As if managing cash flow for your construction company isn’t difficult enough, if you’re working on a commercial project, you may also have to deal with retainage. The practice of short-paying contractors’ invoices to secure completion of the work started as early as the 1800s. These days it’s a part of the law in most states. We’ve got more information on this strange practice, including when retention is released and how to record it in your accounting system.
What is retainage?
Retainage, or retention, is an amount of money that is withheld from each payment to contractors on a construction project. It is most common in commercial construction. Owners and contractors withhold funds to provide an incentive to finish the project according to the owner’s specifications and to serve as funding if there is a problem on the job.
In most states, retention is mandated on certain projects by state law. In addition, the law often caps the amount that can be withheld on projects in that state.
Retainage for a specific project is stipulated in the prime contract between the project owner and the general contractor. Often the retention rate and terms of payment flow down through the general contractor’s contract with each subcontractor.
Who holds retention?
Generally, withholding retention flows down through a project’s contracts. The prime contract stipulates the amount that will be withheld from the general contractor’s payments, and each subcontract the general has also stipulates the amount that will be withheld (usually the same amount as the prime contract).
In most projects, the owner and general contractor withhold retention and are responsible for paying it out once the project is complete.
How much is withheld?
The retainage rate, or how much is withheld, can vary by project. It is usually calculated as a percentage of each payment, usually 5 or 10%. The rate is specified in each contract. Some states have limits on how much can be withheld. For example, in Oregon the limit is 5% and in New Mexico retainage is not allowed.
Say a general contractor has billed its customer $100,000 for a project. With 5% retention the contractor will receive a payment of $95,000. With 10% retention the payment will be $90,000. The balance is tracked until the final payment is made once the work is complete.
When is retention released?
Most contracts stipulate that retention is paid at final completion, once the punchlist work has been finished and the owner has moved in or taken ownership of the project. On large projects this final payment can be quite substantial, so it is in the contractor’s best interest to finish the project quickly so they can get paid.
Some contracts allow contractors to apply for early payment of some retention funds. This can usually be done after the project meets a milestone of completion, usually 50% complete. The contractor sends the owner an application for payment requesting the funds, and when it is approved, the owner makes the payment.
How to record construction retainage
The concept of retainage is unique to the construction industry. Because of this, most general accounting programs do not know how to handle it. That’s why it pays to use software that is designed for the industry. However, it is possible to record retainage using general accounting software if you know how to do it.
Recording retainage held on your invoice
If you are a general contractor or a subcontractor billing a general contractor, you will need to record the amount of retainage that will not be paid until the end of the project. This is done through a separate general ledger account called Retention Receivable. When an invoice is recorded, the retention will go to this account, with the balance going to Accounts Receivable.
Retainage held on your subcontractor’s invoice
If you are a project owner or general contractor with a contractor or subcontractor that has sent you an invoice, you will need to record the retainage that you will not be paying until the work is completed. This is done through a general ledger account called Retention Payable. When an invoice from your vendor is recorded, the retention will go to this account, with the balance going to Accounts Payable.
Conclusion
Hopefully this article has helped you understand retainage and retention better. Unfortunately, it’s almost unescapable in the commercial construction sector. Be sure to take it into consideration when you do your cash flow planning, as it can significantly affect the amount of money you receive throughout a project.
