Understanding Retentions in Construction Contracts

Retentions are sums withheld from contractor payments as a security against incomplete or defective work. Typically, 3–5% of the contract value is retained, with half released on practical completion and the remainder upon final inspection or after the defects liability period.

These withheld funds create accounting challenges as they represent revenue earned but not yet received. Contractors must monitor retention balances closely and ensure they're properly reflected in their financial statements.

Recognising Revenue Accurately

Revenue recognition determines when income from a contract is officially recorded. In construction, where projects span months or years, recognising revenue can be complex. The most widely used method is recognising revenue based on the percentage of completion.

Key factors include:

• Stage of project completion
• Costs incurred to date
• Certified valuations and approvals
• Any outstanding retentions

Accurate forecasting is critical to avoid overstating earnings or underestimating liabilities.

The Impact of Retentions on Revenue Recognition

Because retained sums aren’t paid until specific milestones are met, they should not be recognised as revenue until those conditions are fulfilled.

Misjudging this can distort profit margins and breach accounting standards.

Best practice is to:

• Track retention amounts separately from certified revenue
• Adjust revenue schedules once retention milestones are met
• Reconcile retention releases carefully with contract terms

Cash Flow Implications

Retentions reduce immediate cash inflow, which can strain working capital, especially for smaller contractors. Businesses should account for retention delays when forecasting cash flow and negotiating payment terms.

Some contractors consider retention bonds as an alternative to withheld payments, offering greater liquidity while satisfying client assurances.

Compliance with Accounting Standards

Revenue recognition and retentions must adhere to applicable standards such as FRS 102 and IFRS 15. These guidelines set out how and when income should be recognised, with emphasis on performance obligations and enforceable payment terms.

Failure to comply can trigger financial penalties or affect creditworthiness.

Strategies for Better Retention and Revenue Management

• Maintain detailed contract records
• Use accounting systems to flag and track retentions
• Train staff on compliance and documentation
• Regularly review project performance against billing milestones

Clear internal processes and informed staff can significantly reduce errors and improve visibility of withheld funds.