Written by Sharaz Zaman, Founder of GM Professional Accountants, AAT Member with 15+ years London accounting experience.
Accounting for Retentions in Construction: A Practical Guide for London Contractors
Construction retentions are amounts withheld by a client or main contractor, typically 5% of each interim payment, until defects are remedied and the defects liability period expires. If you are not tracking and provisioning for them correctly, retentions become a silent cash-flow killer that erodes your profit long after a project is complete.
Definition: Construction retention accounting is the process of recording amounts withheld under a building contract as separate balance sheet receivables or payables, recognising the associated revenue under FRS 102 as work progresses, and provisioning for irrecoverable balances once collection becomes uncertain.
Key Takeaways
What Exactly Is a Construction Retention and How Does It Work?
A retention is a contractual holdback, typically 5% of each certified interim payment, that a client or main contractor deducts as security against defective work. The retained sum is normally released in two stages: half at practical completion and the other half at the end of the defects liability period, which is usually 12 months later. Until both releases occur, the money belongs to you in principle but sits in your client’s bank account, not yours.
For subcontractors working under a main contractor, the same logic applies downstream. The main contractor withholds 5% from each of your valuations, and you in turn may withhold the same from your own subcontractors. On a project worth £500,000, that is £25,000 sitting outside your control until completion and defects sign-off.
For London and Essex contractors operating across multiple live projects simultaneously, accumulated retentions can easily represent several months of operating costs. Without a disciplined tracking process, these amounts are routinely forgotten, written off late, or simply lost to client insolvency.
How Should You Record Retentions in Your Accounts Under FRS 102?
Under FRS 102, the standard most UK SMEs follow, revenue on a construction contract is recognised by reference to the stage of completion at the balance sheet date, not when cash is received. This means the full contract value, including the retention element, is included in turnover as the work progresses. The retention portion is then separated out on the balance sheet as a distinct debtor rather than grouped with ordinary trade debtors.
The practical bookkeeping approach recommended for most contractor software is straightforward. When you raise a valuation, post the full gross amount to your sales account. Ring-fence the retention element in a dedicated balance sheet code labelled something like Retention Debtors, keeping it separate from current trade debtors. Your trade debtors balance remains clean and represents only amounts already invoiced and collectible in the near term. The retention debtor balance represents your long-term receivable.
For amounts owed to your own subcontractors, mirror the treatment on the liabilities side. Record the gross subcontract cost but hold the withheld retention in a Retention Creditors code. This gives you a clear view of what you owe and when it falls due.
Important: Corporation tax is calculated on your accounting profit, which includes retention revenue recognised to date. This means you may owe tax on retentions you have not yet been paid. Cash-flow planning must account for this timing gap, or you risk a tax bill you cannot fund.
What Changed Under the Updated FRS 102 from January 2026?
The Financial Reporting Council confirmed that amendments to FRS 102 took effect for accounting periods beginning on or after 1 January 2026. The revised standard introduces a five-step revenue recognition model, borrowed from IFRS 15, which requires contractors to be far more explicit about identifying performance obligations within a contract, allocating transaction prices to each obligation, and recognising revenue only as those obligations are satisfied.
For most construction contracts, revenue will still be recognised over time because the customer controls the asset as it is built, or you hold an enforceable right to payment for work completed to date. However, the updated model places greater scrutiny on how progress is measured and how variable consideration, including retentions whose release may depend on future performance, is estimated and included in the transaction price.
Practically, if you have historically treated all retention income as fully recoverable and recognised it in full, you may need to review whether a constraint should be applied under the new model where collection is genuinely uncertain. This is particularly relevant for old, disputed, or client-risk retentions. See also our guide on FRS 102 Lease Changes 2026: What They Mean for Construction Firms for the broader impact of these amendments.
How Does Retention Accounting Differ for Contractors vs Subcontractors?
The accounting mechanics differ slightly depending on whether you are the main contractor withholding funds from a subcontractor, or a subcontractor having funds withheld from you. The table below summarises the key treatment differences.
| Item | Main Contractor | Subcontractor |
|---|---|---|
| Revenue recognition | Full contract value including withheld retention, recognised over time by stage of completion | Full value of work certified, including the 5% withheld by main contractor |
| Balance sheet debtors | Separate retention debtor for amounts owed by client | Separate retention debtor for amounts owed by main contractor |
| Balance sheet creditors | Retention creditor for amounts withheld from your own subcontractors | May have own retention creditor if engaging sub-subcontractors |
| CIS treatment | CIS deductions calculated on gross payment less the 5% retention withheld | CIS suffered on labour element after retention deduction; no special CIS rule for retentions per HMRC |
| Tax liability timing | Tax owed on recognised revenue including uncollected retention | Tax owed on full certified value before cash is received |
| Bad debt provision | Required where client insolvency risk or disputed defects make recovery doubtful | Required where main contractor insolvency or unresolved defects dispute threatens release |
Why Do Retentions Become a Silent Cash-Flow Problem?
