Cost Plus Contract: Definition

Contractors may sometimes accept a contract on the condition that the contractee will bear all costs incurred in executing the contract, plus a fixed rate or percentage of profit calculated based on the total cost.

A contract of this type is known as a cost plus contract. It is generally adopted in cases where the probable cost of the contract cannot be ascertained in advance with a reasonable degree of accuracy.

Cost plus contracts are frequently offered by the government to produce special articles that are not typically manufactured (e.g., newly-designed aircraft components or urgent repair works for ships, vehicles, and powerhouse).

From the contractor’s perspective, this method protects them from the risks of fluctuations in market prices of material, labor, and other services.

In these contracts, the contractor knows in advance the profit they can expect on a contract when executed.

From the contractor’s point of view, the method ensures that the price will depend on cost rather than on an arbitrary commitment to a specific price.

Escalation Clause

To reduce the element of risk due to market fluctuations, an escalator clause or escalation clause may be included in the contract.

According to this clause, one of the conditions is that in the event of a change in the prices of materials, labor, and other services during the course of the execution of the contract, the contract price should be adjusted accordingly.

If there is an increase in the prices of materials, labor, and other services beyond a particular level, the contractee will bear such additional costs.

Similarly, if there is a reduction in the price of materials and/or labor beyond the specified level, the contractor shall allow a rebate in his bill to the contractee.

Explore More

If you’re interested in knowing more about cost plus contracts, get in touch with a financial advisor in Rye Brook, NY. If you live outside the area, consider browsing our financial advisor page.

True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.