10 Jun Accounting for Holdbacks on Construction Billings
Holdbacks are amounts of progress billings that are not paid until specified payment conditions in the contract are satisfied, or until defects have been rectified.
BC Builders Lien Act
In British Columbia, the Builders Lien Act (the “Act”) provides rights and imposes obligations on most of the parties within a construction project in addition to their respective rights under their contracts, and they must be adhered to. The Act requires holdbacks of 10% of the amount owing until the work is complete and it is clear that no applicable liens have been filed.
The owner is required to open a trust account in a financial institution and keep the holdback amount there until the project or contracted work is substantially complete and the time for filing a lien has expired. If a contractor is not paid for the work they do, they may be entitled to file a lien on the project property to help protect their right to payment.
Holdbacks and Income Taxes
Generally, holdback billings are not considered taxable in Canada until project completion, when they become due and payable to the contractor. When a contractor’s holdbacks receivable balance increases year over year, there is a reduction in the expected amount of income taxes owing as the holdbacks are not taxed. When a contractor’s holdbacks receivable balance decreases year over year (i.e. more holdbacks become due or are received in cash), there is an increase to income taxes owing as the tax on the holdbacks now becomes due. So, the flow of holdbacks needs to be tracked and considered when estimating the amount of income taxes the company will need to pay each year.
Holdbacks of payment by client or to subcontractors until completion of project leads to a temporary difference when using future taxes method of accounting for income taxes.
Accounting for Holdbacks
In the construction industry, contractors are typically given progress payments as construction proceeds. A portion of these progress payments are then held back by the customer until the entire project is completed. This creates a holdback receivable from the perspective of the contractor and a holdback payable from the perspective of the customer. Similarly, the contractor may further require a holdback from subcontractors to incentivize adequate completion of the contract.
Typically, the event which triggers the release of a holdback can vary depending on the contract. Common triggers in the construction industry include:
- Substantial completion of the contract
- Abandonment or termination of the contract
- Completion of abandonment of the improvement
For more information on accounting for the construction industry, refer to our piece on accounting for construction contracts.
Financial Statement Presentation and Disclosure
Separate presentation or disclosure of holdbacks receivable from trade accounts receivable facilitates clarity and transparency for financial statement users. The same logic can also be applied to holdbacks payable and trade accounts payable. In instances where construction contracts span several fiscal years, consideration should be placed on the long-term presentation of holdbacks receivable/payable beyond one year or the enterprise’s normal operating cycle.
How Clearline CPA Can Help
If you are a construction company that is seeking assistance in preparing financial statements, filing corporate income taxes, and advice on how to account for holdbacks and other construction-related accounting matters, we can help. Clearline provides compilation, review and audit engagements for companies in the construction industry. We also prepare and file corporate tax returns and provide tax planning and corporate reorganization and restructuring services to clients within the construction industry.