There are many ways to contract work. But when the agreement is signed, it’s legally binding. Both parties must adhere to its terms and conditions. That’s why contracts vary from fixed-price contracts, in which the quoted price is final, to others with more flexibility.
There are many types of contracts, which makes it necessary to have contract administration procedures in place. For example, a fixed-price contract is only viable for the contractor when they are able to very accurately forecast how much the project will cost. If there are too many variables and unknowns, then setting an arbitrary cost for the work can be too high or too low. It’s too much of a risk to take.
Thankfully, there are many other types of contractual agreements which take into account the fact that not every cent can be accounted for until a project has concluded. For these types of projects, there is a cost-reimbursement contract. Learn about the various kinds of cost-reimbursement contracts and which one might be right for your next project.
What Is Meant By Cost Reimbursement on a Project?
Costs are anything the contractor must pay for in order to execute the project and deliver on its objective. This includes the labor, materials, equipment, tools and more.
Reimbursement means any money spent by the contractor will be given back during or after the project has been completed. Therefore, cost reimbursement is a way for a contractor to secure labor and materials necessary for the execution of the project without having to fit those resources within a tightly defined and predetermined price. As one might expect, getting reimbursed for costs on a project requires an agreement between contractor and customer to avoid misunderstandings.
What is a Cost Reimbursement Contract?
A cost reimbursement contract is an agreement between parties in a construction project that guarantees the owner reimburses the contractor for costs incurred while they work on the project. Reimbursement, however, is not unlimited. There is a ceiling.
The contractor is not paid solely for the costs but is also guaranteed an additional payment. This additional payment will be the contractor’s profit. The contract will still include an estimate for the total cost of the project.
Unlike a fixed-price contract where the overall price for the project is agreed on before the work starts and the price is final (and thus, the risk lies mostly with the contractor,) the cost reimbursement contract places risk more squarely on the project owner. That doesn’t mean there aren’t other risks, such as scope creep, where requirements are unclear.
What Are the Four Types of Cost Reimbursement Contracts?
There is not a one-size-fits-all cost reimbursement contract. There are actually four distinct categories:
Cost Plus Fixed Fee (CPFF)
A CPFF reimburses the contractor for all incurred costs, plus a fixed fee. This additional fee is included regardless of the contractor’s performance of the project. The customer, then, bears the risk. These contracts are often used in high-risk projects where it might be difficult to get bidders to compete. The incentive is that the contractor is protected from risk.
There are two types of CPFF contracts:
- Completion, in which a goal or product the contractor must deliver to receive their fee is identified
- Term, where the contract specifies a time period and level of effort the contractor must achieve
Cost Plus Incentive Fee (CPIF)
The CPIF gives the contractor a reimbursement for all incurred costs, and then adds an incentive based upon achievement of certain agreed-upon performance objectives, which are defined in the contract. The two parties will agree on a formula to determine what the incentive price is. The risk in this type of contract is with the customer (but less so than with a CPFF,) and the incentive motivates the contractor. Usually, the incentive is a percentage of savings both parties share.
Cost Plus Award Fee (CPAF)
The CPAF gives the contractor an award fee when they meet certain performance metrics outlined in the contract. This type of contract differs from the CPIF because the award is not based on a formula defined in the contract, but instead on the customer’s satisfaction. Therefore, it’s a subjective decision and cannot be appealed by the contractor.
Cost Plus Percentage of Costs (CPPC)
The CPPC awards the contractor all costs for the project and a percentage of those costs. This is not a popular choice with project owners unless they trust the contractor, as it shifts the risk to the owner. There is a risk of costs being artificially increased to profit the contractor. These contracts, therefore, have greater regulations applied to them to avoid such risks.
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What Is Typically Included in a Cost Reimbursement Contract?
Contracts are legally binding documents between two parties outlining the terms and conditions of the working relationship between them, usually awarded after a construction bidding process. Therefore, a contract is a contract, and much of the boilerplate follows suit from one to another, despite differences in types.
All contracts will have a valid offer and acceptance between parties and a price, whilst meeting legal standards. There will be detailed descriptions of the service to be rendered and what the expectations are for both parties. Most contracts are the same in that regard.
The difference with a cost reimbursement contract is it reimburses based on cost instead of delivery. Therefore, what is considered allowable costs needs to be defined. Because costs can add up if a project is delayed for whatever reason, often a cost reimbursement contract will have a ceiling that reimbursements cannot exceed, which is also defined in the contract.
Pros and Cons of a Cost Reimbursement Contract
A cost reimbursement contract is best for projects where the scope is uncertain and risk is high, as the risk is being shouldered by the customer who pays for all costs. But a cost reimbursement contract is not always the best type of legal course to take between parties.
Here are some of the advantages and disadvantages of using a cost reimbursement contract:
Pros
- Contractors have little incentive to cut corners
- Ideal when quality over costs is the objective
- Final costs are typically lower because there’s no need to inflate prices to cover contractor risk
Cons
- Final costs are not certain
- Needs oversight to make sure only those agreed-upon costs are paid
- Further oversight is needed for making any award or incentive fee fair
- Less incentive for efficiency
There are reasons to use a cost reimbursement contract over, say, a fixed-price contract, but all contracts have their pros and cons. It’s best to understand the scope and risk of the work in order to determine which contract is best.
Request for Proposal (RFP) Template
This free RFP template helps you define what construction contractors must include in their construction proposals to bid on your project. This includes the scope of work, timeline, budget and other details that should also be factored into your cost-reimbursement contract.
We offer a variety of free construction project management templates for Excel you can use to manage all aspects of your project.
How ProjectManager Helps You with Cost Reimbursement Projects
ProjectManager is award-winning software that allows you to create a budget, keep up with costs and report on those costs. If you use a cost reimbursement contract, you need to have a handle on what you’re spending. The less reimbursement needed, the more likely you’ll receive the incentive award and avoid breaking the price ceiling set up in the contract.
Create Budgets
You can create a budget at any time in the project, though it is most likely this will be done when you are in the planning stages. Your budget, however, can be changed at any time throughout the project’s life cycle. Once set, the project will be displayed on your real-time dashboard and accessible in reports to keep track of your costs.
Manage and Track Costs
Manage both types of costs in our tool, both resources and general costs. Resource costs are automatically calculated as your team logs hours on their tasks when you set their hourly rate. This is all shown on the Gantt and sheet view, where you can organize all your tasks and create a schedule by seeing the whole project laid out on a visual timeline.
Create Instant Reports
One-click reporting gives you even more data on your costs and budget. You can get this information from reports such as the portfolio status, which is color-coded to easily see if you’re over or under budget. Project status, project plan and task report also give you cost figures. All reports can be filtered to zero in on just what you want to see and then shared to keep stakeholders updated.
ProjectManager is a cloud-based software that tracks costs in real-time to help you stay on your budget. Use our tool to manage every phase of your project from planning to closure. Get live data to make better decisions and use our collaborative platform to help everyone work better together. See what we can do to add efficiencies to your project by taking this free 30-day trial today.
