Cost Plus Contracts: Everything You Need to Know
Cost plus contracts are agreements between a buyer and a seller, with the seller agreeing to make or produce a good for the buyer. 3 min read
2. Components of a Cost-Plus Contract
3. Advantages and Disadvantages of Cost-Plus-a-Percentage
Cost plus contracts are agreements between a buyer and a seller, with the seller agreeing to make or produce a good for the buyer. The selling price of the good is the cost to the seller for making or producing the good. This price also includes an agreed-upon fixed fee or percentage of the cost.
Cost-plus contracts are also referred to as time-and-out materials. This type of contract is used on a job that has many unknown and hidden conditions. This type of contract would apply to a situation where there is repair work being done and there may be issues not readily visible. In other words, the condition is "hidden."
Information about Cost-Plus Contracts
- A cost-plus contract may be used on small or large projects. It is an acceptable way to approach a job where specifics or instructions are not ideal.
- The cost-plus contract is a viable agreement between a client and a construction company that takes into consideration the building expenses stated in the contract along with a dollar amount to cover a profit. The dollar amount may be a percentage of the full price of the contract.
- The way the cost-plus contract would work in the client and construction company situation is the builder is paid direct costs and overhead costs plus all expenses, which the construction contractor must document. It is also an option to state within the contract a set dollar amount for reimbursements.
- With a cost-plus contract, the contractor is paid for all expenses agreed upon for the construction. A set limit documented in the contract stating the contractor cannot exceed a set amount is also an option.
- The "plus" portion of the contract refers to any profit the contractor may earn. This type of contract is considered a win-win situation because any risks are covered and the expenses will most likely be paid.
- The cost-plus contract is preferred when a detailed estimate of the work does is not possible because of a lack of data.
- Government agencies use this type of contract because they have control over the selected contractor versus a low-bid contractor.
- It might also be used when the budget for a job is restricted or the actual cost of the job may be reduced.
Components of a Cost-Plus Contract
There are three main components to a cost-plus contract:
- Direct costs include the materials, equipment, supplies, and professional consultants the general contractor used.
- Overhead costs, also referred to as indirect costs, are business-related expenses that must be incurred to carry out the stipulations of the contract. The overhead costs are usually figured as a percentage of the labor costs. Overhead costs may include office supplies, insurance, office rent, mileage, drawing and printing, and communication expenses.
- Fee, also referred to as profit, is generally a fixed percentage calculated using the labor costs directly involved with the contracted work.
Advantages of a Cost-Plus Contract
There are several advantages to a cost-plus contract:
- A contractor cannot reduce workmanship.
- The focus can be on quality instead of cost.
- All related expenses could be covered.
- The risk to a contractor is minimized.
Disadvantages of a Cost-Plus Contract
Depending on one's needs, a cost-plus contract could prove to be disadvantageous, as:
- It instills uncertainty to project owners because a final cost cannot be easily determined.
- Additional resources, including management, is required to justify all related costs.
- There is a possibility of a dispute if there is an issue in recovering construction-related expenses.
- The project could take longer to complete than expected.
- For the contractor, every cost associated with the job must be justified and have evidence to prove that the costs incurred were related to the job.
- It is possible the contractor could be denied in recovering associated costs if negligence or other relevant error related to the job is attributed to the contractor.
Advantages and Disadvantages of Cost-Plus-a-Percentage
- For a job with many hidden or unknown issues, the contractor does not need to "pad" the price to cover the costs with a cost-plus-a-percentage contract.
- Even with incomplete plans, a job can be started immediately.
- You pay only for the work that is completed at a set or known rate.
- A contractor has little to no incentive to keep project costs down.
- The owner assumes all the risk of cost overruns.
- You must have a high level of trust in the contractor.
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