From a financial perspective, what is the key difference between fixed-price and cost-reimbursement contracts?

• A. Fixed-price: price fixed; cost-reimbursement: pay actual costs plus fee; risk and accounting entries differ.
• B. Fixed-price: price fixed; cost-reimbursement: pay actual costs minus fee.
• C. Fixed-price and cost-reimbursement are identical.
• D. Fixed-price: price fixed; cost-reimbursement: pay only the fee.

Answer: (C)

Pricing mechanism and risk allocation differentiate fixed-price from cost-reimbursement contracts. In a fixed-price arrangement, the total price is set upfront and does not change with actual costs to perform the work. The contractor must deliver within that fixed amount, so cost overruns come from the contractor’s profit and savings go to the buyer if costs are lower. This creates strong cost-control incentives for the seller.

In a cost-reimbursement arrangement, the buyer reimburses the contractor for allowable actual costs incurred plus an agreed fee or profit. The final price depends on the actual costs, providing flexibility when estimating is uncertain and transferring more cost risk to the buyer while reducing the contractor’s exposure to overruns. Accounting reflects this by recording costs as incurred and then reimbursing them, with the fee treated as profit or income.