What Is Retainage and How Does It Affect Accounting?

Retainage is a common practice in the construction industry, involving the withholding of a portion of payments. This mechanism helps ensure project completion and quality. It is a standard feature in many construction contracts, providing financial security. While most prevalent in construction, it can also appear in other long-term project agreements.

Defining Retainage

Retainage, also known as retention or holdback, is a specified percentage of a contract amount or payment that one party holds back from another. This amount is typically withheld by a project owner from a general contractor, or by a general contractor from a subcontractor. The funds are held until work is completed to a satisfactory standard or until specific contract conditions are met. This practice represents a deferred payment, not a deduction from the total contract value. For example, if a $100,000 contract includes 10% retainage, the party performing the work receives $90,000 in progress payments, with the remaining $10,000 held back.

Purpose of Retainage

Retainage is implemented as a financial incentive and security within project contracts. It ensures satisfactory work completion and rectifies deficiencies. The party withholding funds uses retainage to protect against potential liens, incomplete work, or defects. This mechanism helps mitigate risks associated with project quality and encourages contractors to meet agreed-upon standards.

Application and Release

Retainage is typically applied as a fixed percentage, commonly 5% to 10% of each progress payment or the total contract value. This percentage accumulates over the project lifecycle. For instance, on a $100,000 contract with 10% retainage, $1,000 would be withheld from each $10,000 payment.

The release of retainage is contingent upon specific conditions outlined in the contract. These often include project substantial completion, final acceptance of the work, or warranty expiration. The process involves inspections to verify work meets contractual standards and submission of final documentation, such as lien waivers, to confirm all payments for labor and materials are resolved.

Financial Implications

Retainage impacts the financial positions of both the party withholding funds and the party whose funds are withheld. For the entity withholding retainage, such as an owner or general contractor, the withheld amount is recorded as a liability, specifically as “retainage payable,” until released. This liability represents an obligation to pay the contractor once contractual conditions are met.

For the general contractor or subcontractor, retainage creates a “retainage receivable” and affects cash flow and working capital. While revenue is earned as work progresses, the cash is deferred, impacting liquidity. Revenue recognition depends on whether the right to payment is unconditional. Effective management of cash flow is important for contractors, as payment delays can strain operational costs.