Cost Contract: Everything You Need to Know
A cost contract is used in construction projects to protect the entitlements for work done by a contractor on a building site.3 min read
2. Three Main Components of a Cost-Plus Contract
3. Variations to a Cost-Plus Contract
4. Costs That the Buyer Covers in a Cost-Plus Contract
5. When to Use a Cost-Plus Contract
6. Advantages of a Cost-Plus Contract
7. Disadvantages of a Cost-Plus Contract
8. Protecting Your Business While Using a Cost-Plus Contract
9. Importance of Good Record Keeping
A cost contract is used in construction projects to protect the entitlements for work done by a contractor on a building site where the cost of work is difficult to estimate.
A cost-plus contract refers to an agreement between a construction contractor and a project owner where the client agrees to pay the company the cost of the project based on the terms of the contract, plus a specific amount to cover their overhead expenses and profit.
To prevent overshooting the project budget, many contracts restrict the amount of money the client can pay to the builder above the actual project value. The cost-plus reimburses the company for direct and indirect costs. However, the contractor must show evidence of all their expenses on the project.
Three Main Components of a Cost-Plus Contract
The three primary elements of a cost-plus contract include the following:
- Direct Costs: this includes labor, supplies, materials, equipment, and professional consultants hired by the general contractor for that project.
- Overhead Costs: this refers to business expenses which are required for contract performance. Generally, overhead costs or indirect costs are part of labor costs and cover things like office rent, office supply, insurance, communication costs, drawing printing among others.
- Fee (or Profit)
Typically, the profit is a specific percentage derived from the total cost of labor used for the project.
Variations to a Cost-Plus Contract
Based on the unique circumstances surrounding individual building projects, a cost-plus contract may have certain variations including:
- Cost-Plus Incentive Fee: this type of cost-plus contract entitles the builder to incentive fees.
- Cost-Plus Award Fee: this refers to a cost-plus contract which offers award fees that are determined in advance and included in the contract provisions.
- Cost-Plus Fixed Rate: a type of cost-plus contract where the contractor can determine the actual project cost.
Costs That the Buyer Covers in a Cost-Plus Contract
When a buyer and the contractor form a cost-plus contract, the buyer promises to finance the actual cost of the project. The costs of the project cover items such as:
- Other expenses related to the project
Some cost-plus contracts have a guaranteed maximum price clause.
When to Use a Cost-Plus Contract
- A cost-plus agreement is ideal for situations where the total cost of a construction or remodeling project is difficult to estimate before the commencement of work.
- It is also the right contract for projects where the owner wishes to change the scope of work in the future.
- It is ideal for projects where the actual cost might be lower than the contract value.
- When the budget is tight.
- When project design is uncompleted.
- Can be used to select contractors based on their qualification.
Advantages of a Cost-Plus Contract
Some of the benefits of cost-plus contract are:
- Cost plus contracts provide more transparency on the cost of the project because it gives the owner access to the contractor's records and allows the project owner a flexible payment regime.
- It helps contractors reduce risk as it protects their entitlements.
Disadvantages of a Cost-Plus Contract
If you are working on a low budget or your company is a newcomer to the construction industry, a cost-plus contract doesn't provide the actual cost of the project. Alternatively, a lump-sum contract might be better as it shows you how much you need to spend on the project.
Protecting Your Business While Using a Cost-Plus Contract
The following steps can help protect your business when using a cost-plus contract:
- Read and understand the terms of the cost-plus contract
- Iron out any contentious terms that could result in disputes such as expenses related to the office and overhead.
- Monitor the usage of materials as a cost-plus contract can result in buying excess materials.
- Be honest about the project cost.
- Minimize your direct and indirect costs.
Importance of Good Record Keeping
To claim expenses and entitlements, the contractor must provide the project owner valid documentation for all the expenses incurred during the project. If the contractor is unable to provide evidence of costs or some expenses were due to the negligence of the builder, the owner might refuse to pay for those expenses.
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