Fixed price contracts can have either a firm price or an adjustable price, in which the adjustable component is constrained by a ceiling and a target price and calculated based on stated circumstances. Fixed price contracts with a firm price provide the lowest risk to the government and the highest risk to the contractor, as the contractor has full responsibility of all costs and the resulting profit or loss.
Firm-fixed-price contracts are most appropriate for the purchase of supplies or services that have established fair and reasonable prices, including adequate price competition, reasonable price comparisons with prior periods or alternate suppliers, and when the contractor is willing to accept assumption of the risks involved.
Fixed price contracts with economic price adjustments generally use three types of price adjustments:
- A change in established prices
- Adjustments to actual cost of labor or material.
- Adjustments to an indexed price of labor or material.
Contracts with price adjustments are most used when there is doubt about the stability of labor or materials prices, and when these price adjustments are outside of the control of the contractor. It is the responsibility of the contracting officer to determine a need to protect the contractor and government against significant fluctuations in labor and material costs, or to provide contract price adjustment in the event of changes in the contractor’s established prices, in order to enter into a fixed price project with price adjustments.
A government contract may also be for a fixed price, but with prospective price redetermination. This allows the government to firmly fix the price for an initial period of time, but allows for subsequent price adjustments. The contract may provide for a ceiling price in the subsequent periods based on the impact of uncertainties. This contract is used for situations where it a reasonable estimate for cost of contract performance can be established in earlier periods, but not for subsequent periods.
When a fair and reasonable price cannot be established negotiated and other fixed-price contract types are impracticable, a fixed-ceiling-price contract with retroactive price redetermination may be used. In this type of contract, a ceiling price is established, and at completion of the contract, the price of the contract is calculated retroactively. These contracts are only for research and development and have an overall ceiling of $150,000 in contract price. Additionally, the contractor’s accounting system must be adequate for price redetermination, and there must be reasonable assurance that price redetermination will take place promptly at the specified time.
In summary, though fixed price government contracts shift risk and responsibility for delivering a project at the specified cost to the contractor, there are mechanisms within the sub types of fixed price projects that will mitigate the contractor’s exposure to factors outside of their control. Fixed price contracts also provide an opportunity for the contractor to increase profits above that which would be recognized in a cost-plus model, if the contractor can deliver the contracted results under the planned level of cost. Determining the components of risk in a fixed price projects, and identifying which are in the control of the contractor compared to outside of the control of the contractor, is critical to selecting the appropriate subtype of fixed price contract.Written by: Wes Lindquist TGG Accounting