Chapter 12, Problem 3DQ

Explanation of Solution

Contract:

Contract is a business and legally binding agreement between two or more organizations to carry out financial transactions in turn for exchange of goods and services...

Explanation of Solution

The different types of contracts and the advantages, disadvantages of each are explained below:

Fixed price or lump sum contract:

• In a fixed price contract, the seller and the buyer agree on a mutually agreed fixed price for the exchange of products or services. In terms of risk in this contract, the seller faces a higher risk than buyer.
• This contract can be Firm-Fixed-Price (FFP), Fixed-Price Incentive Fee (FPIF) and Fixed-Price Economic Price Adjustment (FP-EPA).
• The advantages of this contract are that it is beneficial for buyers as it minimizes their risk. Also, there is no need for adjustments, as both parties agree on a fixed price in advance.
• A major disadvantage is that there is absence of continuous communication between the parties after the contract agreement is set in place.

Cost reimbursable contract:

• Here, the contract focusses on a fixed time period and an extension of the same calls for payment reimbursement.
• The payment can be made separately as direct and indirect costs and the contract puts a lot of risk on the seller.
• Cost reimbursable projects can be classified as Cost Plus Incentive Fee (CPIF), Cost Plus Fixed Fee (CPFF), Cost Plus Award Fee (CPAF) and Cost-Plus Percentage of Cost (CPPC)...