Cost Plus Contract

A cost plus contract is a contract under which the buyer reimburses the contractor for allowable costs actually incurred and pays a separate additional amount as fee or profit. The total price is therefore not fixed when the contract is signed, and the cost risk sits with the buyer rather than the contractor. A cost-plus fee contract is the same arrangement under another name.

In US federal contracting a cost plus contract is one of the cost-reimbursement types. Cost-reimbursement contracts provide for payment of allowable incurred costs to the extent prescribed in the contract, and they set an estimate of total cost that obligates funds and fixes a ceiling the contractor may not exceed, except at its own risk, without the contracting officer’s approval (FAR 16.301-1). The family also holds forms that carry no fee at all: a cost contract is a cost-reimbursement contract on which the contractor receives no fee, so cost plus is the part of the family that pays one (FAR 16.302).

The Named Types

What separates the three named cost-plus types is only how the fee is set.

A cost-plus-fixed-fee contract pays a negotiated fee fixed at the inception of the contract. The fee does not vary with actual cost, though it may be adjusted as a result of changes in the work to be performed, and the type gives the contractor only a minimum incentive to control costs (FAR 16.306).

A cost-plus-incentive-fee contract starts from an initially negotiated fee and adjusts it later by a formula based on the relationship of total allowable costs to total target costs (FAR 16.304). Where the job lands against target is what moves the fee.

A cost-plus-award-fee contract splits the fee into a base amount fixed at inception, which may be zero, and an award amount set on the buyer’s judgmental evaluation of performance (FAR 16.305). The award half is discretionary by design, and that is what separates it from an incentive formula.

The fee on the fixed-fee form is capped by statute. It may not exceed 15 percent of the contract’s estimated cost for experimental, developmental or research work, and 10 percent of estimated cost on any other cost-plus-fixed-fee contract, in each case excluding the fee itself. A separate cap runs on architect-engineer services for public works or utilities, where the contract price or the estimated cost and fee for production and delivery of designs, plans, drawings and specifications may not exceed 6 percent of the estimated cost of construction of the public work or utility, excluding fees (FAR 15.404-4). The base for every one of those tests is the estimate, not what was finally spent.

Cost Plus a Percentage of Cost Is Prohibited

Cost-plus-a-percentage-of-cost is often listed as a fourth variant. In US federal contracting it is not one. That system of contracting shall not be used, and prime contracts other than firm-fixed-price must carry a clause prohibiting cost-plus-a-percentage-of-cost subcontracts (FAR 16.102).

The ban is statutory rather than a regulator’s preference. It sits in 41 U.S.C. 3905(a) in the public contracts title and in 10 U.S.C. 3322(a) in the armed forces title. A fee computed as a percentage of the cost actually incurred rises with every dollar of cost.

What Allowable Restricts

On a federal contract, allowable is the load-bearing word in the definition, and it is narrower than incurred. A cost is allowable only when it satisfies five requirements together: reasonableness, allocability, the Cost Accounting Standards where they apply and otherwise generally accepted accounting principles and practices appropriate to the circumstances, the terms of the contract, and the limitations set out in the cost principles themselves (FAR 31.201-2).

Reasonableness carries a burden most cost labels do not. A cost is reasonable if, in its nature and amount, it does not exceed what a prudent person would incur in the conduct of competitive business. No presumption of reasonableness attaches to a contractor having incurred it, and where the contracting officer or the officer’s representative challenges a specific cost, the burden of proof is the contractor’s (FAR 31.201-3).

Documentation is the other half. The contractor must maintain records adequate to demonstrate that claimed costs were incurred, are allocable to the contract and comply with the cost principles, and the contracting officer may disallow all or part of a claimed cost that is inadequately supported (FAR 31.201-2).

A Worked Example

Say a buyer and a contractor sign a cost-plus-fixed-fee contract on the figures below, and the work runs to two different outcomes.

Estimated cost                      $500,000
Fixed fee                            $50,000

Allowable costs of $460,000  ->  460,000 + 50,000  =  $510,000 paid
Allowable costs of $540,000  ->  540,000 + 50,000  =  $590,000 paid

The fee is the same number on both lines, because it was fixed against the estimate at inception rather than against what performance cost. The estimate is a ceiling on cost and is exclusive of any fee, so what the ceiling reaches on the second line is the cost above the estimate rather than the whole payment (FAR 52.232-20).

Cost Plus in a CPA Firm’s Work

For a contractor client on one of these contracts, revenue is measured off costs the firm has to be able to prove. Job-cost records stop being a management report and become the audit trail behind the billing, because a cost that cannot be tied to the job and supported is a cost that may be disallowed after it has already been spent.

The allowable and unallowable split has to live in the accounts rather than be reconstructed at year end. Costs that are expressly unallowable or mutually agreed to be unallowable, and the costs directly associated with them, must be identified and excluded from any billing, claim or proposal applicable to the contract (FAR 31.201-6).

The fee then sits on top of that cost base, so the indirect side needs the same discipline as the direct side. Under the standard allowable cost and payment clause the contractor must submit an adequate final indirect cost rate proposal, based on its actual cost experience for the period, within the 6-month period following the end of each of its fiscal years (FAR 52.216-7). How those pools and bases get built is set out in overhead and direct costs versus indirect.

Which period the revenue belongs to is a separate question, answered in revenue recognition principle, and what makes a cost repayable by another party at all is covered in reimbursable.

What a Cost Plus Contract Is Confused With

A firm-fixed-price contract is the opposite arrangement. Its price is not subject to any adjustment on the basis of the contractor’s cost experience, which places maximum risk and full responsibility for all costs and the resulting profit or loss on the contractor (FAR 16.202-1).

A time-and-materials contract buys direct labor hours at specified fixed hourly rates that already include wages, overhead, general and administrative expenses and profit, plus the actual cost of materials (FAR 16.601). The profit sits inside the hourly rate there; on cost plus it is a separate fee paid alongside reimbursed cost.

Common Questions

Firms carrying contractor clients can test whether job-cost and allowability tracking survives a handoff through Accountably’s trial task on their own work.