A cost-plus contract, more accurately termed a Cost Reimbursement Contract, is a contract framed in such a way that when the contractor finishes the agreed-upon work, they receive compensation equal to their expenses plus a profit. Cost reimbursement contracts contrast with fixed-price contract, in which the contractor is paid a negotiated amount regardless of incurred expenses.

Types

There are four general types of cost reimbursement contracts, all of which pay every allowable, allocable, and reasonable cost incurred by the contractor plus a fee or profit which differs by contract type.

                   Cost Plus Fixed Fee contracts pay a pre-determined fee that was agreed upon at the time of contract formation.

                   In a Cost-Plus-Incentive Fee contract, the fee paid to the contractor is determined using a mathematical formula which provides for a specific fee to be paid if the contractor’s final cost comes in equal to the negotiated target cost. The fee is raised or lowered in the event of a cost underrun or overrun, respectively.
     A cost-plus-incentive fee contract is a contract based on a Cost-plus contract that includes an incentive fee which is awarded if the contractor completes the work under budget. The amount of the incentive fee can be fixed, or proportional to the difference between the actual cost and the total cost agreed to in the contract; this allows for the contractor to earn a greater profit by beating cost targets.

Like a cost-plus contract, the contractor will make money even if they suffer from cost overruns (cost + profit margin). The contractor will make more money if they surpass the contracted total cost (cost + profit margin + incentive fee).

                   Cost Plus Award Fee contracts pay a fee based upon the contractor’s work performance. In some contracts, the fee is determined subjectively by an awards fee board whereas in others the fee is based upon objective performance metrics. An aircraft development contract, for example, may pay award fees if the contractor achieves certain speed, range, or payload capacity goals.

                   Cost Plus Percentage of Cost pay a fee that rises as the contractors cost rise. Because this contract type provides no incentive for the contractor to control costs it is rarely utilized. The U.S. Federal Acquisition Regulations specifically prohibit the use of this type for U.S. Federal Government contracting (FAR Part 16.102).

Usage

A cost reimbursement contract is appropriate when it is desirable to shift some risk of successful contract performance from the contractor to the buyer. It is most commonly used when the item purchased cannot be explicitly defined, as in research and development, or in cases where there is not enough data to accurately estimate the final cost.

Pros and cons

Advantages:

                   In contrast to a fixed-price contract, a cost-plus contractor has little incentive to cut corners.

                   A cost-plus contract is often used when long-term quality is a much higher concern than cost, such as in the United States space program.

Disadvantage:

                   Requires additional oversight and administration to ensure that only permissible costs are paid and that the contractor is exercising adequate overall cost controls.
Source: Wikipedia, the free encyclopedia

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