Cost-Reimbursement Contracts: What You Need to Know

In a previous #FARFriday, we introduced the four contract types recognized by the FAR.

1.???? Fixed-price contracts

2.???? Cost-reimbursement contracts

3.???? Time and materials contracts

4.???? Indefinite delivery/Indefinite quantity (IDIQ) Contracts

This week we will discuss Cost-Reimbursement (CR) contracts.

So... What are CR contracts anyway?

CR contracts, sometimes known as cost-plus contracts, are a type of contract that allows a contractor to be paid for all allowable expenses up to a predetermined limit, and in some cases an additional amount for profit, performance incentive, and/or fee. Within the CR framework, there are five types of contracts (See FAR 16.302 – 16.306):

1.???? Cost Contracts: Only the actual costs of completing the work prescribed in the contract are covered; the contractor receives no additional fee. Cost contracts are typically used for research and nonprofit work.

2.???? Cost-Sharing Contracts: The contractor agrees to assume part of the contract expenses, and the agency will reimburse the contractor for an agreed-upon portion of those expenses.

3.???? Cost-plus-incentive-fee contracts (CPIF): The contract prescribes a formula where an initially negotiated fee will be adjusted later based on the relationship of total allowable costs to total target costs.

4.???? Cost-plus-award-fee contracts (CPAF): Allows a fee consisting of a base amount (which may be zero) fixed at inception of the contract and an award amount. The award amount is a financial incentive for excellence in contract performance, as evaluated by the Government.

5.???? Cost-plus-fixed-fee contracts (CPFF): A negotiated fee is fixed at the inception of the contract and does not vary with the 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.

When to Use a CR Contract

The contracting officer shall use cost-reimbursement contracts only when one of the following two circumstances exits:

1.???? Circumstances do not allow the agency to define its requirements sufficiently to allow for a fixed-price type contract; or

2.???? Uncertainties involved in contract performance do not permit costs to be estimated with sufficient accuracy to use any type of fixed-price contract.

Research and development contracts often result in a cost-reimbursement type contract where the scope of work is highly uncertain and the government is looking for innovative solutions to a specific challenge. Also, where a project's scope is expected to evolve, a CR ontract provides the flexibility to adapt the the necessary or desired changes. This is also the case for a large, complex or multiphase project. Lastly, where there is insufficient cost or pricing data, a CR contract may be used to form the basis for future requirements.

Best Practices and Key Attributes of Cost-Reimbursement Contracts

It is important for contracting officers to justify the use of a CR contract by conducting a thorough risk assessment and determining that there is not a more suitable contract for the requirement. In addition, proper oversight and control mechanisms by the contractor are necessary to ensure costs incurred are reasonable, allocable and allowable.

1.???? Allowable Costs: The government reimburses the contractor for allowable, reasonable, and allocable costs incurred in the performance of the contract. These costs can include direct labor, materials, subcontractor costs, overhead, and other expenses directly related to the contract.

2.???? Negotiated Fee or Profit: The government and the contractor negotiate a fee or profit to compensate the contractor for its performance. This fee is typically based on factors such as the contractor's performance, the level of risk involved, and other considerations to incentivize efficient and effective contract performance.

3.???? Audit and Oversight: Cost-reimbursement contracts require close government oversight and auditing to ensure that the costs claimed by the contractor are reasonable, allocable, and allowable to ensure taxpayer funds are being spent prudently. Proper contract management and audit processes are critical to prevent the misuse of government funds.

4.???? Risk Sharing: Cost-reimbursement contracts involve a degree of risk-sharing between the government and the contractor. The government bears the risk of uncertainty in estimating the total cost, while the contractor bears the risk of controlling costs and delivering in accordance with contract requirements.

Stay tuned to #FARFriday for discussion regarding other contract types!

FAR Citation: FAR 16.3 Cost-Reimbursement Contracts