We were approached by one of our favorite construction clients the other day. They had a Invoices on their Accounts receivable reports that were over 250 days over due. The problem wasn’t that they were overdue, it was that every time they looked at that report, they had to remind themselves that those items were in retention. There wasn’t a clear way for them to identify their receivables in retention, from their normal receivables.
First, what is retention?
Retention is an established amount of money that a primary contractor may hold from their sub contractors while waiting for some pre established condition to pay out the full amount of the invoice. The reasons that they may not have paid retention include, completion of the overall contract or payment of the primary contractor. There are a lot of other factors that may be involved, but when the company is a sub contractor working for a larger primary contractor, it is normal to expect retention.
Here are a couple things to consider when considering how to account for retention properly:
- If the business is on a cash basis, then this isn’t an issue, revenue is recognized when the cash is received so everything below doesn’t matter.
- If the business is on an accrual basis it is important to ensure that the entire amount of the revenue is recognized at the time of the original invoice. If the revenue for the entirety of the services is $100,000, but there is a 10% retention on the invoice, it is appropriate to expect only $90,000, to be paid on the invoice.
- Quickbooks has quirks, these exist because it is attempting to make life easier for bookkeepers, but when transactions are more complex, a well thought approach is necessary.
In order to make sure that our approach addresses the needs of accrual basis and the quirks of Quickbooks.
We will work our way through the full transaction cycle of this retention. Preparing for retention, the original invoice, payment on the original invoice, and payment on retention.
Preparing for retention receivables:
- Create an account as a current asset called “Retention Receivables.”
- Create an item titled “Retention” and ensure that the account it is attached to is the “Retention Receivables” account that you just created.
The Original Invoice:
- Bill an invoice as you normally would, as if there were no retention.
- At the bottom of the item list of the invoice, add the item “Retention” that was created earlier. This item will be for a negative amount.
- Double check that the invoice is for the amount of cash expected to be received. We have an example below:
Retention is 10% on a $100,000 invoice. The entity has performed $100,000 worth of services and expect $100,000 when the entity is eventually paid in full. On the first invoice, there will be $100,000 worth of revenue, offset by the -$10,000 retention item (100,000 x 10% = 10,000). The total billed invoice will be for $90,000, it will show the full $100,000, but it will also show the expected retention to be paid in the future. The amount due, however, is $90,000.
Invoicing for Retention:
- Create an invoice for the total retention expected to be paid (a positive number now), date it the same date as the original invoice, and we recommend a modified version of the original invoice number. If the invoice number was #5054, the modified would be #5054R. Or whatever works for your entity.
- There is no need to send this invoice to the customer, as the information was transmitted to the customer in the original invoice.
Now there are two invoices on the Receivables report, one for the original invoice, and one for the retention. The total amount being the amount of total payment eventually expected. In our example, it should be $90,000 and $10,000 for a total of $100,000, which is the original value of the services.
Payment on the original invoice:
- Payment will be received, lets say for the $90,000.
- Apply that payment to original invoice, and clear the invoice.
Now there should only be the retention invoice remaining on the Receivables report. The reason we elect to create an invoice for that receivables report, compared with simply leaving the balances in the Retention Receivables report is a matter of workflow compared with accounting. The accounting considerations are properly addressed either way. But when the Retention amount is immediately invoiced, it allows the users of that Retention Receivables report to see that balance is still owed without having to run a second report.
Payment on the Retention:
- Payment in full or partial arrives on the retention. Some primary contractors pay half at the completion of the sub contractors work, and the other half at the end of the contract. Either way, at some point the entity should be paid some amount on the retention.
- Apply the payment to the Retention invoice, whether full or partial.
- If it is in full then the retention invoice is cleared and the entity is made whole, if it is paid in partial, that partial invoice will remain on the Receivables report.
Did this answer your question, let us know in the comments below. If we missed something, let us know. We can always update this if we learn something new.
Disclaimer: The information contained in this document is provided for informational purposes only and should not be construed as financial or tax advice. It is not intended to be a substitute for obtaining legal, accounting, or other financial advice from an appropriate legal professional, financial adviser or for the purpose of avoiding U.S. Federal, state or local tax payments and penalties.