Retention and Guarantee Letters: Accounting and Regulatory Treatment
Retention Money (Retention) and Letters of Guarantee: Accounting and Control Treatment
Retention: How to treat retention money and letters of guarantee accounting-wise and control-wise? Explanation of work insurance, deduction entries, and recovery of retention and its impact on liquidity and contractor rights—Digital Salla.
- Practical understanding of the meaning of Retention Money and why it is used as Work Insurance in construction.
- The difference between Retention and Letter of Guarantee and common bank guarantees (Performance Bond/Advance Payment/Maintenance).
- How to present retention: Accounts Receivable or Contract Asset? And the “Unconditional Right” standard.
- Numerical example + simplified accounting entries + internal control checklist to avoid the accumulation of “unrecovered retentions”.
1) What is Retention Money (Retention)?
Retention Money is a portion of the value of approved works (progress billing) that the client temporarily withholds from the contractor’s receivables, aiming to guarantee quality of performance and rectification of defects during a certain period. Retention usually appears as a percentage (e.g., 5% or 10%) deducted from each billing, then retention recovery occurs later (partially or fully) at preliminary and final handover according to the contract.
2) Why is Retention used as Work Insurance?
Construction carries performance risks: hidden defects, non-compliance with specifications, delay in repairs… therefore the client resorts to protection tools, the most famous of which are: Retention Money and Letter of Guarantee.
| Objective | How does it serve the client? | What is its impact on the contractor? |
|---|---|---|
| Guaranteeing quality and defect rectification | Having an “available” amount to pressure performance/repair | Liquidity pressure and high working capital need |
| Incentivizing commitment to handover | Linking a portion of receivables to final handover | Delayed collection and potential disputes over entitlement |
| Compensation for default | Ease of offset/deduction upon proven default | Risk of non-documentary deductions if not controlled |
3) Retention vs. Letter of Guarantee: Fundamental Differences
Many confuse “withholding an amount from your receivables” with “a bank commitment to pay an amount upon call.” This table summarizes the picture:
| Item | Retention Money (Retention) | Bank Letter of Guarantee (Bank Guarantee) |
|---|---|---|
| Nature | Funds withheld from contractor receivables | Commitment from a bank to the client for payment upon call conditions |
| Immediate Cash Impact | Reduces collection directly (Cash-in) | Might not withhold cash unless cover/guarantee margin is required |
| When “Realized”? | Upon recovery after handover/warranty period | If called (Call) according to its terms |
| Risks | Entitlement disputes/delayed release | Call risk + issuance and renewal expenses |
You might also like: Construction Costs — because retention “inflates” the impact of costs on liquidity and working capital.
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4) Is Retention Accounts Receivable or a Contract Asset?
The deciding point here is: is your right to collection unconditional except for the passage of time? Or is it still linked to a condition of acceptance/defect rectification/final handover?
- Accounts Receivable: If the right to collection becomes unconditional (e.g., entitlement has been approved and only payment over time remains).
- Contract Asset: If collection is still conditional on additional performance/acceptance/completion of handover procedures/end of warranty period.
5) Accounting Treatment for the Contractor (Simplified Entries)
The goal of the entries here is not to impose one form, but to clarify logic: Retention is part of the consideration to be collected later, and usually tracked as a separate component within receivables/contract assets to facilitate retention recovery.
Subcontractor Tracker - Excel Template
5.1 Upon Approval of Progress Billing with Total Value
Assume the value of approved works (Gross) is the base, then retention is deducted to produce the net collection invoice. In common application: you recognize the total entitlement then separate the retention.
| Account | Debit | Credit |
|---|---|---|
| Accounts Receivable / Client (Net Invoice) | XXX | — |
| Retention Money held by Clients (Receivable/Asset) | XXX | — |
| Revenue/Approved Progress Billings (as per your system) | — | XXX |
6) Accounting Treatment for the Client/Owner
From the client’s perspective: upon approving works for the contractor, a liability for the total value arises, then the net is paid while keeping retention as a deferred liability.
| Account | Debit | Credit |
|---|---|---|
| Asset under construction/Project Expense (based on project nature) | XXX | — |
| Accounts Payable/Contractor (Total approved works) | — | XXX |
| Upon payment: Accounts Payable/Contractor | XXX | — |
| Cash/Bank (Net payment) | — | XXX |
| Retention Payable to Contractor | — | XXX |
7) Numerical Example: Progress Billing + Retention Money (Impact on Liquidity)
Let’s assume a project where Retention Money is deducted at 10% from each progress billing. In month (1), works worth 300,000 were approved.
| Approved Works Value (Gross) | 300,000 |
|---|---|
| Retention Money 10% | (30,000) |
| Net Due for Collection (Net) | 270,000 |
- The income statement/profitability might reflect total approved works, but the incoming cash is less due to retention.
