What is a Cost Plus Contract?
A Cost plus contract is the type of contract in which the contractor gets paid all of their expenses plus and additional payment to allow for profit. Cost plus means something over and above the cost for completing the contract. The former word ‘cost’ includes all the types of cost (direct, indirect and overhead costs) and the latter word ‘plus’ refers to the profit which will be a specific percentage or a fee over and above the total contract cost. Cost Plus contract has its own advantages and disadvantages.
This type of contract is used when you want to reduce the risks and have your expenses covered on a job. But here you won’t get reimbursed for any and every expenses. You’ll need to justify and show evidence that supports the expenses related to the project that you’re working.
Three types of costs come into play in cost plus Contracts,
- Direct Costs: These costs are the actual construction costs. These include cost like direct labour, materials, equipment and consultants.
- Indirect Costs: These expenses can more be referred as overhead costs. These are additional costs required to execute the work. This covers the expenses for renting office spaces or site offices, insurances, transportation etc.
- Profit: Generally this is an agreed upon amount on a percentage of direct costs or markups related to the work.
Types of Cost Plus Contracts
There are generally four types of cost plus contracts;
- Cost Plus Fixed Fee Contract : In this type the contract pay a pre-determined fee that was agreed upon at the time of award of contract. This fee will be fixed even if there is any extra. The risk will be shared by both contractor and client.
- Cost Plus Variable Fee Contract : In this type the contracts have a larger fee awarded for contract which meet or exceed performance targets, including any cost savings. This type is not commonly used.
- Cost Plus Fixed Percentage Contract : In this type the contract fixes up a percentage over and above the total cost at the time of award of contract which will be paid to contractor if the contractor cost rises. Here the owner does not have a control over price and chances of malpractices by contractor is more.
- Cost Plus Variable Percentage Contract/Sliding Scale Percentage : In this type the contract have a variable percentages for different items of work.
Advantages and Disadvantages of Cost Plus Contracts
- Eliminate some risk for the contractor
- Allows the focus to shift from overall cost to quality of work done
- Covers the entire expenses related to project
- It can be used to put a limit or cap on the amount of money that the contractor can spend on a project.
- Contractor gets flexibility
- Budget friednly contract
- Helpful in outsourcing research and development activities
- Leads to longer project timeline
- It leads to disputes when trying to recover the construction related expenses
- Requires additional resource to reproduce and justify all related costs.
- Accounting of all indirect costs creates difficulties for contractor
- Total cost is uncertain
Example of Cost Plus Contracts
ABC is a contractor and has received a contract to construct a building with an estimated total cost of 20 million. Client will reimburse all the costs incurred by ABC. ABC will make a profit of 15% on the actual cost of project. If ABC completes the project within 3 years from the date of contract, ABC will receive an incentive where the amount is decided by both parties and agreed in contract.