How to account for construction retentions

When a client withholds part of the payment to be released once work has been fully completed, it is called retention.

This is common in construction projects where the customer will require you to fully complete the job and fix any defects before they release the funds.

Typical retention is 5-10% of the contract amount and the standard wait period is 6 – 12 months from the end of the contract.

If your business deals with projects that have retention, it’s important to ensure that the details of the retention are clearly stated in the contract.

How to record retentions

Accounting for retention can be confusing, especially when the waiting period spans financial years and VAT periods. However, they must be recorded correctly to comply with UK GAAP.

Retentions are generally not invoiced to the client until they are happy with any rectification works undertaken. However, this does not change the need to consider the total that should be included in income.

In general, retentions should be recorded as follows:

1. Include the retention in turnover amount and estimate how much it will cost to do remedial works. Make sure to consider any possible debt impairment.
2. Include any costs associated with the rectification works the client is requesting as an accrual.

If the work to complete is significant and the client is arguing the project is not complete (i.e. uninhabitable) then the retention need not be recorded as the company has not completed the project.

Recently, construction industry customers have been less willing to pay out retentions. This means that even if there are defects that need to be fixed, they are less likely to pay for them. In these cases, the company may argue the value of the contract is the total
amount less the retention, and so the retention will never be invoiced or recorded.

VAT on retentions

In regards to VAT reporting, the tax point for retentions is when the VAT invoice is issued or when the payment has been received, whichever happens first.

It’s important to note that this tax point rule only applies to the retention portion of the contract. The standard project costs are subject to the standard tax point rules.

Example

Your construction company has completed work for a customer where the total value of the contract is £20,000. You have agreed with the customer that they will pay you 90% (£18,000) now and retain 10% (£2,000) for 6 months.

In your invoicing software, you will have to raise 2 invoices – one for the initial amount, and another for the retention. In the records, you should do the following, unless you think the work is incomplete or the client will never pay whatever you do:

Add the £2,000 within turnover, include the estimated cost of remedial work and make provision for debt impairment (if you doubt the customer doesn’t pay the retention).