Retainage: How It Works and Best Practices

So, if the contract between them provides for retainage, they are allowed to do so under the terms set forth, even if the government is not withholding retainage from the prime. Governor Kathy Hochul signed Senate Bill S.3539/A.4167, popularly referred to as the 5% Retainage Bill, into law on November 17, 2023. This bill modifies Sections 756-a and 756-c of the New York General Business Law, which deal with retainage what is retainage in accounting and payment in construction contracts.

• Therefore contractors need to understand all of their rights, responsibilities, and the retainage laws when it comes to negotiating retention construction and collecting it after the project is done.
• If that contract is paid out over 10 progress payments, $1,000 would be held in retention from each one.
• The American Institute of Architects (AIA) offers standardized pay app templates that provide convenient guidelines for getting these numbers right.
• When ABC writes a check, it is recorded with a debit to accounts payable to clear the amount there.
• Most of these laws were created to regulate and create limitations on the practice, mostly to promote its fair use and to prevent its abuse.

COMPANY

However, it also means that contractors only get partial payments and are at the mercy of client satisfaction. In fact, it creates risk and cash flow challenges that can be difficult but necessary to manage. There are many unique financial practices that apply to construction, including the concept of retainage.

Money Withheld on a Job Cripples a Contractor’s Cash Flow

In this example, for a $30,000 payment, $3,000 would be withheld as retainage, leaving the contractor with a net payment of $27,000. The $3,000 retainage would be held until the completion of the project or a specific phase, as outlined in the contract. You can also look into subcontractor performance bonds or retainage bonds as a unique alternative to traditional retainage. Subcontractor performance bonds are a special agreement between a subcontractor and a surety.

Cost-Plus Contract Construction: Explained

Accurately accounting for retainage payable is fundamental to maintaining financial integrity and transparency in construction projects. The process begins with recognizing the retainage amount as a liability on the balance sheet. There are a lot of things that are different about construction accounting, but retainage may be one of the most unique. These amounts withheld from project payments can be a challenge, since they often account for a contractor’s entire profit margin on a job.

Performance Bond

On public projects in California, for example, state law caps retainage at 5% prior to completion and acceptance of the project. In addition, the same contract has a provision for negotiating variable retainage. Variable retainage can mean that withheld amounts are reduced over the length of the contract, or even paid out entirely once Certified Bookkeeper the contractor’s portion of work is complete. This can help contractors cover up-front costs due for construction materials, where margins are lower.

Paul’s Masonry is a subcontractor working on a project with ABC Contractor as the general contractor. ABC records the transaction as a debit of $50,000 to cost of goods sold, a credit of $45,000 to accounts payable, and a credit of $5,000 to retention payable. Once the project is complete and you’re billing your customer for the retention that was held throughout the project, the amount then moves from retention receivable to accounts receivable. According to Mehdian, a lot of contractors don’t record retention receivable or payable, especially those using Quickbooks accounting software. General retainers are the traditional type of retainers where a lawyer agrees to handle a case or future issues that arise for a client.

Milestones and Partial Retainage Release

• While this does not address the retainage problem head-on, it does minimize the problem significantly since the completion of the project will also trigger the retainage payment.
• This concept of holding back a portion of money until a job is signed off on is called retainage.
• Retainage helps ensure project quality, encourages timely completion, and provides financial security for project owners.
• GAAP also requires clear disclosures regarding the nature, timing, and uncertainty of retainage within financial statements.
• Project owners use retainage to mitigate risk by setting aside a portion of payments (5-10%) should the contractor default or fail to meet contractual obligations.
• If the party responsible (owner, general contractor, or subcontractor) does not release retainage in accordance with legal requirements, they will incur interest at the rate of 1% per month.

Thus, it’s easy to see how retainage only makes a bad problem worse for many contractors. If you do go this route, you’ll need to make sure you do your homework and have plenty of supporting documentation and evidence to support your lien actions. As always, consult with a lawyer before signing contracts or enacting your lien rights. Most payment applications will include specific fields and guidelines to help you calculate payments income statement with retainage included.