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Cost-type contract

Definition A cost-type contract is a type of military contract where the contractor is reimbursed for approved costs related to the project, but also receives a fee, usually a percentage of the total cost. The fee is typically fixed and doesn’t vary with actual costs. Such contracts are used when uncertainties involved in contract performance […]

Definition

A cost-type contract is a type of military contract where the contractor is reimbursed for approved costs related to the project, but also receives a fee, usually a percentage of the total cost. The fee is typically fixed and doesn’t vary with actual costs. Such contracts are used when uncertainties involved in contract performance do not permit costs to be estimated with sufficient accuracy.

Key Takeaways

  1. A cost-type contract is a type of contract that reimburses a contractor for the allowable and allocable costs associated with the production and delivery of goods or services.
  2. These contracts are often used in situations where it is not possible to predict the exact costs of production due to the unpredictable nature of material and labor costs, uncertainties in project scope, or any other factors.
  3. Despite their flexibility, cost-type contracts carry a risk of potential cost overruns, thus necessitating the need for careful administration and oversight to protect both parties’ interests, and often include a fixed fee that provides a contractor’s profit.

Importance

A cost-type contract is critical in military operations due to its flexibility and provisions for unforeseen costs.

This type of contract allows the government or military to reimburse a contractor for all legitimate, allowable, and allocable costs incurred during the project, plus a negotiated profit or fee.

It is particularly beneficial in environments where it is challenging to estimate all costs accurately upfront, such as research and development or large-scale construction projects.

Therefore, a cost-type contract lowers the risk for the contractor, encourages quality, and accommodates adjustments that may be needed as the project evolves, consequently having a profound effect on operational outcomes and efficiency.

Explanation

A cost-type contract, as used in military operations and government procurement, is primarily designed to cover the actual costs that a contractor incurs during the completion of a contract work, plus a fee. The purpose of this type of contract is to reduce financial risks for contractors, particularly in scenarios where the total cost for a project cannot be accurately predicted at the outset.

Such a contract encourages comprehensive and high-quality completion of the project by ensuring the contractor does not suffer losses due to potential unexpected costs. Cost-type contracts are used when the scope of work is highly complex or under certain conditions where precise costs cannot be estimated in advance.

This type of contract is beneficial in research and development work, for example, when it’s difficult to foresee problems that might arise. It is also applicable in cases of major equipment overhaul or modifications, where existing conditions and requirements are hard to determine until work is underway.

Transparency and accountability are encouraged here since contractors are required to keep detailed records of costs during project implementation.

Examples of Cost-type contract

Defense Contract for Aircraft: In 2001, the U.S. Department of Defense entered into a cost-type contract with Lockheed Martin for the development of the F-35 fighter jet. This contract allowed the government to provide Lockheed Martin with funds for the cost of production, plus additional profit based on the firm’s performance. However, the costs significantly exceeded initial estimates, illustrating one of the challenges of cost-type contracts in military operations.

NASA Space Program Contract: In the 1960s, NASA used cost-type contracts to incentivize private aerospace company participation in the Apollo lunar landing program. Companies like Boeing and North American Aviation were among those contracted under a cost-type arrangement to build the Saturn V rocket and the Apollo spacecrafts. The nature of cost-type contracts allowed for flexibility and risk sharing on unproven and highly innovative technologies.

BAE Systems’ Amphibious Combat Vehicle Development: In 2015, BAE Systems was awarded a cost-type contract by the U.S. Marine Corps for the development of Amphibious Combat Vehicles (ACVs). The contract covered the costs of production and development and also provided additional incentives for meeting specific performance and delivery objectives. As the final product was not completely defined at the start, the cost-type contract allowed for unexpected developments and changes in project scope.

FAQs on Cost-type Contract

What is a cost-type contract?

A cost-type contract is a type of contract whereby the contractor is paid for all of its allowed expenses to a set limit, plus additional payment to allow for a profit.

What are the different types of cost-type contracts?

There are several types of cost-type contracts, including: Cost contracts, Cost-sharing contracts, Cost Plus Fixed Fee (CPFF) contracts, Cost Plus Incentive Fee (CPIF) contracts, and Cost Plus Award Fee (CPAF) contracts.

What are the risks involved in cost-type contracts?

Since the contractor has no risk of loss, they have less incentive to control costs. This lack of pressure to operate efficiently may make cost-type contracts more expensive for the government than expected.

What are the benefits of cost-type contracts?

Cost-type contracts can be more flexible to changes in the work to be performed and may require less administrative effort as there is not a requirement for detailed cost estimates.

When are cost-type contracts typically used?

Cost-type contracts are often used when uncertainties in contract performance do not permit costs to be estimated with sufficient accuracy for a fixed-price type contract.

Related Military Operation Terms

  • Indirect Cost Rate
  • Allowable Cost and Payment
  • Cost Reimbursement
  • Cost Accounting Standards (CAS)
  • Fixed Fee

Sources for More Information

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