Cost-reimbursable contracts are used when the scope of work isn’t well defined or is subject to change. For PMP Certification Exam purposes, you should know that this is useful for research and development work.
With this type of contract, the buyer must reimburse the seller for legitimate costs associated with completing the work, plus a fee. The buyer and seller agree to a target cost upfront, and fees are calculated from that target cost. The three main types of cost-reimbursable contracts are
Cost plus fixed fee
Cost plus incentive fee
Cost plus award fee
Cost-reimbursable contract. A type of contract involving payment to the seller for the seller’s actual costs, plus a fee typically representing the seller’s profit. Cost-reimbursable contracts often include incentive clauses where if the seller meets or exceeds selected project objectives, such as schedule targets or total cost, then the seller receives from the buyer an incentive or bonus payment.
Cost plus fixed fee (CPFF) contract. A type of cost-reimbursable contract where the buyer reimburses the seller for the seller’s allowable costs (allowable costs are defined by the contract) plus a fixed amount of profit (fee).
Cost plus incentive fee (CPIF) contract. A type of cost-reimbursable contract where the buyer reimburses the seller for the seller’s allowable costs (allowable costs are defined by the contract), and the seller earns its profit if it meets defined performance criteria.
Cost plus award fee (CPAF) contract. A type of cost-reimbursable contract where the buyer reimburses the seller for the seller’s allowable costs (allowable costs are defined by the contract), but the majority of the fee is earned based only on the satisfaction of certain broad subjective performance criteria defined and incorporated into the contract.
A fixed fee puts more risk on the buyer because the seller gets the same fee regardless of the capability to meet the target cost. Here is an example of how a cost plus fixed fee calculation would work.
Assume that the target cost is $300,000, and the fixed fee is $20,000.
| Project | Final Cost | Fixed Fee | Total Price |
|---|---|---|---|
| Project 1 | $280,000 | $20,000 | $300,000 |
| Project 2 | $300,000 | $20,000 | $320,000 |
| Project 3 | $320,000 | $20,000 | $340,000 |
| Project 4 | $350,000 | $20,000 | $370,000 |
Now look at the same scenario with a cost plus incentive fee with an 80/20 share ratio.
Like a fixed price incentive fee, the incentive percentage is applied to the difference between the target cost and the actual cost. By coming in under the target cost, the seller receives 20% of the difference between target and actual costs.
In Project 1, 80% of the cost savings between $300,000 and $280,000 remains with the buyer, and 20% (or $4,000) goes to the seller as an incentive, in addition to the $20,000 fee.
| Project | Final Cost | Calculation | Total Fee | Total Cost |
|---|---|---|---|---|
| Project 1 | $280,000 | $20,000 + [(300,000 – 280,000) x 20%] | $24,000 | $304,000 |
| Project 2 | $300,000 | $20,000 + [(300,000 – 300,000) x 20%] | $20,000 | $320,000 |
| Project 3 | $320,000 | $20,000 + [(300,000 – 320,000) x 20%] | $16,000 | $336,000 |
| Project 4 | $350,000 | $20,000 + [(300,000 – 350,000) x 20%] | $10,000 | $360,000 |
Sometimes, the fee is expressed as a percentage of the target cost. For example, the target cost is $300,000, and the fee is 10%, so the fee target is $30,000. The fee is not a percentage of the actual cost; it’s a percentage of the target cost.