Retainage, Change Orders and WIP: Why a Builder's Profit and Loss Lies Mid-Project

Retainage, change orders and WIP reporting are why a construction project can look profitable on paper while its cash flow tells a different story. A builder relying on job cost totals alone misses the mid-project swings that disciplined Construction Accounting is built to catch before they turn into a loss at project completion.

By REA Team, Property Management Experts

Retainage is the portion of each progress payment, commonly a percentage in the 5% to 10% range, that a project owner holds back until a construction contract reaches substantial completion or a defined milestone. The builder has earned that revenue and reported it as billed, but the cash sits with the owner until release. That gap is where cash flow problems start: a general contractor still has to cover labor, materials and subcontractor payments while funding the next phase of work, all while a meaningful share of what it has already billed remains unpaid.

On paper the project can look healthy. In the bank account, it often doesn't, because retainage is a financing gap, not a loss. Tracking it separately from ordinary accounts receivable keeps a contractor from confusing earned revenue with collected cash.

Retainage vs. Retention: Is There a Difference?

The two terms usually describe the same mechanism: money withheld from a progress payment as security until the work is complete. Retention is the more common term outside the United States and in some insurance and bonding contexts, while retainage is standard in American construction contracts. Functionally, a contractor should treat them the same way in the books: as a receivable held for future release, not income the company can spend now.

How Much Retainage Can a Contractor Legally Withhold?

There isn't one national number. Many states regulate retainage on public projects, and a common pattern caps it in the 5% to 10% range with a requirement to reduce or release it once the project reaches roughly half complete. Private contracts follow whatever the AIA or ConsensusDocs-style agreement specifies. Because rules vary by state and contract type, confirm the applicable statute and contract language before assuming a standard rate, and loop in a construction attorney or accountant when the numbers look off.

When Should a General Contractor Release Retainage to a Subcontractor?

Retainage typically releases once a subcontractor's scope reaches substantial completion, the punch list is cleared, and any required lien waiver is on file. Some contracts allow a partial release once the project as a whole crosses the 50% mark. Whatever the trigger, the release date belongs on the payment application and in the job cost report, so the WIP schedule reflects the real outstanding amount, not an estimate.

A WIP report, short for work in progress, compares what a construction company has earned on each active job to what it has actually billed. It is built on the percentage completion method, which recognizes earned revenue in proportion to costs incurred against estimated costs, rather than waiting for a project to close out. For a contractor running several jobs at once, the WIP schedule turns scattered job cost data into one current profit and loss picture instead of a cash-basis guess, feeding into broader project accounting practices that track a contract from signed scope to final closeout.

The Formula Behind a Construction WIP Schedule

The core formula is straightforward: percent complete equals costs incurred to date divided by total estimated costs. Multiply percent complete by the total contract value, including any approved change orders, to get earned revenue. Compare that figure to what has actually been billed to date, and the difference tells the contractor whether it is ahead of or behind its own billing.

Calculating Over Billing and Under Billing

Over billing happens when the amount billed to date is higher than earned revenue. It shows up as a liability, because the contractor has collected for work it hasn't finished yet. Under billing is the reverse: earned revenue is higher than what has been billed, which shows up as an asset but also as a cash flow warning, since the company has done the work without invoicing for it. Tracking both, project by project, on the WIP schedule keeps billing practices honest with the actual pace of work.

Retainage, change orders and WIP all depend on the same underlying job cost data, so a change order logged incorrectly shows up as a discrepancy in all three places. A change order adds or removes scope, and with it cost and contract value, and needs to flow into job costing and the WIP schedule the moment it happens, not at month end, or the estimated costs and contract value the WIP formula relies on go stale. A project with several open change orders that haven't been folded into the numbers will show a margin that doesn't match reality, in either direction.

How Should a Contractor Record a Change Order Before It's Approved by the Owner?

Costs tied to a pending change order are usually still real. Labor, materials and any equipment on site get used whether or not the paperwork is signed. Most contractors track these as a potential change order or unapproved change order line, incurring the cost in job costing while holding the associated revenue as conditional until the owner signs off, consistent with how variable consideration is typically handled under current revenue recognition guidance. The accounting policy should stay consistent project to project rather than get decided case by case.

How Do Unapproved or Pending Change Orders Distort WIP and Job Cost Reports?

When costs incurred rise from work already underway but the contract value and estimated costs haven't been updated for the same change order, percent complete calculates against an outdated total. The result is a WIP schedule that either understates margin, because costs are counted without their matching revenue, or overstates it, if the change order estimate gets added before it's priced accurately. A pending change order log attached to the WIP schedule keeps that gap visible instead of hidden inside a single cost code.

Retainage, change orders and WIP each move independently unless someone reconciles them every month. Retainage holds back cash on revenue the company has already earned. Unrecorded or underestimated change orders distort the estimated costs the WIP formula depends on. Put both against a job costing system that hasn't caught up, and a project can show a shrinking margin or even a paper loss on the WIP schedule despite the crew being on schedule and on scope. This is the pattern Real Estate Development Accounting practices are built to catch before a draw request or a bank covenant reports a number the company can't explain. A monthly reconciliation of retainage held, change orders logged and the WIP schedule against actual cash keeps a builder's profit and loss honest before the project closes out.

Lenders and bonding companies use the WIP report to gauge a contractor's real financial position across every active job, not just one project. They're looking at backlog, the trend in over billing versus under billing, and whether gross profit is holding steady as revenue grows, all of which signal bonding capacity and credit risk. On a project financed by a construction loan, retainage withheld by the owner sits alongside loan draw accounting, which tracks how a lender releases disbursements against costs incurred, and a lender comparing the two wants them to reconcile. A contractor that can produce a current, accurate WIP schedule on request moves faster through underwriting than one piecing numbers together from job files.

What percentage of retainage is typical on a construction project? There's no universal figure. A common range on both public and private contracts is 5% to 10% of each progress payment, though the exact rate depends on the contract, the project type, and the state. Some contracts reduce the rate once the project passes the halfway point. Always confirm the specific number in the signed contract rather than assuming a standard rate.

Can a subcontractor invoice for retainage on a separate bill? Usually not. Retainage is withheld from the regular progress payment rather than billed separately, and it typically becomes due as its own payment once the release conditions in the contract are met, such as substantial completion and a signed lien waiver. Some contracts do allow a separate retainage invoice at that point, so the payment terms should spell out the process in advance.

What happens if a change order is left out of the WIP schedule? The WIP schedule calculates percent complete and earned revenue against an estimated cost and contract value that no longer match the actual scope. That typically understates or overstates margin on that job, and if it happens on several projects at once, it can make total company profit and loss unreliable in the exact months a lender or owner is most likely to ask for it.

Is a WIP schedule required by GAAP? The percentage completion method itself is a recognized approach under current U.S. revenue recognition standards for long-term contracts, but whether a formal WIP schedule is required usually comes down to the lender, bonding company or CPA a contractor works with, not a blanket GAAP mandate for every company. Most contractors that carry bonding or a construction loan produce one monthly regardless.

A WIP schedule that reconciles retainage, change orders and job costing every month is the difference between finding a margin problem in week six and finding it at closeout. Lets Connect to see what that reconciliation looks like for your projects.