What Is a Cost-Plus Contract?

What Is a Cost-Plus Contract?

Let me explain what a cost-plus contract really is. It's an agreement between you, as the project owner, and a contractor where you reimburse them for all the expenses they incur, plus an extra amount for their profit. This profit is usually a percentage of the total contract price.

You'll see these contracts mostly in construction projects where you want to cut down on the contractor's risk from unexpected costs, giving them some flexibility. In return, the contractor has to deliver on the terms we've agreed upon, and you pay that extra based on their performance.

Compare this to fixed-cost contracts, where everything is set upfront at a specific price, no matter what actual expenses come up. Sometimes, people call cost-plus contracts cost-reimbursement contracts.

Key Takeaways

In a cost-plus contract, you agree to cover the contractor's expenses and add a profit that's proportional to the contract's full value. These are handy in construction when budgets are tight or estimates are hard to pin down. Remember, contractors need to prove all their expenses, including both direct and indirect costs.

Understanding a Cost-Plus Contract

You'd typically use a cost-plus contract if you're facing budget limits or if the project's full scope isn't clear from the start. This could be you as the owner pushing for a quick start, or the contractor not having enough info for a solid estimate.

In construction, these contracts let contractors get reimbursed for direct costs like materials and labor, plus indirect overhead like insurance. You need to see invoices and receipts for everything to verify the spending.

The 'plus' part is where the contractor gets their profit on top, making it worthwhile for them.

Error and Negligence

Keep in mind that cost-plus contracts usually don't cover mistakes or negligence by the contractor. Some contracts cap the reimbursement to protect you, the owner, if things go wrong during the project.

Other Users of Cost-Plus Contracts

These aren't just for construction. In research and development, a big company might outsource R&D to a smaller one, like a pharma giant contracting a biotech lab. The U.S. government uses them with defense companies for new tech. Governments like them because they can pick the best contractors, not just the cheapest.

Advantages and Disadvantages of Using Cost-Plus Contracts

On the plus side, these contracts cut risk for the contractor, letting everyone focus on quality over just cost. They cover all project expenses, avoiding surprises, and help you start projects faster since contractors know they'll get paid.

But there are downsides: The final cost might not be clear if not all expenses are predictable, often leading to higher totals. Disputes can happen over recovering costs, and you might need extra effort to verify everything.

Example of a Cost-Plus Contract

Take ABC Construction Corp. building a $20 million office. The contract caps costs at $22 million, with ABC getting 15% profit, or $3 million. There's an incentive if they finish in nine months.

ABC submits receipts for all expenses, and you inspect the site to check quality on things like plumbing and electrical. They can bill direct costs for materials, labor, and subs, plus overhead at $50 per labor-hour.

Special Consideration: Percentage of Completion in a Cost-Plus Contract

This project uses percentage of completion for accounting profit and billing. For instance, once 20% of materials are bought and the foundation is verified, ABC bills 20% of the contract, or $4 million, and records 20% of their profit, $600,000.

What's a Risk of Cost-Plus Contracts?

For you as the owner, a risk is the contractor padding expenses. For them, it's cost overruns they don't track. Miscommunications can lead to unexpected bills.

Does the Owner Benefit From a Cost-Plus Contract?

Yes, you can benefit. It builds confidence in the contractor that they'll be paid, so they're more likely to start even if details aren't final. That's great if you need to move fast.

Why Do Contractors Like Cost-Plus Contracts?

Contractors favor them because they lower the risk of not getting paid and ensure they make a profit.

The Bottom Line

In summary, a cost-plus contract means you pay the contractor's expenses plus a profit percentage. Weigh the pros and cons, including risks, before signing one.