Retention in construction contracts
Question
We run a construction company and regularly sign contracts for the construction of buildings for our customers. The customers usually pay us at different points of time defined in the contracts (“milestones”). These milestones and payments usually reflect the progress towards completion and we recognize revenue over time.
According to all our contracts, the customer has the right to retain 5% of the invoiced amount. This amount is due when we complete the construction, the building is inspected and handed over to our customer.
How shall we account for the retained amounts? Is there a significant financing component since often these payments are retained by the clients for more than one year?
Answer
The primary aim of the retention amount is to provide a sort of a security to the customer that the building will be finished, inspected and handed over.
The goal is not to provide a financing benefit, thus there is no significant financing component as defined in IFRS 15 and these retention payments should not be accounted for as such.
The retention payments should be recognized as a trade receivable, because the supplier has the right to invoice the amount to a customer based on the completion of a certain milestone.
Let me give you the illustration:
Let’s say you agreed to build a house with total contract price of CU 100 000 on 1 August 20X1. On 31 December 20X1, your client agreed to pay CU 30 000 based on the completion of walls and roof; with retention of 5% held until the building is handed over.
You assessed that the building is 35% complete at 31 December 20X1.
The journal entries at 31 December 20X1 are as follows:
- Recognition of revenue
Firstly, you should recognize a revenue based on the progress towards completion. The project is 35% complete, thus you would recognize the revenue of CU 35 000:-
Debit Contract assets: CU 35 000
-
Credit Revenues from contracts with customers: CU 35 000
-
- Amount billed to the customer
Secondly, you are entitled to bill CU 30 000 to the client (let’s assume the walls and roof are completed).-
Debit Trade receivables: CU 30 000
-
Credit Contract assets: CU 30 000
-
- Cash paid by the client
The client has the right to retain 5%, thus he pays CU 28 500 (95% of CU 30 000).-
Debit Bank account: CU 28 500
-
Credit Trade receivables: CU 28 500
-
As you can see, after the payment, your client still owes you CU 1 500 being the retention amount. Since there is no significant financing component, this is simply deemed as long-term receivable (depending on the expected date of settlement) and it will be cleared when the client pays it.
One final note: it is OK to have a contract asset of CU 5 000 because the project is completed at 35%, but repaid only at 30%. It will be cleared out as the project continues and completes.
JOIN OUR FREE NEWSLETTER AND GET
report "Top 7 IFRS Mistakes" + free IFRS mini-course
Please check your inbox to confirm your subscription.
10 Comments
Leave a Reply Cancel reply
Recent Comments
- Abdul Rehman on How to Account for Employee Loans (interest-free or below-market interest)
- Silvia on What are directly attributable costs?
- Oluwatobi Esan on Change in the reporting period and comparatives
- Developer on What are directly attributable costs?
- Silvia on IFRS Reporting in Hyperinflationary Economy (IAS 29)
Categories
- Accounting Policies and Estimates (14)
- Consolidation and Groups (24)
- Current Assets (21)
- Financial Instruments (55)
- Financial Statements (52)
- Foreign Currency (9)
- IFRS Videos (70)
- Insurance (3)
- Most popular (6)
- Non-current Assets (54)
- Other Topics (15)
- Provisions and Other Liabilities (44)
- Revenue Recognition (26)
- Uncategorized (1)
When do we recognise retention sum under contract asset or trade receivables?
I had constructed asset worth 10 Million and received invoice of same in four installment and payment to be made keeping 5 percent retention i.e. I had 0.5 Million in retention of the constructor. After party gave invoice for 10 Million and inspection is completed we came across a fault in building leading to adjustments of 0.2 Million to payable i.e. only 0.3 million should now be paid to the construction company. How shall I account for that adjustment either deduct from asset(but I am already invoiced for 10 Million in full) or book 0.2 Million as some income or any other treatment.
Kindly help
Same query pls reply
Dear silvia,
In the above case, should we transfer the retention amount to a seperate ledger account called retention or keep it in the same customer ledger account. If seperated, in which group we have to classify the retention ledger?
Chacko, that is up to you and your systems. Whatever makes it easier to track these amounts.
Hello Silvia,
I would appreciate your guidance regarding a contractual situation. We have entered into a five-year contract with a customer who retains a portion of our invoices, approximately 10%. My question pertains to the preparation of our Financial Statements at the end of the first year of the contract. Should we include the Retention Receivables under Non-Current Assets?
Yes, as indicated above – long-term receivables.
Hi Silvia
Thanks for sharing all this helpful information.
As for the retention issue explained above, I have a confusion about it as sometimes the retention is kind of a warranty provided to the customer with a service in addition to the assurance that the product complies with agreed-upon Specification (as explained in the IFRS 15 ( B28 – B33 Warranties) ). For example, the client is entitled for maintenance/repair/re-construction of the delivered construction in case there is any damage or default.
Will this point affect the treatment so the retention will be treated as performance obligation? Hope you can help clarifying this point.
Dear Muhanned,
my answer does not change 🙂 It is as described above.
Dear Silvia
Thank for your time to share your response.
That’s interesting so it should be treated as receivable. Do you mean that in this case it will not be considered a performance obligation? (My query is about the performance obligation not about the significant financing component)
Can you please provide a practical example for what is mentioned in Appendix B of IFRS 15 (B28 – B33 Warranties) and specifically B32
“If a warranty, or a part of a warranty, provides a customer with a service in addition to the assurance that the product complies with agreed-upon specifications, the promised service is a performance obligation. Therefore, an entity shall allocate the transaction price to the product and the service. ……”
Thank you again for your help and support.