- Therefore tracking retention within working capital is not a “detail,” but a key element in liquidity management.
8) Retention Recovery: When and How?
There is no single model for all contracts, but the most common pattern: partial release at preliminary handover (provisional acceptance), and final release at final handover or end of warranty and defect liability period.
8.1 Simplified entry upon release/collection
| Account | Debit | Credit |
|---|---|---|
| Cash/Bank | XXX | — |
| Retention Money held by Clients | — | XXX |
9) Types of Letters of Guarantee and Quick Accounting Notes
Letters of guarantee in construction are diverse and vary according to purpose. Common examples:
| Type | Purpose | Accounting/Control Note |
|---|---|---|
| Bid Bond | Commitment of applicant to the seriousness of offer | Usually not recognized as an asset/liability unless there’s cash cover or material risk of call |
| Performance Bond | Guaranteeing contract execution as per terms | Track expiry/renewal dates + bank commissions + any “restricted” cash cover |
| Advance Payment Guarantee | Protecting client when making an advance payment | Usually decreases with progress of works or according to consumption schedule |
| Maintenance/Warranty Guarantee | Covering defects after handover | Ensure matching with warranty period terms that also affect retention release |
10) Internal Control for Retentions and Bank Guarantees (with Common Mistakes)
Success in this file is not just an “accounting entry,” but a tracking system. Here are the main control points:
10.1 Quick Control Checklist
- Retention log for each project: (Client, percentage, billings, retention balance, release stage).
- Monthly reconciliation between: approved progress billings + collections + retention + other deductions.
- Documenting handover certificates (preliminary/final) and linking them to release claims.
- Letter of guarantee log: (Type, amount, bank, issue/expiry date, call terms, renewal status).
- Reviewing any “deduction” from retention: it must be by official document and contract clause.
- Closing the project before final handover without tracking retention release.
- Not separating retention by project/client → makes claims difficult and increases oversight probability.
- Letter of guarantee expiry without renewal while the contract requires its validity.
- Not distinguishing “earned retention” from “not yet earned” during presentation and tracking.
11) Ready Tools and Templates for Retention and Guarantee Management
To reduce manual work and improve control, these tools are directly related to the article topic:
Retentions & Bank Guarantees Tracker – Excel Template
The retentions and bank guarantees tracker shows amounts and dates, with maturity and renewal alerts to always ensure compliance. Suitable for a project accountant/finance manager who wants a “monitoring dashboard” for retentions and letters of guarantee for each project.
Accountant Handover Protocol – Checklist Templates
An organized handover protocol for the accountant, with checklists and documentation of files and custody, to ensure a complete smooth transition. Excellent for reducing file loss (handover certificates/letters/release claims) which is the root cause of “unrecovered retentions”.
12) Frequently Asked Questions
What is Retention Money (Retention) in construction?
It is a portion of the value of approved works/progress billings withheld temporarily for the client’s benefit as a quality and performance guarantee, recovered at preliminary and final handover according to contract terms.
Is retention the same as a letter of guarantee?
No. Retention is funds withheld from contractor receivables, while a letter of guarantee is a commitment from a bank to pay upon call. A letter of guarantee may require cash cover per bank policy.
Is retention presented as accounts receivable or a contract asset?
If the right to collection is unconditional except for the passage of time, it is accounts receivable. If conditional on acceptance/performance/defect removal, it is usually treated as a contract asset until the right becomes unconditional.
When is retention recovered?
Usually in two stages: a percentage at preliminary handover (provisional acceptance), and the remainder at final handover or end of warranty and defect liability period.
How do I avoid the accumulation of unrecovered retentions?
With a project-by-project tracking log, linking retention to handover certificates and release claims, monthly client reconciliation, and clear responsibility to follow release and renewal/expiry dates.
13) Conclusion
Retention Money is not just a percentage deducted from a billing; it is a liquidity, risk, and control file. If you separate it analytically for each project, distinguish between Accounts Receivable and Contract Asset according to entitlement terms, and follow a tracking system for handover certificates and release— “pending retentions” will decrease and collection and project closing will become more disciplined.