CFO summary (30 seconds):
Retention is a portion of contract value withheld by the client. It can be replaced by a bank guarantee, releasing cash. The decision is purely financial: cost of bank guarantee (0.5–1.5% p.a.) vs the company's WACC. At 2023–2025 interest rates and on long contracts the calculation usually favours the guarantee. Note: retention and guarantee are treated differently in financial statements — incorrect classification is an audit risk.
Retention is a portion of contract value withheld by the client. It can be replaced by a bank guarantee, releasing cash. The decision is purely financial: cost of bank guarantee (0.5–1.5% p.a.) vs the company's WACC. At 2023–2025 interest rates and on long contracts the calculation usually favours the guarantee. Note: retention and guarantee are treated differently in financial statements — incorrect classification is an audit risk.
Does this apply to your company
This article applies if you run construction, project or service contracts with a retention clause, have more than one concurrent contract, or retention lasts longer than 12 months from completion.
What is retention — the basics
Retention (contract withholding) is a contract performance security mechanism. The client typically retains 5–10% of each payment and releases it after the defects liability period. The invoiced revenue is recognised, but part of the cash does not arrive on your account — it stays with the client as a deposit.
Cost calculation — worked example
Construction company, contract value PLN 10m net, 5% retention, 24-month defects liability period from completion.
| Parameter | Value |
|---|---|
| Retention withheld by client | PLN 500,000 |
| Frozen period | 24 months |
| Company WACC | 8% p.a. |
| Cost of freezing (2 years × 8% × PLN 500k) | PLN 80,000 |
| Bank guarantee cost (1% × 2 years × PLN 500k) | PLN 10,000 |
| Saving by switching to guarantee | PLN 70,000 |
On 5 concurrent contracts of the same scale: PLN 350,000 per year in capital cost savings. This is not a marginal decision.
Financial statement treatment
- Retention as a long-term receivable — when payment is expected after 12 months. Common error: classified as short-term despite a long repayment period.
- Discounting under IFRS — when the period exceeds 12 months and the amount is material, discounting at the effective rate is required. Rate: typically the company's working capital credit rate.
- Bank guarantee — a contingent liability not recognised on the balance sheet. The guarantee fee is a financial cost accrued over time.
From my practice: In construction company audits retentions are one of the first areas I verify. Most common error: retention classified as a short-term receivable despite an 18-month period. Second error: no discounting under IFRS when amounts are material.
Errors in the decision and in accounting
- No calculation before the decision — the company automatically accepts retention without analysing the alternative.
- Incorrect classification — retention in short-term receivables despite a long repayment period.
- Missing discount under IFRS — for material amounts and long retentions.
- VAT — VAT tax point arises at service completion, not at retention release. A frequent misunderstanding in construction companies.
FAQ
Frequently asked questions
Must the client agree to swap retention for a bank guarantee?▾
It depends on the contract. In FIDIC contracts a swap is typically permitted as standard. In the client's own contracts it requires negotiation. A guarantee from a reputable bank is generally acceptable.
How do I determine the discount rate for retention under IFRS?▾
The standard is the market rate for instruments with similar credit risk — typically the company's working capital credit rate or WIBOR plus the bank's margin for the company.
Want to discuss how this topic applies to your company?
Book a short consultation with a statutory auditor and assess which risks or actions may apply to your situation.
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