A Cost-Reimbursement contract (FAR Subpart 16.3) is a type of contract that provides for payment of allowable incurred costs to the extent prescribed in the contract. These contracts establish an estimate of the total cost for the purpose of obligating funds and establishing a ceiling that the contractor may not exceed (except at its own risk) without the approval of the contracting officer. Costs are things that the contractor has to pay for in order to finish the project and reach its goal. This includes the work, the materials, the tools, equipment, and more.
Definition: A cost-reimbursement contract is a contract where all allowable contractor expenses are covered to an agreed-upon limit and an additional payment for a profit.
What is a Cost Reimbursement Contract
A cost reimbursement contract is an agreement between parties in executing a project that says the owner will pay the contractor back for any costs they have to pay while working on the project. But there are ceiling limits to how much can be paid back. The contractor doesn’t just get paid for the costs; he or she is also guaranteed an extra amount. The contractor will make a profit from this extra payment. The contract will still have an estimate of how much the whole project will cost.
Main Cost-Reimbursement Contract References
Website: FAR Subpart 16.3 Cost-Reimbursement Contracts
Website: DFARS 216.3 “Cost-Reimbursement Contracts
Purpose of a Cost Reimbursement Contract
A cost reimbursement contract is used to make a deal when the exact cost of the deal can’t be figured out. It might not be possible to know for sure how much certain goods or services will cost over the course of the government contract. In these situations, the government agency will usually agree to a cost-reimbursement contract, in which the agency takes some risk for the final costs. These contracts will establish an estimate of the total cost for the purpose of obligating funds and establishing a ceiling that the contractor may not exceed (except at its own risk) without the approval of the contracting officer.
When to Use a Cost-Reimbursement Contract
A cost-reimbursement contract should be used when there are too many uncertainties in contract performance that will not allow the use of a fixed-price contract. In a fixed-price contract, the project’s total cost is agreed upon before work begins, and that price is set in stone. This means that most of the risk lies with the contractor, while in a cost-reimbursement contract, most of the risk lies with the project owner. That doesn’t mean there aren’t other risks, like when requirements aren’t clear, and the project’s scope grows.
How to Set-Up a Cost-Reimbursement Contract
A Cost-Reimbursement contract requires the contracting officer to negotiate a “total estimated cost” and payment of a fixed dollar fee to the contractor. The total estimated cost is a contract cost limitation that the contractor cannot exceed, except at the risk of non-reimbursement.
Any cost-reimbursement contract must have a “limitation of cost” or “limitation of funds” clause which will limit the government’s liability if the contractor exceeds the total estimated cost.
The fee cannot be changed unless the government changes the scope of work in the contract.
Types of Cost-Reimbursement Contracts
There is no one contract for cost reimbursement that works for everyone. The main types of cost-reimbursement contracts are. [1]
- Cost Contracts (FAR 16.302): A cost contract is a cost-reimbursement contract in which the contractor receives no fee.
- Cost-Sharing Contracts (FAR 16.303): A cost-sharing contract is a cost-reimbursement contract in which the contractor receives no fee and is reimbursed only for an agreed-upon portion of its allowable costs.
- Cost-plus-incentive-fee Contracts (CPIF) (FAR 16.304): A cost-plus-incentive-fee contract is a cost-reimbursement contract that provides for an initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to total target costs. See Incentive Contracts.
- Cost-plus-award-fee Contracts (CPAF) (FAR 16.305): A cost-plus-award-fee contract is a cost-reimbursement contract that provides for a fee consisting of (a) a base amount (which may be zero) fixed at the inception of the contract and (b) an award amount, based upon a judgmental evaluation by the Government, sufficient to provide motivation for excellence in contract performance. See Incentive Contracts.
- Cost-plus-fixed-fee Contracts (CPFF) (FAR 16.306): A cost-plus-fixed-fee contract is a cost-reimbursement contract that provides for payment to the contractor of a negotiated fee that is fixed at the inception of the contract. The fixed fee does not vary with actual cost but may be adjusted as a result of changes in the work to be performed under the contract. This contract type permits contracting for efforts that might otherwise present too great a risk to contractors, but it provides the contractor only a minimum incentive to control costs.
