Cost-Plus Contract
What Is a Cost-Plus Contract, and How Does It Work?
A cost-plus contract is an arrangement in which a corporation gets reimbursed for expenditures plus a certain amount of profit, commonly expressed as a percentage of the contract's overall price. These contracts are commonly used in construction, where the customer accepts some risk while simultaneously allowing the contractor considerable freedom. In this situation, the party drafting the contract expects the contractor to deliver on their promises, and agrees to pay more so that the contractor may earn more when the project is completed.
Cost-plus contracts contrast with fixed-amount contracts, in which two parties agree on a certain cost up advance regardless of the contractor's actual charges. Cost-plus or cost-reimbursement contracts are other terms for cost-plus contracts.
TAKEAWAYS IMPORTANT
In a cost-plus contract, one party promises to compensate the other for expenditures as well as a profit proportional to the total contract value.
When a budget is tight or there's a good chance that real costs will be lower than expected, cost-plus contracts are frequently employed in construction.
Contractors must give documentation of all expenses, including direct and indirect, incurred.
Cost-Plus Contracts: What You Need to Know
If the party drafting the contract has financial constraints or the full extent of the job cannot be accurately determined in advance, cost-plus contracts are typically employed.
Cost-plus contracts are used in construction to allow contractors to be compensated for practically every item made on a project. The builder is compensated for both direct and indirect or overhead expenditures under a cost-plus contract. All expenditures must be accompanied by invoices or receipts that show the contractor's spending. The
Furthermore, a cost-plus contract permits the contractor to collect a set amount beyond the amount paid, allowing them to earn a profit—hence the "plus" in cost-plus contracts.
Some contracts may include a cap on the amount of money that may be reimbursed, therefore not all expenses will be covered. This is especially true if the contractor makes a mistake during the building process or is determined to be irresponsible in any way.
Cost-plus contracts are also utilised in research and development (R&D), where a bigger corporation may contract with a smaller company to outsource R&D tasks, such as a large pharmaceutical company contracting with a small biotech company's lab. Cost-plus contracts with military defence corporations that create innovative technology for national security are also used by the US government.
Cost-plus contracts are preferred by governments because they allow them to select the best qualified contractors rather than the lowest bidder.
Cost-plus contracts come in a variety of shapes and sizes.
There are four different types of cost-plus contracts. They all provide for expense reimbursement as well as an additional profit margin:
Contracts with cost-plus-award-fees allow the contractor to be compensated for good performance.
In addition to a set charge, cost-plus fixed-fee contracts cover both direct and indirect costs.
When a contractor is paid a fee if their performance meets or exceeds expectations, this is known as a cost-plus incentive fee contract.
Contracts based on cost-plus-percent-of-cost allow the amount of payment to increase as the contractor's costs grow.
The Benefits and Drawbacks of Using Cost-Plus Contracts
The following are some of the benefits and drawbacks of utilising these sorts of contracts:
Pros
They take away part of the contractor's risk.
They enable the attention to move away from the total cost and onto the quality of the job.
They cover all project costs, so there are no unpleasant surprises.
Cons
They may leave the ultimate cost up in the air because it is impossible to predict.
They may cause the project's timetable to be extended.
It's possible that disagreements will arise while attempting to recoup construction-related costs.
Additional resources are required to duplicate and justify all associated expenses.
Assume you're working on a cost-plus contract. ABC Construction Corp. has a $20 million contract to develop an office complex, and the contract stipulates that the total cost cannot exceed $22 million. The profit for ABC is set at 15% of the contract's entire price of $3 million. ABC Construction is also eligible for a bonus if the project is finished in less than nine months.
ABC must produce dated receipts for all costs, and the client will examine the construction site for quality to ensure that certain components, such as plumbing, electrical, and fixtures, are done to specification. The agreement permits ABC to incur direct expenditures such as legal fees.
supplies, labour, and the expense of hiring subcontractors Insurance, security, and safety are examples of indirect or overhead charges that ABC might levy. Overhead expenditures are billed at $50 per work hour, according to the contract.
In a cost-plus contract, a special consideration is the percentage of completion.
The above project accounts for profit and submits bills to the customer using the percentage of completion procedure, and the contract specifies particular percentages for billing.
Assume ABC may charge for 20% of the total contract price once 20% of the supplies have been acquired and the client has confirmed the concrete foundation is in place. At that moment, ABC submits a $4 million invoice for 20% of the $20 million contract and posts 20% of the company's earnings.
