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How do you account for retention payments?

Retention payments are common in the building and construction industry but these are still being accounted for incorrectly, even overlooked and not accounted for, which leads to lost income or advanced tax payment.

Retention payments are when a customer retains a portion of the contract price until the project is completed based on the contract terms, which can be six, 12 or 24 months. The retention serves as a security that the project will be completed without defects. Once the retention period passes, the retained funds are paid to the builder.

The contract must disclose if the project has retentions so read your contracts before you sign as sometimes builders do not realise this is in the contract. This may cause cash flow challenges as retentions are often where the profit is. The contract must outline the amount that will be retained, when it will be paid and what’s expected for its release.

One of the issues is advance payment of income taxes and GST because of incorrect accounting where the retention is recorded in the total sales invoice and the customer pays less this amount resulting to an outstanding amount on the invoice. Inadvertently, income tax may be paid as your tax return will be prepared on an accrual basis. If you are in an accrual’s basis for GST, you’ll pay GST on income that you haven’t received and may not receive in a while, causing cash flow challenges.

You need to have a recording system to make sure you collect the retention and not overlook it until it’s too late. The customer will not proactively tell you they owe you money.

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