Definition: A Cost Reimbursement Contract is a type of government contract where the contractor is paid back for all allowable costs incurred during the performance of the work, plus an additional fee or profit on top of those costs.
In simple terms: the government says, "Do the work, track your costs carefully, and we will reimburse you, as long as the costs are reasonable and within the approved budget."
Common Terms Associated with Cost Reimbursement Contracts
Simple Examples of Cost Reimbursement Contract
Imagine a state department of health hires a research firm to study the spread of a new disease. Nobody knows exactly how long the research will take, what equipment will be needed, or how many scientists will be involved. A fixed price contract would be impossible to structure fairly, as the scope is just too uncertain.
So instead, the agency signs a cost reimbursement contract. The research firm tracks every dollar it spends, salaries, lab equipment, travel, software, and submits invoices to the government. The government reimburses those costs and also pays the firm an agreed fee on top. The risk of cost uncertainty shifts from the contractor to the government.
The Department of Defense regularly uses Cost Plus Fixed Fee contracts for early-stage weapons system development. When the Army needed to develop a next-generation combat vehicle, the exact engineering requirements, testing cycles, and materials were unknown at the outset. A fixed price contract would have been unrealistic. Instead, defense contractors like General Dynamics or BAE Systems work under CPFF contracts, they are reimbursed for every approved dollar spent and earn a negotiated fixed fee on top.
Similarly, NASA uses cost reimbursement contracts extensively for space exploration programs where technical unknowns make upfront pricing impossible
Key Characteristics of a Cost Reimbursement Contract
- Government bears the cost risk: If the project ends up costing more than expected, the government typically covers it, up to the funded ceiling.
- Costs must be allowable, allocable, and reasonable: Not every expense qualifies. The government reviews costs against standards set in the FAR and Cost Accounting Standards (CAS).
- Contractor earns a fee: On top of reimbursed costs, the contractor earns a fee, which can be fixed, award-based, or incentive-based, depending on the contract type.
- More government oversight: Because the government is paying actual costs, it has the right to audit the contractor's books and monitor spending closely.
- Best for uncertain or complex work: Used when the scope cannot be clearly defined upfront.
Types of Cost Reimbursement Contracts
- Cost Plus Fixed Fee (CPFF): The contractor is reimbursed for all allowable costs and earns a fixed fee that does not change regardless of performance. Most common type.
- Cost Plus Incentive Fee (CPIF): The fee varies based on how well the contractor controls costs. If they come in under budget, they earn a higher fee. If they go over, the fee shrinks.
- Cost Plus Award Fee (CPAF): The base fee is fixed, but the contractor can earn additional award fees based on subjective performance evaluations by the government.
- Cost Plus Percentage of Cost (CPPC): The fee is a percentage of actual costs. This type is prohibited in federal contracting because it incentivizes contractors to spend more.
How It Works: Step by Step
- The government determines the work cannot be clearly scoped or priced with certainty.
- A solicitation is issued for a cost reimbursement contract with an estimated cost and a fee structure.
- A contractor is selected and work begins.
- The contractor tracks and submits all allowable costs regularly.
- The government reviews, approves, and reimburses the costs plus the agreed fee.
- The Defense Contract Audit Agency (DCAA) or equivalent may audit costs at any time.
When Is a Cost Reimbursement Contract the Right Choice?
Cost reimbursement contracts are appropriate when:
- The scope of work is uncertain or evolving
- The project involves research, development, or innovation
- Technical risks are high and cannot be accurately priced in advance
- The government wants to closely monitor and control how work is performed
They are generally not suitable for:
- Routine, well-defined purchases (use fixed price instead)
- Commercial off-the-shelf (COTS) products
- Situations where the government lacks the capacity to oversee contractor spending
Pros and Cons: A Vendor's Perspective
Pros
- Lower financial risk: You are reimbursed for your actual costs, so there is no danger of absorbing overruns out of your own pocket.
- Access to complex, high-value contracts: Cost reimbursement contracts are often used for large, sophisticated programs — giving vendors access to significant, long-term revenue.
- Flexibility during performance: As the project evolves, you can adjust your approach without worrying about blowing a fixed budget.
- Encourages innovation: Because cost risk is shared, contractors are free to explore solutions without fear of financial penalty for trying new approaches.
Cons
- Heavy administrative burden: You must track, document, and report every allowable cost meticulously. This requires strong accounting systems and dedicated finance staff.
- DCAA audit risk: The government has the right to audit your costs at any time. Any costs found to be unallowable must be returned, which can create financial surprises.
- Lower profit ceiling: Because the government controls the fee, your upside is capped. You cannot earn significantly more by being highly efficient, unlike a fixed price contract.
- Requires approved accounting system: To win a cost reimbursement contract, vendors must have a DCAA-approved accounting system in place. This is a significant compliance investment, especially for small businesses.
- Slow reimbursement cycles: Billing, review, and reimbursement can take time, creating cash flow challenges for smaller vendors.
Key Statistics
- Cost reimbursement contracts represent a significant portion of federal R&D spending. The federal government spends over $90 billion annually on R&D, much of it through cost-type contracts. (Source: AAAS.org)
- The DCAA audits billions of dollars in contractor costs each year to ensure compliance with allowability standards. (Source: DCAA.mil)
- According to the FAR Part 16.3, cost reimbursement contracts are only appropriate when the contractor's accounting system has been found adequate for determining costs applicable to the contract. (Source: acquisition.gov)
Cost Reimbursement Contracts in the SLED Market: What Vendors Should Know
Cost reimbursement contracts are less common in the SLED market than in federal contracting, but they do exist, particularly for research, public health studies, grant-funded programs, and complex technology initiatives.
Where you will see cost reimbursement structures in SLED:
- Grant-funded projects: Many state and local agencies receive federal grants (from HHS, DOE, DOJ, etc.) and pass through those funds to vendors via cost reimbursement agreements. The vendor does the work, submits documented costs, and gets reimbursed, exactly like a federal cost-type contract.
- University and higher education research: Public universities frequently use cost reimbursement structures for sponsored research programs, funded by state budgets or federal grants.
- Public health and social services programs: State health departments running pilot programs or studies often use cost reimbursement agreements because the exact scope and cost of the work is hard to predict upfront.
Key differences for SLED vendors:
- No DCAA requirement: State and local agencies do not use DCAA. However, they may require an independent audit or review of costs, especially if federal grant funds are involved.
- OMB Uniform Guidance applies for federal pass-through funds: If a SLED agency is passing through federal money, vendors must comply with 2 CFR Part 200 (Uniform Guidance), which governs allowable costs similarly to the FAR.
- Vary by state: Some states have their own cost reimbursement contract standards and audit processes. Always review the specific state's procurement code.
The key takeaway: if you work with universities, state health departments, or agencies running federally funded programs, you will encounter cost reimbursement structures. Understanding allowable costs, documentation requirements, and audit readiness is just as important in SLED as it is in federal contracting.
Quick Summary
A cost reimbursement contract shifts financial risk from the contractor to the government. It is the right tool for complex, uncertain work, like R&D, defense development, or public health research, where no one can accurately predict costs upfront. For vendors, it offers lower financial risk but demands strong accounting systems, meticulous cost tracking, and audit readiness. In the SLED market, similar structures appear through grant-funded agreements and university research contracts.