The cash-flow danger with retentions is structural. You recognise revenue and pay tax on it, but the physical cash arrives months or years later. In the meantime, you are funding payroll, materials, and overheads from your working capital. On a £1 million annual turnover, a 5% retention across multiple projects could mean £30,000 to £50,000 tied up at any one time. Add a 12 month defects liability period and the mismatch between profit recognised and cash received can be severe.
The problem compounds when projects finish and retentions are simply forgotten. A London contractor with 20 completed projects in the last three years may have retention debtors from a handful of those that have never been chased. Some will be past their defects liability period and legally overdue for release. Others may relate to clients who have since become insolvent. Without a tracker, none of this is visible.
The follow-on problem is overstatement of profit. If you carry stale retention debtors without provision, your accounts show an asset that may never be collected, inflating your net asset position and potentially triggering a tax liability on income that will never arrive as cash. This is particularly damaging when you are using accounts to support a bank facility or tender financial assessment. See our guide on How to Pass the Financial Standing Test in a Construction Tender for why clean retention reporting matters during procurement.
When Should You Raise a Bad Debt Provision on a Retention?
A bad debt provision is a reduction in the carrying value of a debtor that reflects the risk of non-collection. For retention debtors, the trigger points to consider at each year-end review include the following scenarios.
Aged retention beyond release date
Any retention outstanding significantly beyond its scheduled release date without an agreed extension should be reviewed. If the defects period has expired and no formal dispute exists, the amount is legally overdue and recovery action should be underway. If it is not, provision may be appropriate.
Disputed defects or unresolved snagging
Where a client has issued formal defects notices or withheld a Maintenance Certificate, the retention release is contingent on resolution. Depending on the likelihood of outcome and the estimated cost of remedial work, a partial or full provision may be needed.
Client insolvency risk
If a client or main contractor is showing signs of financial distress, deteriorating payment patterns, or has entered administration, the retention becomes a general unsecured creditor claim. Provision at this stage protects your accounts from carrying an asset that will not be recovered.
Project completed over two years ago with no action taken
Any retention more than two years old with no active recovery in progress is a high-risk asset. HMRC accepts bad debt relief for trade debts over six months old that are formally written off, subject to conditions. Your accountant should review these annually rather than carrying them indefinitely.
What Should a Retention Tracker Include and How Do You Use It?
A retention tracker is a simple register that sits alongside your accounts and is reviewed monthly. It does not need to be complex. The essential columns for any contractor or subcontractor operating in London and Essex are set out in the template structure below.
| Column | What to Record | Why It Matters |
|---|---|---|
| Project / Contract Name | Client name, contract reference, site address | Links ledger balance to a specific live or completed job |
| Total Retention Amount | Cumulative total withheld to date under the contract | Reconciles to your retention debtor or creditor balance |
| Practical Completion Date | Actual or expected date of Certificate of Practical Completion | Triggers release of first half retention; prompts cash-flow forecast update |
| Defects Liability End Date | Usually 12 months after practical completion | Triggers release of second half; chase date if not received |
| Amount Released | Cash actually received against this retention | Shows outstanding balance and flags overdue amounts |
| Status / Notes | Live, Complete, Disputed, Provisioned, Written Off | Drives year-end provisioning decisions and HMRC bad debt relief claims |
| Provision Required | Estimated irrecoverable amount, reviewed each month-end | Prevents profit overstatement; reduces corporation tax on irrecoverable income |
The tracker should reconcile to your accounting software retention balance every month. If the two figures do not agree, investigate before year-end, not during it. Our clients in Ilford, Wimbledon, Old Street, and across East London typically review this as part of their monthly management accounts review. This discipline alone has recovered thousands of pounds in forgotten or late retention releases. This approach also links directly to your work in progress management: see our guide Construction WIP Explained: How to Calculate It, With Examples for how the two reports work together.
How Do Retentions Interact with CIS Deductions?
HMRC is explicit that there are no special CIS rules for retention payments. Retentions are treated as part of the overall contract payment, and CIS deductions are calculated in the normal way on the labour element of each payment after the retention is deducted. To illustrate: if a subcontractor submits a valuation of £50,000 gross, the main contractor withholds 5% retention of £2,500, leaving a net payment of £47,500. CIS at 20% is then calculated on the labour element of that £47,500 net figure.
