what is a cost plus contract 
a cost plus contract is an agreement to reimburse a company for expenses incurred plus a specific amount of profit usually stated as a percentage of the contract s full price these type of contracts are primarily used in construction where the buyer assumes some of the risk but also provides a degree of flexibility to the contractor in such a case the party drawing up the contract anticipates that the contractor will make good on their promises to deliver and agrees to pay extra so that the contractor can make additional profit upon completion 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 understanding cost plus contractscost 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 in construction cost plus contracts are drawn up so contractors can be reimbursed for almost every expense actually incurred on a project the cost plus contract pays the builder for direct costs and indirect or overhead costs all expenses must be supported by documentation of the contractor s spending in the form of invoices or receipts the contract moreover allows the contractor to collect a certain amount above the reimbursed amount so they may be able to make a profit hence the plus in cost plus contracts some contracts may limit the amount of reimbursement so not every expense would be covered this is especially true if the contractor makes an error during the course of the project or is found to be negligent in any part of the construction cost plus contracts are also used in research and development r d activities where a larger company may outsource r d activities to a smaller firm such as large pharmaceutical company contracting 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 governments generally prefer cost plus contracts because they can choose the most qualified contractors instead of the lowest bidder types of cost plus contractscost plus contracts can be separated into four categories they each allow for the reimbursement of costs as well as an additional amount for profit advantages and disadvantages of using cost plus contractsthe pros and cons of using these types of contracts include the following 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 they may leave the final cost up in the air since they can t be predetermined they may lead to a longer timeline for the project might lead to disputes when trying to recover construction related expensesrequires additional resources to reproduce and justify all related costsexample of how a cost plus contract worksassume 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 of 3 million additionally abc construction is eligible for an incentive fee 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 are completed to specification such as the plumbing electrical fixtures etc the contract allows abc to incur direct costs such as 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 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 at 4 million and posts 20 of the firm s profit or 600 000 to the financial statements 