How Contractors Track Retention: 3 Methods (One of Them is a Problem)

accountant-paperwork

In this blog, we’ll explore three common scenarios contractors face when handling retention and revenue recognition, particularly as it relates to financial reporting on the balance sheet. By definition, “retention, also known as retainage, is the practice of withholding a portion of a project’s payment until the project is completed. This amount is held as security to ensure the project is finished on time and to a high standard.” While retention has been an established practice for years, how it’s handled on financial statements can vary across firms.

The way you track retention matters. The right methods not only improve your financial accuracy but provide the visibility you need to manage projects more effectively. They allow for better cash flow management and project outcomes with transparent reporting. 

So, to determine whether your approach is on the right track, it’s important to ask yourself the right questions. 

Key Questions to Ask About Retention and Financial Reporting:

  • Do your total Accounts Receivable (AR) from the sub-ledger report match the total AR on the balance sheet?
  • Is retention tracked in a separate account?
  • Is retention included in your financial review for bonding, compliance reporting, etc.?

The answer to all of these questions should be a resounding “Yes!” If not, it’s time to reassess your practices. Now, let’s explore three ways contractors are tracking retention— the good, the bad, and the ugly.

Scenario 1: Retention Not Separated from Accounts Receivable (Don’t Do This)

In this scenario, retention is not tracked separately but instead lumped together with Accounts Receivable.

The amounts are recorded as “outstanding,” often aging 91+ days. The journal entry for this situation would look like this: 

  • Debit – Accounts Receivable
    • Credit – Revenue

This approach is the least favorable for several reasons. It makes it difficult to distinguish between money that is owed, legitimately past due and amounts held as retention. Without a clear separation, your financial records will lack the visibility needed to track retention effectively, which could lead to issues with cash flow management and financial reporting. It could also lead to confusion when reconciling accounts or during audits.

Scenario 2: Retention Tracked in a Separate Account

In this scenario, retention is tracked in its own ledger account. This allows contractors to clearly track dollars on both the balance sheet and the sub-ledger report. The journal entry for this setup would look like:

  • Debit – Accounts Receivable
  • Debit – Accounts Receivable – Retention
    • Credit – Revenue

If you want to improve this method even more, create an extra account to capture retention which would be displayed on the balance sheet and (hopefully) the Accounts Receivable report. By creating a separate account, you can easily track retention amounts for each project and each client, thus, ensuring transparency in your financial records.

Contractors using construction accounting software like TRUE will benefit from a dedicated retention column that captures data on a per-client, per-job, or per-contract basis. This enables greater accuracy and streamlines reporting. Learn more in our blog, “Tracking Accounts Receivable and the Art of Getting Paid, Fast”, for a detailed breakdown of TRUE’s Accounts Receivable report. 

Scenario 3: Retention Not Included in Sales

In this scenario, retention is tracked in an Accounts Receivable retention ledger account, but it is not included as part of sales revenue. So, the Accounts Receivable retention ledger account acts similar to an Accounts Receivable account since it will be reduced as the project is completed, but it still lets you track the data.

The journal entry for this approach looks like:

  • Debit – Accounts Receivable $10K
    • Credit – Accounts Receivable Retention $1K
    • Credit – Revenue $9K

This method is a good choice as it adheres to a newer revenue recognition model for contractors: Topics ASC 606. Under the new ASC 606, retention is not realized as sales in the period(s) in which it is billed. Instead, it’s recognized as sales when the work is done via completion of punch list items or final project sign-off. This approach accurately reflects revenue as the work is performed and the retention is earned.

Consistency is Key for Accurate Financial Reporting

A main focus for any and all reporting, especially for financial statements, is consistency. Whether you choose Scenario 2 or Scenario 3, sticking to one method will help keep your books in order and offer the visibility one needs in a reporting environment. 

If you want to learn more about how TRUE’s construction accounting software can assist with retention tracking and reporting, contact us at support@constructtrue.com today!