Cost Reimbursable Contracts

Cost-reimbursable contracts are as the name implies. The allowable costs—allowable is defined by the contract—associated with producing the goods or services are charged to the buyer. All the costs the seller takes on during the project are charged back to the buyer; thus, the seller is reimbursed.

Cost-reimbursable contracts carry the highest risk to the buyer because the total costs are uncertain. As problems arise, the buyer has to shell out even more money to correct the problems. However, the advantage to the buyer with this type of contract is that scope changes are easy to make and can be made as often as you want—but it will cost you.

Cost-reimbursable contracts have a lot of uncertainty associated with them. The contractor has little incentive to work efficiently or be productive. This type of contract protects the contractor's profit because increasing costs are passed to the buyer rather than taken out of profits, as would be the case with a fixed-price contract. Be certain to audit your statements when using a contract like this so that charges from some other project the vendor is working on don't accidentally end up on your bill.

Cost-reimbursable contracts are used most often when the project scope contains a lot of uncertainty, such as for cutting-edge projects and research and development. They are also used for projects that have large investments early in the project life. We'll look at four types of cost-reimbursable contracts:

Cost plus fixed fee (CPFF) Cost plus fixed fee (CPFF) contracts charge back all allowable project costs to the seller and include a fixed fee upon completion of the contract. This is how the seller makes money on the deal; the fixed fee portion is the seller's profit. The fee is always firm in this kind of contract, but the costs are variable. The seller doesn't necessarily have a lot of motivation to control costs with this type of contract, as you can imagine. And one of the strongest motivators for completing the project is driven by the fixed fee portion of the contract.

Cost plus incentive fee (CPIF) The next category of cost-reimbursable contract is cost plus incentive fee (CPIF). This is the type of contract in which the buyer reimburses the seller for the seller's allowable costs and includes an incentive for meeting or exceeding the performance criteria laid out in the contract. An incentive fee actually encourages better cost performance by the seller, and there is a possibility of shared savings between the seller and buyer if performance criteria are exceeded. The qualification for exceeded performance must be written into the contract and agreed to by both parties, as should the definition of allowable costs; the seller can possibly lose the incentive fee if agreed-upon targets are not reached.

There is moderate risk for the buyer under the cost plus incentive fee contract, and if well written, it can be more beneficial for both the seller and then buyer than a cost-reimbursable contract.

Cost plus percentage of cost (CPPC) In the cost plus percentage of cost (CPPC), the seller is reimbursed for allowable costs plus a fee that's calculated as a percentage of the costs. The percentage is agreed upon beforehand and documented in the contract. Since the fee is based on costs, the fee is variable. The lower the costs, the lower the fee, so the seller doesn't have a lot of motivation to keep costs low.

Cost plus award fee (CPAF) This is the riskiest of the cost plus contracts for the seller. In this contract, the seller will recoup all the costs expended during the project but the award fee portion is subject to the sole discretion of the buyer. The performance criteria for earning the award is spelled out in the contract, but these criteria can be subjective and the awards are not usually contestable.

Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

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