When the retention is eventually released, it forms part of a subsequent CIS payment and the same gross or net deduction rules apply at that point. Subcontractors should ensure that CIS deductions suffered on retention releases are captured in their monthly CIS reconciliation to avoid over-paying tax or missing refund opportunities.
Are There HMRC Changes Coming That Affect Retention Accounting in 2026 or 2027?
Two significant changes are already in motion that affect how construction businesses manage their accounting obligations, including retention reporting.
Making Tax Digital for Income Tax (MTD ITSA) becomes mandatory from 6 April 2026 for sole traders and landlords with income above £50,000, and from 6 April 2027 for those above £30,000. Sole trader contractors caught by these thresholds will need quarterly digital submissions to HMRC. If retention income is not properly recorded in your bookkeeping software in the period it is earned, your quarterly MTD submissions will be inaccurate, creating reconciliation problems at year-end.
The updated FRS 102 revenue model, effective from 1 January 2026, also changes how companies recognise contract revenue and associated retention balances. Construction businesses applying the new five-step model for the first time may need to restate comparative figures and review whether existing retention debtors are correctly measured under the updated standard.
For company contractors, the audit threshold changes effective from 1 October 2025 mean that more small contractors will fall below the audit requirement, making accurate self-prepared or accountant-prepared retention schedules even more important as an internal control. See our post Does Your Construction Company Still Need an Audit? A 2026 Guide for the current size thresholds.
Frequently Asked Questions About Construction Retention Accounting
Is VAT charged on retentions in construction?
VAT is due on retentions when a VAT invoice is raised or the tax point for that payment is triggered, which is typically when the retention is released and certified. Under normal VAT rules, the tax point for the retention portion of a construction payment arises on the earlier of receiving payment or issuing a VAT invoice for it. For businesses using the domestic reverse charge, the same tax point rules apply but the obligation shifts to the customer to account for the VAT.
Can I write off an irrecoverable retention against tax?
Yes. HMRC allows a bad debt deduction for trade debts that have been formally written off in your accounts and are more than six months old from the due date. The write-off reduces your taxable profit in the period it is made. You should not simply stop chasing a debt; it must be positively written off in the accounts and documented as such. A provision alone, without a write-off, does not qualify for HMRC relief under the loan relationship or trade income rules applicable to most contractors.
What is the standard retention rate in UK construction contracts?
The standard rate in UK construction is 5% of each interim payment, capped at either a fixed monetary amount or a percentage of the total contract value once that cap is reached. Some contracts, particularly in the public sector, are moving towards lower rates or retention-free models. JCT contracts have been lobbied to remove standard retention clauses, and NEC contracts have already done so following pressure from the Construction Leadership Council.
How long does a contractor have to release a retention?
Under most standard UK construction contracts, the first half of retention is released on practical completion and the second half at the end of the defects liability period, typically 12 months after practical completion. The release is usually tied to the issue of a Maintenance Certificate or Making Good Defects Certificate. If a contractor or client withholds retention beyond the contractual release date without justification, the subcontractor or contractor can pursue recovery through the contract’s dispute resolution mechanism.
Should retentions be included in my year-end debtors figure?
Yes, but separately. Best practice under FRS 102 is to show retention debtors in a distinct line on your balance sheet rather than combined with ordinary trade debtors. This gives a cleaner view of your immediate liquidity and prevents retention balances distorting your current ratio. If your accounting software combines them, your accountant should adjust the balance sheet presentation in the statutory accounts.
Related Guides for Construction Businesses
Retention and WIP are the twin pillars of construction financial reporting. Learn how to prepare both.
The 2026 FRS 102 amendments affect leases and revenue recognition simultaneously.
Understand the size thresholds and exemptions under current UK company law.
Your retention schedule is often scrutinised during tender financial assessments.
Specialist support for London and Essex contractors from a dedicated construction accounting team.
Need Help Getting Your Retention Accounting Right?
GM Professional Accountants works with construction businesses across London and Essex, including contractors and subcontractors based in Ilford, Wimbledon, Old Street, and East London. We set up retention registers, clean up historic retention debtor balances, and prepare year-end accounts that reflect the true financial position of your business. Whether you need a one-off review or an ongoing monthly service, our team understands the specific demands of construction accounting.
Written by the GM Professional Accountants Team. GM Professional Accountants is an AAT-regulated accounting practice serving contractors, subcontractors, and construction businesses across London and Essex, with offices in Ilford and across the region. For specialist construction accounting support, visit gmprofessionalaccountants.co.uk.
Disclaimer: This content is for general guidance only and does not constitute financial or tax advice. Tax rules change and how they apply depends on your individual circumstances. Please speak to a qualified accountant before acting on anything here.
