Construction Management

Cost Plus Contracts in Construction

Cost Plus Contract

It’s something great to get paid for every construction costs you have incurred on a construction project. A plus-cost contract, known as a contract for cost-reimbursement, is a type of contract for the contractor to pay for all of his expenses related to construction. Moreover, a specific agreed amount is paid to the contractor for a profit.

What is Cost Plus Construction Contract?

A cost-plus contract is an agreement to reimburse a company for expenses incurred plus a specified amount of profit, which is normally expressed as a percentage of the contract’s total price.

These contracts are often used in construction, where the buyer assumes some of the risks while still allowing the contractor some flexibility. In such a case, the party drafting the contract expects the contractor to deliver on his or her commitments and decides to pay more so that the contractor can earn more after completion.

The client agrees to cover the real project costs in a building cost-plus agreement. These expenses include equipment and labor, plus additional expenses incurred in completing all works. The “plus” part refers to a fixed fee or percentage agreed upon in advance that covers the contractor’s overhead & profit.

Typically, these contracts are “open book,” meaning the owner has the right to see actual expenses. In construction, some cost-plus agreements involve a guaranteed maximum price. This type of contract is different from Lump Sum Contract.

Main components of a cost-plus contract

1-Direct costs:

The main contractor uses materials, supplies, labor, machinery, and professional consultant.

2-Overhead costs/ indirect costs:

All related expenses that are needed to perform the contract; typically a percentage of labor costs and can include office rent, insurance, office supply, communication expenses, mileage, and printing or reproduction of construction drawings.

3-Fee or profit:

Typically a fixed percentage (%) based on the cost of labors directly associated with the work

When to use a Cost-Plus Contract?

This type of contract may be used when the budget is being restricted or when there is a high probability that the actual cost of works might be reduced. A cost-plus contract is preferred when there is not enough data to perform a detailed estimate of the work or when the design is not completed.

Governmental agencies prefer these contracts because they can select the contractor based on their qualification instead of the low bidder.

Cost-plus is widely used to perform research & development works because the risk can be controlled by the contracting officer.

Pros and Cons of Cost-Plus Contracts

Cost Plus contracts have many pros and cons:

Advantages of a Cost-Plus Contract

  • The contractor won’t be able to reduce labors.
  • It can focus on the quality of works instead of cost.
  • It could cover all related expenses.
  • The contractor’s risk is minimized

Disadvantages of a Cost-Plus Contract

  • Present uncertainty to the project owners because the final cost cannot always be determined at the beginning
  • Require additional resources and management to reproduce and justify all associated costs
  • May lead to dispute when trying to recover construction-related expenses
  • May lead to projects running longer than expected

Types of Cost Plus Contracts

Cost-plus contract agreements may include features or variants to meet particular construction projects‘ requirements or special circumstances.

1.Cost-Plus incentive fee:

Incentive fees are based on the contractor’s performance and are set under the contract provisions. The type and amount of the incentive may be based on the project goals or schedule deadlines.

2.Cost-plus award fee:

A cost-plus award fee provides for award fees, predetermined & set forth in contract documents. The fee can be gratitude or a penalty fee.

3.Cost-plus fixed rate:

A cost-plus fixed-rate contract sets predetermined labor rates based on the contractor’s history and labor costs. It is a contract used by contractors who really know their actual costs, but it provides little flexibility for contingencies.

4.Cost-plus fixed fee:

It covers direct & indirect costs plus a pre-determined fixed fee.

Example of Cost Plus Contract

XYZ Construction Company has a contract to build a $50 million high-rise building, and the agreement states that costs can’t exceed $55 million. XYZ’s profit is agreed at 20% of the contract’s full price of $10 million. Additionally, XYZ Construction is eligible for an incentive fee if the project is completed within nine months.

XYZ must submit dated invoices for all expenses, and the client will inspect the job on-site for quality to verify those specific components are completed to the specification such as the plumbing, electrical, fixtures, etc.

The contract allows XYZ to incur direct costs such as materials, labor, and costs incurred to hire subcontractors. XYZ can also bill indirect, or overhead, costs, which include insurance, security, and safety. The contract states that overhead costs are billed at $50 per labor hour.

Bottom Line

Cost-plus contracts are commonly used in the construction industry, where the contractor is reimbursed for the number of expenditures incurred for the contract as well as a fixed percentage fee of the contract cost as profit.