Cost Reimbursement Contract Advantages and Disadvantages
Cost reimbursement contract advantages and disadvantages are the benefits of an agreement in which the contractor is reimbursed for actual project costs.3 min read
Cost reimbursement contract advantages and disadvantages are the benefits of a legal agreement in which the contractor is reimbursed for his or her actual project costs. Other types of legal contracts include fixed price and time and materials.
What Are Cost Reimbursement Contracts?
Cost reimbursement contracts, also called cost-plus contracts, are often used for research projects, construction, and other undertakings that will require the purchase of materials. Because the cost of these materials is unknown when the contract is written, the contracting party agrees to reimburse the contractor for the full cost of materials.
Usually, the contractor will also be paid a fee on top of the materials cost. These contracts sometimes include clauses that offer financial incentives when the contractor exceeds performance targets or schedules or decreases costs.
Unlike a cost-plus contract, a fixed price contract specifies an exact fee for the work to be done, which means the contractor may earn less profit if the materials cost more than anticipated. An unscrupulous contractor may cut costs on materials to increase his or her profit.
Cost reimbursement contracts are best when project flexibility is needed, such as when the project is high-risk or the scope of work is unclear at the outset.
Federal agencies, particularly defense agencies, commonly use this type of contract, including the National Weather Service, Federal Transit Administration, and Department of Defense.
Types of Cost-Reimbursable Contracts
Cost-plus contracts can be structured in different ways to provide profit beyond the cost of materials. These include:
- A cost plus fixed fee contract in which the contractor receives a designated amount over the cost of materials. This can be a completion contract in which the end project and cost report must be delivered for the fee to be received, or a term contract in which the contractor must put a certain amount of effort toward the project for a definitive time period before the fee is received. After this period, the term contract can be renewed.
- A cost plus incentive contract provides a higher fee when the contractor keeps costs down or meets the project deadline without delay. This type of contract is used to motivate an effective performance of the project and includes a target cost and fee, minimum and maximum fee, and a formula by which the fee is to be adjusted.
- A cost plus award contract provides a higher fee when certain project metrics are reached and is usually based on subjective analysis by the buyer. This type of contract is usually used when objective measures are not appropriate for that specific contract.
- Cost plus percentage contract means that as the project costs increase, the fee also increases. This is not typically used because the contractor has no incentive to control costs. In fact, federal government agencies are prohibited from using this type of contract.
- Cost-sharing contracts reimburse the contractor only for a portion of project costs, with no added fee. These are typically used when contracting with a private company for research and development and the company in question will benefit from the contract in other ways.
Cost Plus Contract Advantages
Benefits of a cost-plus contract for the buyer include:
- Higher quality since the contractor has incentive to use the best labor and materials
- Less chance of having the project overbid
- Often less expensive than a fixed-price contract since contractors don't need to charge a higher price to cover the risk of a higher materials cost than expected
Contractor benefits include:
- The ability to take on a project in which the design or scope of work is not fully defined
- The chance for additional profit with performance incentives
Cost Plus Contract Disadvantages
For the buyer, the major disadvantage of this type of contract is the risk for paying much more than expected on materials. The contractor also has less incentive to be efficient since they will profit either way. Additional administration and oversight are needed to ensure that the contractor adheres to cost controls and other austerity measures.
When using this type of contract, it is prudent to establish a maximum limit for materials costs, provisions on how reimbursements will be made and costs documented, and what costs can be reimbursed.
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