs
Failure to provide the correct lien waiver may result in the GC withholding your retainage. It’s important to note that retainage payable should not be recognized as revenue until it is earned. Therefore, any retainage amounts received should not be included in your revenue calculations.
