Are You Recovering the Correct Costs Under Your NEC Contract?
Are You Recovering the Correct Costs Under Your NEC Contract?
Recovery of Actual Costs in NEC Cost Reimbursable and Target Cost Contracts
In the context of NEC (New Engineering Contract) cost reimbursable and target cost contracts, the recovery of actual costs is a crucial aspect that influences both the contractor's profitability and the client's financial exposure. This discussion focuses particularly on the fee structures and rates applicable in these contracts.
Understanding NEC Contracts
NEC contracts are designed to promote collaboration and flexibility between the contracting parties. They are categorized primarily into two types relevant to this discussion:
Cost Reimbursable Contracts: These contracts allow the contractor to recover actual costs incurred during the project, along with an agreed-upon fee.
Target Cost Contracts: In these contracts, a target cost is established, and any cost savings or overruns are shared between the contractor and the client based on predetermined percentages.
Fee Structures in NEC Contracts
The fee structure in NEC contracts can significantly affect the recovery of actual costs.
The main components include:
Fixed Fee: A predetermined amount that the contractor receives regardless of the actual costs incurred. This is common in cost reimbursable contracts.
Variable Fee: A fee that may vary based on performance metrics or cost savings achieved. This is often seen in target cost contracts.
Rates for Recovery of Costs
The recovery of actual costs also hinges on the rates applied to various cost elements, which typically include:
Direct Costs: These are costs directly attributable to the project, such as labor, materials, and equipment. In NEC contracts, these costs are usually recoverable at actual rates.
Indirect Costs: These costs, such as overhead and administrative expenses, are also recoverable but may be subject to specific limits or rates defined in the contract.
Profit Margin: In cost reimbursable contracts, the contractor’s profit margin is typically added on top of the actual costs, while in target cost contracts, the profit is often tied to achieving or coming in under the target cost.
Key Considerations for Cost Recovery
Documentation: Accurate and timely documentation of all costs is essential for recovery. Contractors must maintain detailed records to substantiate claims for actual costs.
Transparency: Both parties should foster a transparent relationship where cost reporting is regularly shared and discussed. This can help mitigate disputes over cost recovery.
Negotiation of Rates: The rates at which costs are recovered should be clearly defined and mutually agreed upon. This includes discussions around labor rates, markup percentages, and overhead allocations.
Risk Sharing: In target cost contracts, understanding how risks are shared can influence cost recovery. Clarity on who bears costs overruns and how savings are split is vital.
Conclusion
The recovery of actual costs in NEC cost reimbursable and target cost contracts is a complex process that requires careful consideration of fee structures, rates, and documentation practices. By understanding these elements, both contractors and clients can navigate the financial implications of their agreements more effectively, ensuring fair compensation for work performed while managing risks associated with cost overruns.
Under these NEC contracts, inaccuracies in the build-up of rates, treatment of overheads, Fee calculations or Defined Cost can create significant commercial exposure.ure.re.e..
Under-recovery can result in legitimate cost being missed and margin being unnecessarily eroded.
qually problematic. If rates, Fee or Defined Cost are being overstated, this may:
Overstate the value and profitability being reported through monthly commercial reporting;
Create an inaccurate forecast of the project's final commercial position;
Increase the risk of costs being challenged or disallowed during a Client or Main Contractor audit; and
Result in significant adjustments or deductions when the Final Account is agreed — potentially reducing previously reported margin.
Fire Horse26 offers an independent, contract-specific NEC Cost Assurance Audit to establish whether the costs and rates currently being applied are correct, contractually compliant and appropriately evidenced.
Our review can include:
• Labour rate verification • Plant rate verification • Materials and other Defined Cost reviews • Overhead and cost allocation assessment • NEC Fee calculation and application • Defined Cost and Disallowed Cost review • Open-book cost verification • Identification of duplicate, unsupported, over-recovered or potentially
unrecovered costs • Review against the applicable NEC contract and Schedule of Cost
Components • Final report identifying findings, risks and recommendations
With 25 years' construction commercial experience, Fire Horse26 helps contractors and subcontractors understand whether their current cost recovery mechanisms are contractually compliant, properly evidenced and commercially effective.
The objective is simple: to give you confidence that the commercial position you are reporting each month is an accurate reflection of the project's true position — reducing the risk of both lost entitlement and unexpected Final Account adjustments.
It is far better to identify and correct discrepancies during the project than discover at Final Account that previously reported revenue or margin cannot be substantiated.
Audits are undertaken on a 100% independent and confidential basis and are specific to the individual contract/s being reviewed.
If you have an NEC Option C, Option E or other open-book/reimbursable project and would like an independent review, please contact us info@firehorse26.co.uk / 01403 913 360 to discuss the scope.
References
NEC Contracts. (2023). NEC3 and NEC4 Contracts: Guidance and Best Practices.
Association for Project Management. (2023). Cost Management in Project Management.
Chartered Institute of Building. (2023). Understanding Target Cost Contracts.
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