What is Cost Plus Contract? – Definition
Sometimes contractors may accept a contract on the condition that the contractee would bear all costs incurred in executing a contract plus a fixed rate or percentage of profit calculated with reference to the total cost. Such contract is known as Cost Plus Contract and 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 given frequently by Government for production of special articles not usually manufactured, e.g., production of a newly designed aircraft component, or in case of urgent repair of ships, vehicles, powerhouse, etc., or in case of constructions during the war period. From the contractor’s point of view, this method protects him from the risks of fluctuations in market prices of material, labor and other services.
In case of these contracts, the contractor knows in advance, the profit he can expect on contract when executed. From the contractor’s point of view, this method ensures that the price will depend on cost rather than on arbitrary commitment to a specific price.
In order to reduce the element of risk by market fluctuations, an ‘escalator clause’ or ‘escalation clause’ may be included in the contract. According to this clause, one of the conditions of the contract would be, that in case of a change in the prices of materials, labor and other services during the course of the execution of the contract, the contract price shall be adjusted accordingly. In case these are the rise in the prices of materials, labor and other services beyond a particular level, the contractee would bear such additional costs. Similarly, if there is a fall in the price of material and/or labor beyond the specified level, the contractor shall allow a rebate in his bill to the contractee.