What Is a Cost-Plus Program in Government Contracting?

A cost-plus contract in government contracting is an agreement in which a federal agency reimburses a contractor for all allowable project costs and then pays a separately negotiated fee on top as profit. Agencies reach for this structure when the work is too uncertain to price in advance: early-stage research, complex weapons development, prototype engineering, and similar efforts where nobody can reliably estimate the final cost at award. The government carries most of the financial risk because the total price is not locked in, and in exchange it gets the flexibility to move forward on work that would otherwise stall or attract wildly inflated fixed-price bids.

The trade-off only functions because a dense framework of regulations, audits, and statutory fee caps keeps contractors from running the tab up unchecked. The Federal Acquisition Regulation governs every dollar. The Defense Contract Audit Agency scrutinizes the books. And federal law caps how much fee a contractor can actually take home.

When Agencies Can Use Cost-Plus Contracts

Cost-reimbursement contracts are not a default option. The FAR restricts them to situations where the agency either cannot define its requirements well enough to support a fixed-price contract or faces uncertainties too significant to estimate costs accurately.¹ The contracting officer has to document that rationale in a written acquisition plan approved at least one level above their own authority.

Two prerequisites must be satisfied before award. The contractor’s accounting system has to be adequate for tracking costs against the contract, and the government has to have enough staff to oversee performance, including surveillance to confirm that the contractor is using efficient methods and effective cost controls.¹ Cost-reimbursement contracts are also flatly prohibited for buying commercial products and services.

Every cost-reimbursement contract sets an estimated total cost that functions as a funding ceiling. The contractor cannot exceed it without the contracting officer’s approval, and any spending beyond the ceiling happens at the contractor’s own risk.¹

The Three Fee Structures

Every cost-plus contract reimburses allowable costs. What changes across the three main variations is how the fee is calculated, and that fee mechanism is what drives contractor behavior.

Cost-Plus-Fixed-Fee (CPFF)

The cost-plus-fixed-fee contract is the simplest version. The contractor receives a fee negotiated at award that stays put regardless of actual costs. Come in under budget, the fee doesn’t rise. Blow through the estimate, the fee doesn’t fall.² The fee only moves when the government changes the scope of work.

That creates a real limitation. The contractor has little financial reason to squeeze costs, since profit doesn’t grow if they do, and the government absorbs almost all of the cost risk. CPFF contracts come in two flavors: a completion form tied to a defined deliverable, and a term form that obligates the contractor to a specified level of effort over a set period.² The FAR prefers the completion form whenever the work can be defined well enough to permit a realistic estimate.

Cost-Plus-Incentive-Fee (CPIF)

A cost-plus-incentive-fee contract puts the contractor’s fee on the line based on cost performance. The parties negotiate a target cost, a target fee, a minimum fee, and a maximum fee up front. After performance, the fee is adjusted by a formula that compares actual costs to the target.³

The formula uses a sharing ratio, often something like 80/20 or 70/30, that splits savings or overruns between the government and the contractor. Finish below target and the fee rises toward the maximum. Overshoot and it shrinks toward the minimum. The minimum floor prevents the contractor from working essentially for free on a badly overrun job; the maximum ceiling prevents a windfall on work that was simply underestimated at the start. CPIF works best when both sides can agree on a realistic cost target and want to align incentives around efficiency.

Cost-Plus-Award-Fee (CPAF)

The cost-plus-award-fee contract ties profit to subjective performance assessments rather than to cost outcomes. The fee has two parts: a base amount fixed at award, which can be as low as zero, and an award amount determined by the government’s periodic evaluation of the contractor’s work.⁴ Some agencies cap the base fee at specific percentages; NASA, for instance, limits it to 3 percent on certain contracts.⁵

Award-fee evaluations happen at set intervals and typically measure technical quality, schedule adherence, and management effectiveness. Because those judgments are inherently subjective, CPAF works best for complex services where quality and performance matter more than hitting a specific cost figure. Unearned fee from one evaluation period does not roll over to the next.

Statutory Fee Caps and the CPPC Ban

Federal law places hard ceilings on fees under cost-plus arrangements. On a CPFF contract for research, development, or experimental work, the fee cannot exceed 15 percent of the estimated cost, not counting the fee itself.⁶ For other CPFF work, the cap is generally 10 percent.

One structure is banned outright. The cost-plus-a-percentage-of-cost arrangement, in which the contractor’s fee grows in direct proportion to costs incurred, is prohibited by federal statute. The ban applies to prime contracts and, through required flow-down clauses, to subcontracts.⁷ The reason is intuitive: if profit is a percentage of costs, the contractor profits more by spending more. Every other cost-plus variation exists partly to avoid that perverse incentive.

