Disadvantages Of Cost Reinbursement Contract

As pricing books are printed, the information contained within them is naturally historic. Therefore in a volatile market, rates may quickly be outdated by the end of the year. So items are more exposed to inflation than others and may distort any cost pricing. As identified by (Kirkham, 2007, p. 219), that ‘in periods of rapid inflation or market changes they have suffered the drawback of having to prepare their information well in advance of the year of publication’. this could lead to cost data being misaligned with current market rates and will not reflect the true value in construction.

However, the fact remains that the Trident submarine is a new ship, and the shipbuilders could be faced with unrealized production challenges, such as mirror welds, which could slow down the build time and increase labor costs. These types of unexpected costs are the basis for the cost-reimbursement contract approach and remain a risk within every fixed cost contract. Fixed cost contracts also run the risk of reducing the quality of work in favor of remaining under budget.

If a good cost-measurement system was set up, cost-plus contracts will demonstrate the advantages of cost-management better than fixed price contracts do. With a robust cost-measurement system, managers are able to know the real revenue drivers, to recognize the most valuable customers, and to offer more reasonable price bid. That is to say, cost-measurement system’s strength lies in differentiating clients’ value, projects’ value and operation processes’ value case by case. Under this circumstance, cost-plus contracts would surely dig more utilization and benefit more from such a system, because CitySoft would be able to charge different customers and projects for different prices, which is critical for increasing profitability.

Firm Fixed Price Contracts (FFP), it is appropriate for most commercial transactions, example: Software package that can be bought for $1,500 regardless of the seller’s cost.

A cost plus, is a fixed-price contract where the contractor paid for all the allowed expenses to certain limit

3. If the contract doesn’t have applicable and similar cost in it, the contractor should propose a cost and submit to the stakeholders to get a approval, and carry out.

While settling the costs of an item, the firm ought to consider the cost required in creating the item. This cost incorporates both the variable and settled expenses. Therefore, while settling the costs, the firm should have the capacity to recoup both the variable and settled expenses.

LPI clearly did not identify the costs that were relevant in the decision making of offering the Contract Revenue Programs. Cost behaviour and time frame is also important in the decision making of taking on a new project. It is critical to determine how cost changing with conditions such as

Prices in these contracts are either fixed, or may vary with the price level of raw materials

This cost system treated most, sales, marketing, and administrative costs as fixed costs or as a percentage of sales revenue. This simplistic approach was used to allocate overhead costs. Indirect costs were manufacturing costs that were allocated to products based on direct labor, or they were selling & administrative costs that were treated as period expenses and were unanalyzed. In this system if a customer sales price exceeded the full manufacturing cost plus the allocation of SM&A (sales, marketing, and administrative costs) then the customer appeared to be profitable when in fact the customer wasn’t profitable at all.

Under the construction it involves the issue that revenue should be recognised continuously. Some of the contracts are fixed price based contracts but they will not remain fixed as the contract extends over a long period of time that’s when the contract may include escalation clauses. At the stage of completion that is determined by the reference of the contract costs incurred to date ,the cost will reflect on the work performed that is in the costs incurred to date .Contract costs which are excluded may involve the contract costs that applies to the future activities that is on the contract, this includes the costs of the materials that have been brought to a contract site but not yet used during the contract performance .Also the payments made to subcontractors in advance of work performed under the subcontract.

It is typically used when there is a scope of services, but it is not well defined or when there are too many uncertainties for the seller to use a fixed price contract.

When ordering a set number of items from a manufacturer who is in the business of making that product and will not have to engage in any research, development, or real custom work, the standard contract would be a fixed-price contract . This scenario describes a simple bulk order of an item. Therefore, in this situation, the most appropriate contract mode is the fixed price contract. This allows the company to receive a number of bids for the 20,000 pencil contract and compare the costs in those bids. It also does not put the seller at tremendous risk because they do not face tremendous variation in the costs of their supplies for manufacturers. Also, as the purchaser fixed price contracts are good for purchasers, because the sellers bear most of the risk of the contract.

There are several types of contract method and these methods generally fall under three categories: Fix price (FP) or lump sum (LS), guaranteed maximum price (GMP) and reimbursable contracts. These methods can be applied to any contracting for construction management.

Traditional method tends to use arbitrary allocations that are not significant determinants of the costs. On the contrary, ABC mainly uses cause-and-effect allocations as significant determinants of the costs and refrains from arbitrary allocations. Therefore, cause-and-effect allocations should be used to get accurate assignment of indirect costs to cost objects. Figure 1 below describes the different types of product costing systems.