What Is a Cost-Plus Contract?

A cost-plus contract is an agreement made between a project owner and a contractor to reimburse the contractor for expenses incurred and to add a specific, additional payment for their profit. Thi🔴s profit is usually stated as a percentage of the contrac🎃t’s full price.

These types of contracts are primarily used in construction for projects where the owner reduces some of the contractor's risk related to expenses, thereby providing the contractor with a degree of flexibility.

In such cases, the owner agrees to pay the contractor extra based on the contractor's agreement (and obligation) to deliver according to the contract's terms.

Cost-plus contracts can be contrasted♕ with fixed-cost contracts, in which two parties agree up front to a specific cost, regardless of the actual expenses incurred by the contractor. Cost-plus contracts may also be known as cost-reimbursement contracts.

Understanding a Cost-Plus Contract

Cost-plus contracts are generally used if the party drawing up the contract has budgetary restrictions or if the overall scope of the work can't be properly estimated in advance.

For example, this party could be either the project owner, who wants to encourage a timely project launch or the contractor, who lacks necessary informatioꦍn for a thorough estimate.

In construction, cost-plus contracts are drawn up so contractors can be reimbursed for direct costs and indirect or overhead costs. A💧ll expenses must be supported by invoices and receipts that identify the contractor's spending.

The contract also provides the contractor with the opportunity to make a specific profit—hence, the term "plus" in cost-plus contracts.

Error and Negligence

Cost-plus contracts normally don't cover contractor error or negligence. Therefore, some contracts may limit the amount of reimbursement, so that not every expense is covered.

This contractual limitation benefits the owner if the contractor makes an error during the course of the project or is 澳洲幸运5开奖号码历史查询:negligent with regard to any part of the construction.

Other Users of Cost-Plus Contracts

Cost-plus contracts are also used in 澳洲幸运5开奖号码历史查询:research and development (R&D) activities, where a larger company may outsource R&D activities to a smaller firm, such as when a large pharmaceutical company contracts to the la🌠b of a small biotech company.

The U.S. government also uses cost-plus contracts with military defense companies that develop new technologies for national defense.

Types of Cost-Plus Contracts

Cost-plus contracts can be separated into four categories. E🌳ach allows for the reimbursement of costs as well as an additional amount for profit:

1. Cost-plus award fee contracts allow the contractor to be awarded a fee usually for good performance.
2. Cost-plus fixed-fee contracts cover both direct and indirect costs, in addition to a fixed fee.
3. Cost-plus incentive fee contracts are made to give the contractor a fee if their performance meets or exceeds expectations.
4. Cost-plus percent-of-cost contracts allow the amount of reimbursement to rise if the contractor's costs rise.

Advant﷽ages and Disadvantages of Using Cost-Plus Contracts

Example of a Cost-Plus Contract

Assume ABC Construction ꧒Cor🅰p. has a contract to build a $20 million office building, and the agreement states that costs cannot exceed $22 million.

ABC’s profit is agreed at 15% of the contract’s full price, or $3 million. Additionally, ABC Construction is eligible for an incentive fee if the project is completed within nine months.

A🎃BC must submit dated receipts for all expenses, and the client will inspect the job site for quality to verify that specific components, such as the plumbing, electriܫcal, and fixtures, are completed to specification.

The contract allows ABC to incur direct costs for materials, labor, and costs incurred to hire subcontractors. ABC can also bill indirect, or overhead,🐭 costs, which include insurance, security, and safety. The contract sta😼tes that overhead costs are billed at $50 per labor-hour.

Special Consideration: Per🅺centage of Completion in a Cost-P🌳lus Contract

The above project uses the percentage of comple𒁏tion process to 🦩account for profit and to submit bills to the client, and the contract provides specific percentages for billing.

Assume, for example, that ABC can bill for 20% 𝄹of the full contract price once 20% of the materials are purchased, and the client verifies the concrete foundatio♏n is in place.

At that point, ABC sends an invoice for 20% of the $20 million contract, or $4 million, and posts 20% of the firm’s pro🦩fit, or $600,000, to the financial statements (.20 x $💙3 million).

The Bottom Line

A cost-plus contract is a contract whereby the owner of a project agrees to pay the expenses incurred by a contractor during the project and agrees to pay pay a specific amount that represents profit for the contractor. T📖hat amount is usually a percentag𝓰e of the full price of the contract.

Cost-plus contracts have their p🎶ros and cons so be sure to consider all aspeꦜcts of a contract, including the risks, before entering into one.