What Counts as an Allowable Cost

The heart of any cost-plus contract is which expenses the government will actually reimburse. FAR Part 31 controls, and a cost qualifies only if it clears every one of these tests: it must be reasonable, it must be allocable to the contract, it must comply with applicable Cost Accounting Standards and generally accepted accounting principles, it must conform to the contract terms, and it must not fall into any category the FAR declares off-limits.⁸

Reasonableness is judged by a “prudent person” standard: a cost is reasonable if it doesn’t exceed what a careful businessperson would pay under competitive conditions. Nothing gets a presumption of reasonableness just because the contractor incurred it. If the contracting officer challenges an expense, the contractor carries the burden of proving it was reasonable.⁹

Allocability means the cost has a real connection to the contract. A programmer’s salary charged entirely to one project is a direct cost and easy to allocate. Overhead expenses like rent, utilities, and IT infrastructure benefit multiple projects and get pooled into indirect cost categories (typically overhead and general-and-administrative), then spread across contracts using predetermined allocation rates. The contractor has to document that every expense meets these standards, and the contracting officer can disallow any cost that isn’t adequately supported.⁸

Costs the Government Won’t Reimburse

The FAR specifically prohibits reimbursement for several categories no matter how reasonable the contractor thinks the spending is:

Lobbying and political activity, including campaign contributions, PAC expenses, and efforts to influence pending legislation.¹⁰
Fines and penalties from violations of federal, state, local, or foreign laws, with a narrow exception for penalties incurred because the contract itself required the action.¹¹
Entertainment, including tickets, social events, club memberships, and meals tied to entertainment. Costs made unallowable under this rule cannot be recovered under any other cost principle.¹²
Bad debts, along with the collection and legal costs of chasing them.¹³
Interest on borrowings, bond discounts, and financing-related professional fees, with a limited exception for the imputed cost of capital invested in facilities.¹⁴

The Employee Compensation Cap

Employee pay is one of the most scrutinized cost categories. For executive-agency contracts awarded on or after June 24, 2014, the government will not reimburse compensation for any employee that exceeds a benchmark set annually by the Office of Federal Procurement Policy.¹⁵ The cap applies to all contractor employees, not just senior executives as under earlier rules.¹⁶ The initial benchmark was $487,000 in 2014, adjusted each year based on the Employment Cost Index. For 2025 the cap stood at $671,000. Anything above the year’s cap comes out of the contractor’s own pocket.

Audits, Accounting Systems, and Getting Paid

Cost-plus contracts come with audit obligations that go well beyond ordinary commercial practice. The Defense Contract Audit Agency handles contract audits for both defense and civilian agencies and is the default audit organization for most government contractors.¹⁷

Before award, the government evaluates the contractor’s accounting system using Standard Form 1408, a checklist covering more than 15 criteria. The system must separate direct from indirect costs, track expenses by contract and task, enforce daily employee timekeeping with proper approvals, isolate unallowable costs in the chart of accounts, apply consistent methods for allocating indirect costs, maintain audit trails with access controls, and use accrual-based accounting. Fail the review and the contract award is blocked.¹

Payment during performance runs on a provisional basis. The contractor submits payment requests as work progresses, generally no more often than every two weeks, detailing direct costs, indirect costs applied at provisional billing rates, and a proportional share of the fee.¹⁸ The government typically pays within 30 days of a proper request. The word “provisional” is doing real work: because indirect rates are estimated at the start of each fiscal year, every interim payment is a best guess. If final audited rates come in below the provisional rates used for billing, the contractor owes money back.

Each year, the contractor submits a final indirect cost rate proposal within six months after its fiscal year ends.¹⁸ The DCAA then runs an incurred cost audit, usually contractor-wide rather than contract by contract, testing whether costs are reasonable, allowable, and properly allocated, and confirming that the accounting system remains adequate for future work.¹⁹ Contractors must keep records available for three years after final payment.²⁰

Closeout happens only after final indirect rates are settled and any unallowable costs from the incurred cost audit are formally disallowed. The contractor remits any overpayments from the provisional billing period, submits a completion invoice reflecting final amounts, and executes a release discharging the government from further claims.¹⁸ A cost-plus contract isn’t truly done until every rate is settled and the final payment clears.

1
Acquisition.GOV. FAR Subpart 16.3 – Cost-Reimbursement Contracts
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Acquisition.GOV. FAR 16.306 – Cost-Plus-Fixed-Fee Contracts
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Acquisition.GOV. FAR 16.304 – Cost-Plus-Incentive-Fee Contracts
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Acquisition.GOV. FAR 16.305 – Cost-Plus-Award-Fee Contracts
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eCFR. 48 CFR 1816.405-271 – Base Fee
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Office of the Law Revision Counsel. 41 USC 3905 – Cost Contracts
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Acquisition.GOV. FAR Part 16 – Types of Contracts
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Acquisition.GOV. FAR 31.201-2 – Determining Allowability
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eCFR. 48 CFR 31.201-3 – Determining Reasonableness
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eCFR. 48 CFR 31.205-22 – Lobbying and Political Activity Costs
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eCFR. 48 CFR 31.205-15 – Fines, Penalties, and Mischarging Costs
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Acquisition.GOV. FAR 31.205-14 – Entertainment Costs
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eCFR. 48 CFR 31.205-3 – Bad Debts
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Acquisition.GOV. FAR 31.205-20 – Interest and Other Financial Costs
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Acquisition.GOV. FAR 31.205-6 – Compensation for Personal Services
16
Federal Register. Federal Acquisition Regulation: Limitation on Allowable Government Contractor Employee Compensation Costs
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Acquisition.GOV. FAR 42.101 – Contract Audit Responsibilities
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Acquisition.GOV. FAR 52.216-7 – Allowable Cost and Payment
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DCAA. DCAA Chapter 6 – Incurred Cost Audit Procedures
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Acquisition.GOV. FAR 4.703 – Policy