Pros and Cons of a Cost Reimbursement Contract
Cost reimbursement contracts are best for projects where the scope isn’t clear and the risk is high since the customer pays for all costs and takes on all the risk. But a cost-reimbursement contract isn’t always the best way for two people to settle a legal dispute. Here are some good things about using a cost-reimbursement contract and some bad things about it:
Positives
- Contractors don’t have much of a reason to cut corners.
- Ideal when quality is more important than cost
- Most of the time, final costs are lower because prices don’t have to be raised to cover contractor risk.
Negatives
- The final costs are not known. More oversight is needed to make sure that only agreed-upon costs are paid.
- Less reason to be efficient
Considering the Use of a Cost-Reimbursement Contract
As a Program Manager and contracting officer, numerous crucial considerations exist when deciding whether to use a cost-reimbursement contract type for a project. Here are some crucial things to remember:
- Project nature: Evaluate the project’s complexity, unpredictability, and dangers. Cost-reimbursement agreements are frequently appropriate for projects with high degrees of technical difficulty, ongoing research, and development, or ambiguous objectives.
- Cost Estimation: Assess your capacity to predict project costs with reasonable accuracy. In order to determine an initial target cost or anticipated cost, which serves as the foundation for payment, cost-reimbursement contracts need a credible cost estimate.
- Contract Structure: Based on the needs of the project, choose the right kind of cost-reimbursement contract. Cost-plus-fixed-fee (CPFF), cost-plus-incentive-fee (CPIF), and cost-plus-award-fee (CPAF) are a few examples of the many sorts. Each has unique characteristics and methods for distributing risk.
- Project Risk Identification and Mitigation: Evaluate Project Risks and Cost Impact. Think about risk-mitigation techniques like cost caps, performance bonuses, or sharing risks with the contractor.
- Contracting Mechanisms: Take into account the relevant contract clauses to provide efficient cost control and supervision. A cost monitoring and reporting system may need to be set up, audits may need to be done, and performance-based incentives may need to be implemented.
- When choosing a contractor, consider their track record of success, qualifications, and financial standing. A high degree of trust and confidence in the contractor’s capacity to properly manage costs is necessary for cost-reimbursement contracts.
- Contract Monitoring: Create a strong tracking and reporting system to keep tabs on the project’s advancement, expenses, and deliverables. Review the contractor’s cost submissions, invoices, and progress reports frequently to ensure the contract conditions are followed.
- Project Change Management: Be prepared for potential adjustments to the project’s objectives, requirements, or scope. Establish systems to deal with revisions and change orders, including as processes for negotiating and recording adjustments to the budget and schedule.
- Adequate Government Oversight: Make plans for sufficient government oversight to guarantee adherence to laws, terms of contracts, and cost-cutting initiatives. Assign competent individuals to oversee the project, carry out regular reviews, and, as necessary, give the contractor technical support.
- Documentation and Communication: Throughout the contracting process, keep full records of all correspondence, cost estimates, and negotiation memos. Encourage honest and open communication with the contractor to quickly resolve any difficulties.
Remember that the government assumes most of the expense risk with cost-reimbursement contracts. To reduce the possibility of cost overruns and ensure effective contract performance, it is necessary to examine the project and contractor’s skills properly. To make wise decisions and adhere to relevant laws and policies, consult with technical, financial, and legal specialists inside your company.
AcqNotes Tutorials
Other Types of Contracts
– See Firm-Fixed Price Contract
– See Indefinite Delivery Contract
– See Incentive Contract
– See Time and Materials Contract
AcqLinks and References:
- [1] Website: FAR Subpart 16.3 – Cost-Reimbursement Contracts
- GAO Report – Contract Management under Cost Reimbursement Contracts – Sept 2009
- DAU “Comparison of Major Contract Types” – Jan 2014
- Website: Navy Contract Management Process Guide
- Website: FAR Subpart 16 – Contract Types
Updated: 7/9/2023
Rank: G5.8
