# Cost-Plus Contract: Definition, Types, and Example

![Cost-Plus Contract: An agreement to reimburse a company for expenses plus a specific amount of profit.](https://www.investopedia.com/thmb/hR480JOF9Shda75ElY6pYiaditU=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Cost-plus-contract_final-4ab1b6d9b70f4d3f97ce20efef50ba87.png)

*— Investopedia / Michela Buttignol*

> **Definition**
>
> A cost-plus contract is an agreement where a project owner reimburses a contractor for expenses plus an additional profit margin, typically expressed as a percentage of the total contract price.

## What Is a Cost-Plus Contract?

A cost-plus contract is an agreement made between a project owner and a contractor to reimburse the contractor for expenses incurred and to add a specific, additional payment for their profit. This profit is usually stated as a percentage of the contract’s full price.

These types of contracts are primarily used in construction for projects where the owner reduces some of the contractor's risk related to expenses, thereby providing the contractor with a degree of flexibility.

In such cases, the owner agrees to pay the contractor extra based on the contractor's agreement (and obligation) to deliver according to the contract's terms.

Cost-plus contracts can be contrasted with fixed-cost contracts, in which two parties agree up front to a specific cost, regardless of the actual expenses incurred by the contractor. Cost-plus contracts may also be known as cost-reimbursement contracts.

### Key Takeaways

*   In a cost-plus contract, one party agrees to [reimburse](https://www.investopedia.com/terms/r/reimbursement.asp) the contracting party for expenses plus a specified profit proportional to the full value of the contract.
*   Cost-plus contracts are often used in construction when the budget is restricted or when an estimate is difficult to finalize.
*   Contractors must provide proof of all related expenses, including direct and indirect costs.

## Understanding a Cost-Plus Contract

Cost-plus contracts are generally used if the party drawing up the contract has budgetary restrictions or if the overall scope of the work can't be properly estimated in advance.

For example, this party could be either the project owner, who wants to encourage a timely project launch or the contractor, who lacks necessary information for a thorough estimate.

In construction, cost-plus contracts are drawn up so contractors can be reimbursed for direct costs and indirect or [overhead](https://www.investopedia.com/terms/o/overhead.asp) costs. All expenses must be supported by invoices and receipts that identify the contractor's spending.

The contract also provides the contractor with the opportunity to make a specific profit—hence, the term "plus" in cost-plus contracts.

### Error and Negligence

Cost-plus contracts normally don't cover contractor error or negligence. Therefore, some contracts may limit the amount of reimbursement, so that not every expense is covered.

This contractual limitation benefits the owner if the contractor makes an error during the course of the project or is [negligent](https://www.investopedia.com/terms/c/contributory-negligence.asp) with regard to any part of the construction.

### Other Users of Cost-Plus Contracts

Cost-plus contracts are also used in [research and development (R&D)](https://www.investopedia.com/terms/r/randd.asp) activities, where a larger company may outsource R&D activities to a smaller firm, such as when a large pharmaceutical company contracts to the lab of a small biotech company.

The U.S. government also uses cost-plus contracts with military defense companies that develop new technologies for national defense.

> **Important**
>
> Governments generally prefer cost-plus contracts because they can choose the most qualified contractors instead of the lowest bidder.

## Types of Cost-Plus Contracts

Cost-plus contracts can be separated into four categories. Each allows for the reimbursement of costs as well as an additional amount for profit:

1.  **Cost-plus award fee contracts** allow the contractor to be awarded a fee usually for good performance.
2.  **Cost-plus fixed-fee contracts** cover both direct and indirect costs, in addition to a fixed fee.
3.  **Cost-plus incentive fee contracts** are made to give the contractor a fee if their performance meets or exceeds expectations.
4.  **Cost-plus percent-of-cost contracts** allow the amount of reimbursement to rise if the contractor's costs rise.

## Advantages and Disadvantages of Using Cost-Plus Contracts

Pros

*   They eliminate some risk for the contractor.
    
*   They allow the focus to shift from the overall cost to the quality of work being done.
    
*   They cover all the expenses related to the project, so there are no surprises.
    
*   Owners can start projects more quickly because contractors are confident they'll be paid.  
    

Cons

*   They may leave the final cost up in the air if all costs can't be predetermined.
    
*   Typically, a higher total cost.
    
*   Disputes can arise when trying to recover construction-related expenses.
    
*   Additional resources may be needed to reproduce and justify all related costs.
    

## Example of a Cost-Plus Contract

Assume ABC Construction Corp. has a contract to build a $20 million office building, and the agreement states that costs cannot exceed $22 million.

ABC’s profit is agreed at 15% of the contract’s full price, or $3 million. Additionally, ABC Construction is eligible for an [incentive fee](https://www.investopedia.com/terms/i/incentive-fee.asp) if the project is completed within nine months.

ABC must submit dated receipts for all expenses, and the client will inspect the job site for quality to verify that specific components, such as the plumbing, electrical, and fixtures, are completed to specification.

The contract allows ABC to incur direct costs for materials, labor, and costs incurred to hire subcontractors. ABC 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.

### Special Consideration: Percentage of Completion in a Cost-Plus Contract

The above project uses the percentage of completion process to account for profit and to submit bills to the client, and the contract provides specific percentages for billing.

Assume, for example, that ABC can bill for 20% of the full contract price once 20% of the materials are purchased, and the client verifies the concrete foundation is in place.

At that point, ABC sends an invoice for 20% of the $20 million contract, or $4 million, and posts 20% of the firm’s profit, or $600,000, to the financial statements (.20 x $3 million).

## What's a Risk of Cost-Plus Contracts?

For the owner, one risk can be the manipulation of expenses by the contractor. For the contractor, cost overruns that they don't keep track of can be another. Miscommunications with the owner can result in unexpected costs.

## Does the Owner Benefit From a Cost-Plus Contract?

They can. For instance, a cost-plus contract can instill confidence in the contractor that they'll be paid and therefore, they'll be more willing to start a project even if not every detail has been finalized. That's a plus for owners who need to get a project going fast.

## Why Do Contractors Like Cost-Plus Contractors?

They can be attractive to some contractors because not only do they reduce the risk of not getting paid, they also guarantee profitability.

## The Bottom Line

A cost-plus contract is a contract whereby the owner of a project agrees to pay the expenses incurred by a contractor during the project and agrees to pay pay a specific amount that represents profit for the contractor. That amount is usually a percentage of the full price of the contract.

Cost-plus contracts have their pros and cons so be sure to consider all aspects of a contract, including the risks, before entering into one.

> **Article Sources**
>
> 1.  U.S. Securities and Exchange Commission. “[Vectrus, Inc. Form 10-K for the Fiscal Year Ended December 31, 2019](https://www.sec.gov/Archives/edgar/data/1601548/000160154820000016/vec-1231201910xk.htm).” Page 10.