Accounting for retentions payable in Xero

I’m adding a quick post about accounting for retentions payable in Xero because I couldn’t find an article explaining it.

I found quite a few posts explaining it from the perspective of a building company invoicing a client. But I couldn’t find anything from the perspective of the client / customer.

A retention is when a customer retains an amount of money for a specified time period after the service has been provided. It is particularly common in the building industry.

Example

Acme Building Contractors are repairing a roof for a charity. All works invoices are subject to a 5% retention. They send their first invoice, which looks like this:

£
Roof Repair – contract value100,000
Less retention (5%)(5,000)
Amount less retention95,000
plus VAT (20%)19,000
Total payable114,000

Note that the VAT is added to the subtotal, not the full contract value. When the retention is due, VAT will be payable on top.

Accounting for the retention

It might be tempting to just account for £95K plus VAT. However, this isn’t correct, because the charity has had £100K of work done (and may need to demonstrate this to funders).

Another option would be to enter the full value of the work (£100,000 plus VAT) and then only pay part of it. However, this would get the VAT wrong – the charity has only incurred £19,000 of VAT. It’s also technically not part of accounts payable at this point – the retention amount of £5,000 isn’t actually due.

The best way to account for retentions payable in Xero is to create a Retentions Payable code within liabilities. You then post the full value of the work to the correct code(s) plus VAT. You then add a second negative line to the invoice, also with VAT, to account for the retention. This will look something like this:

Screenshot showing the “Add Bill” screen with the retention shown as a negative line

Once posted, the charity’s accounts will correctly show the full value of the work (£100,000), the correct amount of VAT charged (£19,000) and a liability to pay £5,000.

When the retention is due, the contractor should issue an invoice for £5,000 plus VAT. The charity will account for this by coding the £5,000 to the Retentions payable code, thus clearing this liability, and the VAT will go to the VAT control account as usual.

If you’ve come to this page via a search engine, you might find some of my other posts about Xero useful. I mostly blog about Excel and finance team management.

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