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Document and cost-tracking for potential construction audits or disputes

Jun 06, 2022

Every contractor and subcontractor start a project with the hope that all goes well. If you’ve been in the construction industry long enough, you likely know that this wish is often just a dream. And this dream can turn into a shipwreck.

What can be done to prevent this scenario? Thoughtful and purposeful procedures and documentation can help you navigate this sea of dreams more efficiently.

But why does proper cost tracking and documentation even matter? Continuing with a nautical theme consider the following:

  • Wayfinding: You can’t see where you’re going if you don’t know where you’ve been. Study project trends.
  • Creating a map: Others can’t follow your path if you can’t accurately plot it. Be sure you share your procedures and standards.
  • The return voyage: If asked, can you find the records requested? You need be able to produce documentation accurately and promptly.
  • The post-trip slideshow: Demonstrate where you’ve been and what you’ve seen. Use information to show how it affected productivity.

Just as maps and graphs guide the captain, the contract between the owner and contractor steers the construction project. Your contract is the single most important map for your project. The first steps in the contractor’s process are to read the contract, know the contract and follow the contract. Then:

  • Differentiate between costs that can and cannot be billed and specify how costs are to be billed (e.g., progress billings, milestones, cost).
  • Consistently track costs against your estimate by work scope (e.g., earthwork, electrical) and cost type (e.g., labor, material).
  • Know how changes impact your estimate and actuals and, where possible, create discrete cost-tracking for disputed issues.

Differentiate costs

You have reached the end of the project and now a request has been made for an audit or a dispute has occurred. Now what?

Remember those first steps: Read the contract, know the contract and follow the contract. The contract will define what is and isn’t an allowable cost. Here are some examples:

Usually allowed Often not allowed
On-site project management
Offsite project management
Direct craft labor (wage rate, burden calculations)
Items included in labor rates (vehicles, tools, taxes)
General conditions/requirements
Home office expenses
Subcontractor costs
Improper methods/rework
Equipment (internal vs. third party) Unauthorized rate changes/OT/holidays

An auditor will look to the contract for the Cost of Work definition clauses and will evaluate costs billed by what the contract defines as allowable costs. Consider the following with regard to costs related to craft labor:

If the contract included defined labor rates by position, the auditor will focus on documentation to support that hours were incurred and billed at the proper labor classification. If the contract defines that labor is to be billed at actual costs, the audit will still focus on support for the hours billed but will also evaluate the labor rates applied in the billings.

 Examples of adjustments to labor rates potentially include:

  • Applying actual effective tax rates compared to maximum tax rates (e.g., federal and state unemployment)
  • Applying burden components inappropriately (e.g., applying workers compensation to fringe benefits)
  • Applying amounts that don’t relate to labor (e.g., allocation of general liability insurances that are based on contract revenue).

Similar issues exist relating to project costs related to equipment, materials and consumables. Ensure equipment is billed according to contract terms, which includes billing at the appropriate rates (contractual rates vs. actual cost vs. third-party rentals) and for the appropriate periods (providing documentation in support of the equipment’s existence on site and hours of use). Materials and consumables should be supported by invoices that identify items that are allowable costs per the contract and make reference to the project.

Many subcontractor costs are billed on a lump sum basis, which reduces the potential for review, but these costs also have items to monitor. The contractor should maintain records of the bidding process. Subcontractor change orders without supporting cost documentation will receive additional review. And subcontractor change orders to address productivity, escalation, delay, backcharges, damages and any other claim will be heavily scrutinized.

Preventing problems later

So how do you lessen the impact of an audit or address the inquiries of a claim? Be intentional and proactive when it comes to your contract. During the contract creation period, take the time up front to create or negotiate a workable contract. If you think you are due a cost, it should be in the contract

During the construction period, follow the contract and bill for allowed costs as defined by the contract. Maintain constant communication with the owner. Ask for clarity or guidance on gray areas as they arise.

As the contractor, proactively bring up potential issues during project meetings. Highlight costs that you as the contractor are not billing the owner. If you do find an error in your billing to the owner, identify it and make the appropriate correction. Do not allow the owner to have any reason to doubt the accuracy of your billing or lose your credibility with the owner.

So many problems can be prevented or reduced by understanding your contract, communicating early and often with all stakeholders, negotiating in good faith, maintaining credibility and building a defensible position with solid reports, cost data and schedules.

But even after your best effort to document and communicate your position on the project, potentially costly disputes can still arise. It’s almost always best to avoid litigation.

How Wipfli can help

Dealing with a dispute or an audit related to a construction project is no longer merely a negotiation between parties. You’ll be expected to prove your actions and statements. There are no guarantees with an arbitrator or a jury. Wipfli professionals can help you optimize your cost-tracking and documentation processes to keep projects moving efficiently. But if you get in a dispute, our team can help you navigate mediation or the settlement process. Learn more about how Wipfli supports construction organizations.

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Kevin P. Krueger, CPA
Senior Manager
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Alex McBride, PE
Senior Manager
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