In the construction industry, retainage (or retention) is a common practice designed to protect project owners and ensure contractors complete their work satisfactorily. While it serves as a safeguard for quality and performance, retainage introduces unique challenges for accounting, cash flow management, and financial reporting. Understanding how retainage works on both accounts receivable (AR) and accounts payable (AP) is essential for accurate job costing and financial control.

What Is Retainage?

Retainage is a percentage of the contract amount withheld from each progress payment until the project reaches substantial completion or final acceptance. The typical retainage rate ranges from 5% to 10%, though it can vary by contract, state law, or project type.

For example:

• If a contractor bills $100,000 for work completed and the retainage rate is 10%, the owner will pay $90,000 and withhold $10,000 until the project is complete.

Why Does Retainage Exist?

Retainage serves two main purposes:

1. Quality Assurance: Ensures contractors finish the job and correct any deficiencies.
2. Financial Protection: Provides leverage for owners in case of disputes or incomplete work.

While beneficial for owners, retainage can create cash flow strain for contractors and subcontractors, as significant sums may remain unpaid for months after work is completed.

How Retainage Affects Accounts Receivable (AR)

From the contractor’s perspective, retainage withheld by the owner is part of accounts receivable, but it’s not immediately collectible. Here’s how it works:

Recording Retainage in AR

When a contractor submits a progress billing:

• Invoice Amount: $100,000
• Retainage (10%): $10,000
• Current Payment Due: $90,000

The accounting entry typically looks like this:

Accounts Receivable – Regular: $90,000
Accounts Receivable – Retainage: $10,000
Revenue: $100,000


This separation is important because:

• The $90,000 is expected soon (current AR).
• The $10,000 is collectible later (retainage receivable), often classified as a long-term asset if payment is more than a year away.

Impact on Cash Flow

Retainage reduces immediate cash inflow, even though the contractor has earned the revenue. This can create liquidity challenges, especially on large projects with high retainage rates.

How Retainage Affects Accounts Payable (AP)

Subcontractors often face the same issue with retainage withheld by the general contractor. From the GC’s perspective, retainage payable is a liability:

Recording Retainage in AP

If a subcontractor bills $50,000 and the GC withholds 10% retainage:

• Invoice Amount: $50,000
• Retainage Withheld: $5,000
• Current Payment Due: $45,000

The GC’s entry might look like:

Accounts Payable – Regular: $45,000
Accounts Payable – Retainage: $5,000
Job Costs: $50,000


This ensures the GC tracks what is owed now versus what will be owed later when retainage is released.

When Is Retainage Released?

Retainage is typically released in two stages:

1. Substantial Completion: A portion of retainage may be released when the project is substantially complete.
2. Final Completion: The remaining retainage is released after punch list items are resolved and all closeout documents are submitted.

Release timing can vary widely, sometimes taking months after project completion, especially when change orders extend project scope, which further impacts cash flow.

Impact on Financial Statements

Balance Sheet

• Retainage Receivable: Appears as an asset, often in a separate line under accounts receivable.
• Retainage Payable: Appears as a liability, separate from regular accounts payable.

Income Statement

• Revenue is recognized based on work performed (percentage-of-completion), not when retainage is collected. This means profit may be reported even though cash is tied up in retainage.

Cash Flow Statement

• Retainage delays cash inflows, which can create a mismatch between reported profit and available cash.

Challenges and Risks of Retainage

Cash Flow Strain: Contractors may need to finance operations while waiting for retainage release, increasing reliance on credit lines.

Disputes and Delays: Owners may delay retainage release due to punch list disputes or paperwork issues.

Impact on Subcontractors: Subcontractors often face even greater challenges, as they typically have less financial flexibility.

Compliance with State Laws" Many states have laws governing retainage limits and release timing. Non-compliance can lead to penalties.

Best Practices for Managing Retainage

Track Retainage Separately: Use dedicated accounts for retainage receivable and payable to avoid confusion and ensure accurate reporting.

Monitor Aging: Regularly review retainage aging reports to follow up on overdue amounts.

Negotiate Favorable Terms: Where possible, negotiate lower retainage rates or early release provisions. Strong financial oversite is critical.

Plan for Cash Flow: Include retainage in cash flow forecasts to avoid surprises.

Automate with Software: Construction accounting systems like Sage 300 CRE, Viewpoint, ComputerEase, or Foundation can automate retainage tracking and reporting.

Example of Retainage Flow

Scenario:

• Contract Value: $1,000,000
• Retainage Rate: 10%
• Progress Billing: $200,000

Calculation:

• Retainage: $20,000
• Current Payment: $180,000

Entries:

• AR Regular: $180,000
• AR Retainage: $20,000

This process repeats until the project is complete, at which point retainage is billed and collected.

Final Thoughts

Retainage is a standard practice in construction, but it adds complexity to accounting and cash flow management. By understanding how retainage affects accounts receivable, accounts payable, and financial statements, companies can plan effectively, maintain liquidity, and avoid surprises at project closeout. Accurate tracking and proactive management of retainage are essential for financial stability and project success.

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