Cost-Reimbursement Contracts are used by the government for projects where it is difficult to estimate the actual costs involved. These contracts involve the government reimbursing the contractor for the reasonable and allowable costs incurred under the contract. The government assumes all the risk with these contracts, which is why contracting officers are hesitant to use them. Contractors may choose to inflate the proposed contract price to protect themselves from uncertainties if a fixed-price contract is insisted upon.

Cost-reimbursement contracts establish a total cost estimate and a ceiling that the contractor must not exceed, except at its own risk. The contractor agrees to put forth its best effort to complete the job within the agreed-upon cost estimate. The contracting officer closely monitors the contractor’s performance to ensure effective and efficient work. The contractor must notify the contracting officer when its expenditure rate reaches a specified percentage of the agreed-upon cost estimate. If the estimated cost to complete becomes greater than the original estimate, the contractor must submit a revised estimate. If the contractor completes the job for less than the estimated cost, the excess funds can be used for other projects.

Before issuing a cost-reimbursement contract, the government must determine if the contractor’s accounting system has the ability to accumulate costs by contract. Direct costs are costs specifically identified with a particular contract, while indirect costs are expenses that cannot be attributed to any one particular contract. Indirect costs are further classified as overhead expenses or general and administrative expenses. The total operating cost of a company is the sum of all direct and indirect costs.

To determine the cost of a cost-reimbursement contract, the contractor calculates its overhead and general and administrative rates. The overhead rate is determined by dividing indirect overhead expenses by total direct labor, and the general and administrative rate is calculated by dividing indirect G&A costs by total cost input. These rates are then applied to various contracts to determine the allocation of costs.

Profit in cost-reimbursement contracts is referred to as fee. The government sets limitations on the amount of fee that can be earned on cost-reimbursement contracts. Various types of cost-reimbursement contracts include cost contract, cost-sharing contract, cost-plus-fixed-fee contract, cost-plus-incentive-fee contract, and cost-plus-award-fee contract. Each of these contract types has its advantages and disadvantages for contractors.

Overall, cost-reimbursement contracts involve the government carrying all the risk, which makes them less favorable compared to fixed-price contracts. However, they are necessary for projects where costs are uncertain and difficult to estimate.

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