How to Invoice for Retentions: A Practical Guide

Retentions are fairly commonplace in the building and construction industry, however if not accounted for correctly, businesses open themselves up for a range of financial issues including compromising the accuracy of their financial position, paying more tax (both income tax and GST) than is required, and/or paying tax earlier than necessary.

Consider the scenario of a builder and their client: after completing a stage of the project, the builder submits an invoice totaling $100,000 for the completed work. However, as per the contractual agreement, the client withholds $10,000 as a retention until any potential defects are rectified. In navigating such situations, understanding and implementing proper invoicing techniques are paramount to financial integrity and compliance.

Understanding Retentions

Before delving into the invoicing process, it’s essential to grasp the concept of retentions. Retentions refer to a portion of the total invoice amount that is withheld by the client until certain conditions are met, typically relating to the completion of work or fulfillment of contractual obligations. These withheld funds serve as a safeguard against potential defects or deficiencies in the delivered goods or services.

Proper Invoicing Technique

When invoicing for services or products subject to retentions, it’s crucial to adopt the correct approach to ensure accurate accounting. Let’s illustrate this with the builder-client scenario we described earlier:

Splitting the Invoice: Instead of invoicing the entire $100,000 as sales revenue, allocate $90,000 to the sales account. This reflects the portion of the invoice amount excluding the retention.

Recording Retentions: To accurately record the retention amount, create two-line items in the invoice:

Allocate $10,000 to the “Liability for Defects” account, representing the obligation to rectify any defects.

Deduct $10,000 as a negative entry under “Retentions Held”, reflecting the amount withheld by the client.

Balancing Accounts: This dual-entry approach ensures that the retention amount is properly accounted for:

The “Retentions Held” entry acts as an asset representing the funds due, offsetting the liability recorded under “Liability for Defects”.

This maintains equilibrium in the balance sheet, preventing any undue impact on financial statements.

Benefits of Properly Invoicing

Adhering to this invoicing technique offers two major advantages:

• Accurate Financial Reporting: Properly recording retentions ensures transparency in financial statements, preventing misrepresentation of revenue and liabilities – this is important from both a regulatory perspective but also when assessing business performance.
• Avoid overpaying or paying tax earlier: Because the retention amount is rightly not recorded as revenue it is not assessable from a GST or Income Tax perspective.
  By implementing the outlined invoicing technique, businesses can ensure accurate financial reporting, regulatory compliance, and avoid incorrect GST and income tax outcomes.

If you’d like a hand with setting up retention invoices or have any other questions about best practice business and construction accounting, get in contact today or drop us a line on 1300 233 723.