Many government contracts are fixed price, meaning the price quoted in the proposal is final and includes all expenses.
In some cases, however, it's difficult, if not impossible, to predict exactly how much certain items or services will cost over the life of the government contract.
In these situations, the government agency will usually agree to a cost-reimbursement contract, in which the agency assumes some level of risk for the final costs.
What is a Cost-Reimbursement Contract?
A cost-reimbursement contract is a type of government contract in which the government pays the contractor for the costs of completing the project, plus an additional payment depending on the specific contract type agreed upon.
Whereas a fixed-price contract has the project's final price agreed upon before work begins, in a cost-reimbursement contract, the final price will be determined when the contractor completes the contract. It could also be determined at another previously established date during the contracting period.
A total cost estimate for the contract will be determined before work commences, allowing the agency to set a project budget and establish a maximum reimbursement amount. The prime contractor cannot exceed that maximum without the contracting officer's permission, but can stop work if the project costs reach that maximum.
Types of Cost-Reimbursement Contracts
There are several types of cost-reimbursement contracts, which you can read about in further detail below:
- Cost contracts
- Cost-sharing contracts
- Cost-plus-fixed-fee (CPFF) contracts
- Cost-plus-incentive-fee (CPIF) contracts
- Cost-plus-award-fee (CPAF) contracts
- Cost plus percentage of cost (CPPC) contracts
Cost Contracts
This type of contract only covers the actual costs of completing the contract, and the contractor receives no additional fee. Research and non-profit work commonly use cost contracts.
Cost-Sharing Contracts
The contractor agrees to assume part of the contract expenses in a cost-sharing contract. The government agency will reimburse the contractor for an agreed-upon portion of those expenses. As with a cost contract, the contractor receives no additional fee.
This contract type involves some risk to contractors. A contractor should only enter a cost-sharing contract if the work sufficiently benefits the company to offset the shared expenditures.
Cost-Plus-Fixed-Fee (CPFF) Contracts
In a cost-plus-fixed-fee contract, the contractor receives reimbursement plus a predetermined fee negotiated at the time the agreement is finalized. This fee will not change based on the actual contract cost.
However, the fee may be revised if the work required to complete the contract also changes. A cost-plus-fixed-fee contract is useful when the contractor's risk might otherwise outweigh any non-financial benefits.
There are two types of cost-plus-fixed-fee contracts:
- Completion: The government agency identifies a goal or product,, and the contractor must deliver the product to receive the fee. If the costs exceed the original estimate, the government will continue to reimburse for the cost, but won't increase the fixed fee.
- Term: The scope of work is less specific, but the contract states a time period and level of effort expected of the contractor. When that time period expires, the agency pays the fee after it approves the work completed and the level of effort. Any necessary further work will require a new agreement.
Cost-Plus-Incentive-Fee (CPIF) Contracts
With a cost-plus-incentive-fee contract, the contractor receives reimbursement plus an adjustable fee.
The initial contract clauses will establish targets for cost and fee, as well as a minimum and maximum fee and a formula for fee adjustment. Once the contractor completes the contract, the government pays the contractor based on this formula. In essence, the fee increases if the contractor completes at less than the target cost and decreases if the contract exceeds the target cost.
With a cost-plus-incentive-fee contract, it's definitely in the contractor's best interest to keep costs as low as possible — the less money spent, the more profit the contractor receives, up to the maximum.
Cost-Plus-Award-Fee (CPAF) Contracts
Under a cost-plus-award-fee contract, the contractor receives reimbursement and a fixed fee, with the potential to earn an additional fee. The agency will determine the award amount based on an assessment of the contractor's performance.
Both cost-plus-award-fee and cost-plus-incentive-fee contracts intend to motivate contractors to complete the contract as thoroughly and cost-efficiently as possible.
Cost-Plus-Percentage-of-Cost (CPPC) Contracts
With a cost-plus-percentage-of-cost contract, the seller receives payment for all costs incurred and a percentage of these costs. This type of contract is preferred when shifting some of the contract performance risk from the contractor to the buyer is desirable.
Advantages And Disadvantages Of Cost-Reimbursement Contracts
Cost-reimbursement contracts work best for projects with uncertain scope or greater risk.
These types of contracts benefit contractors, as the customer assumes the risk by paying all costs. However, a cost-reimbursement contract may not always be the most suitable form of agreement between the parties.
Here are some of the advantages and disadvantages of using cost-reimbursement contracts
Advantages of Cost-Reimbursement Contracts
- The contractor is incentivized to use the best labor and materials, leading to a higher quality outcome.
- They can be less expensive than a fixed-price contract since the government will reimburse the contractor for the actual cost of materials rather than estimated costs that might make up an agreed fixed price.
Disadvantages of Cost-Reimbursement Contracts
- The final cost is uncertain.
- There is a reduced incentive for cost efficiency.
- Oversight is necessary to ensure the buyer only pays for approved costs.
- Monitoring is required to ensure that any award or incentive fees are fair.
Government Regulation on Cost-Reimbursement Contracts
Of course, there are more regulations that apply to the various types of cost-reimbursement contracts.
To learn about all government regulations on cost-reimbursement contracts, you can reference subpart 16.3 of the FAR.
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