In the last post we discussed that various contracts type based on compensation method may include Lump Sum, Item Rate and Cost Plus Contracts. Also, we further discussed about Lump Sum Contracts. Please click on the link below to read this post
Difference Among Lump Sum, Item Rate & Cost Plus Contracts
In this post, I wish to explain Item Rate and Cost Plus Contracts in more detail. In construction industry, there is enough use of item rate contracts especially for the execution of civil works by Contractor as per Owner’s design. However, Cost Plus are not so common and we see them rarely
Contracts Classification based on Compensation Method
B) Item Rate Contracts:
Item Rate means “contract price” for “unit quantity” of each “work item” as defined under scope of work. Sometime it may not be possible for the Owner to ascertain exact quantities for identified work items. This may happen because of the nature of the work, and/or design not fully completed and/or some inputs are missing to ascertain exact quality. So, the Owner stipulates the “estimated quantities” of each work items. Accordingly, the quantities, finally executed by Contractor, may be different. Therefore, in these circumstances, where quantities are likely to change, it is not prudent to invite Lump Sum Price or sign a Lump Sum Contract. Here Item Rates Contract (i.e. unit price contract) seems best fit, as it extend flexibility to address “quantity changes” within certain range (as agreed by parties), without any need to follow lengthy Variation & Variation Order Procedure.
In Item Rate Contracts, Owner defines the comprehensive Bill of Quantities, which consists of detailed description of Work Items, Unit of Measurement and estimated quantities. Accordingly, Owner invites and bidder quote the “Rate/Price” for “unit quantity” of each BOQ Item. Such contracts where different unit price exists for respective BOQ Items are called Item Rate Contracts.
Unit Rates contractually binding, not total price
The Unit Rate mentioned against each work items is the “contract price” for “unit quantity” of such item. Therefore, it is a contractually binding price. However, the item price which is obtained by multiplying the unit price with estimated quantity is a notional price. The actual item-wise price to be paid contractually shall depend upon the actual executed quantities.
Subject to other contract conditions, Owner is bound to pay for actual executed quantities based on the Unit Prices stipulated in the Contract. This is true as long as actual quantities do not vary beyond the prescribed limits. Total Price which is obtained by adding the item price of all BOQ items is again the estimated Total Price rather than Total Contractual Price. Total Contract Price (or Contract Price) as stipulated in the item rate contracts is necessary for the purpose of ascertaining BG or LD Amount. However, it does not dilute the spirit of Item Rate Contracts
C) Cost Plus Contracts:
In certain situation, in view of nature of work, it may not be possible for the Owner to clearly mention work items as well as quantities with greater certainty. So the scope of work is a stipulation of final requirements with a general description of work items and tentative quantities. Also, there is a high probability that the work items and/or the associated quantities may change.
Therefore, in the above circumstances, it would not be possible for the contractor to quote Lump Sum Price or Unit Rates because both work items and quantities are not fixed. Hence, it is prudent to select a reputed contracting organization having versatile experience and enter onto Cost plus Contract. Under such contracts Owner pay the contractor based on actual cost incurred plus reasonable profit.
Significance and relevance of cost plus contracts
Cost Plus Contracts are best fit and most suitable when there is high degree of uncertainty in the scope of work and both work items & quantities are likely to change. This mainly happened for scope of work where:
a) industry practice is not established
b) scope of work is entirely new or some thing totally different
c) work is being executed first time and
d) Owner and/or Contractor have not executed similar work in the past
e) Owners and/or Contractor are not able to estimate the cost with reasonable accuracy