Cost-Plus Contract: Definition, Types, and Example

Cost-Plus Contract: Definition, Types, and Example

A cost-plus contract is a type of contract where the buyer agrees to reimburse the seller for all allowable or agreed-upon costs incurred during the performance of the contract. In addition to the costs, the seller is also entitled to receive a predetermined profit margin or fee.

There are several types of cost-plus contracts:

Type	Description
Cost-Plus-Fixed-Fee (CPFF)	The seller is reimbursed for costs and receives a fixed fee, regardless of the final cost of the project.
Cost-Plus-Incentive-Fee (CPIF)	The seller is reimbursed for costs and receives a fee based on meeting certain performance targets or objectives.
Cost-Plus-Percentage-of-Cost (CPPC)	The seller is reimbursed for costs and receives a fee based on a percentage of the total project cost.

Here’s an example to illustrate how a cost-plus contract works:

Company A hires Company B to build a new office building. They agree on a cost-plus-fixed-fee contract. Company B incurs $1 million in costs during the construction process. According to the contract, they are entitled to a fixed fee of $100,000. Therefore, Company A reimburses Company B $1.1 million ($1 million in costs + $100,000 fixed fee).

Cost-plus contracts are commonly used in construction projects or contracts where the scope of work is uncertain, and it is difficult to determine the final cost upfront. They provide flexibility for both the buyer and the seller, but also carry some risks, such as potential cost overruns.

Types of Cost-Plus Contracts

Cost-plus contracts are commonly used in various industries and can be categorized into different types based on the nature of the project and the payment structure. Here are some of the most common types:

1. Cost-Plus-Fixed-Fee (CPFF) Contract:

2. Cost-Plus-Incentive-Fee (CPIF) Contract:

A cost-plus-incentive-fee contract includes a performance-based incentive fee in addition to the reimbursement of actual costs and a fixed fee. The incentive fee is based on predetermined performance targets, such as completing the project ahead of schedule or achieving specific quality standards. If the contractor meets or exceeds these targets, they receive an additional payment as an incentive.

3. Cost-Plus-Percentage-of-Cost (CPPC) Contract:

4. Cost-Plus-Award-Fee (CPAF) Contract:

A cost-plus-award-fee contract involves the reimbursement of actual costs, a fixed fee, and an award fee based on the contractor’s performance. The award fee is determined by evaluating the contractor’s performance against specific criteria, such as meeting project milestones, delivering high-quality work, or demonstrating innovation. The better the contractor’s performance, the higher the award fee they receive.

These are just a few examples of the types of cost-plus contracts that exist. Each type has its own advantages and disadvantages, and the choice of contract type depends on the specific needs and goals of the project.

Example of Cost-Plus Contract

A cost-plus contract is a type of contract where the buyer agrees to reimburse the seller for all allowable costs incurred in completing the project, in addition to a predetermined fee or percentage of the total costs. This type of contract is commonly used in construction projects, government contracts, and consulting services.

Let’s consider an example to better understand how a cost-plus contract works:

Scenario:

ABC Construction Company has been contracted to build a new office building for XYZ Corporation. The project is estimated to cost $1 million and has a timeline of one year. The contract between the two parties is a cost-plus contract with a fee of 10% of the total costs.

Cost Breakdown:

During the construction process, ABC Construction Company incurs various costs, including:

• Materials: $500,000
• Labor: $300,000
• Equipment: $100,000
• Permits and licenses: $20,000
• Subcontractor fees: $80,000

Based on the cost-plus contract, XYZ Corporation will reimburse ABC Construction Company for these allowable costs, which amount to $1 million.

Fee Calculation:

In addition to the allowable costs, ABC Construction Company is entitled to a fee of 10% of the total costs. Therefore, the fee for this project would be $100,000 (10% of $1 million).

After completing the project, ABC Construction Company submits the total costs of $1 million plus the fee of $100,000 to XYZ Corporation for reimbursement. XYZ Corporation reviews the costs and fee, and upon approval, reimburses ABC Construction Company a total of $1.1 million.

This example demonstrates how a cost-plus contract works, where the seller is reimbursed for all allowable costs incurred during the project, along with a predetermined fee or percentage of the total costs. It provides flexibility for the seller to cover unforeseen expenses and ensures transparency in cost reimbursement.