Construction Contracts

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Meaning of construction contracts

A construction contract can be explained as the warranty that ensures that the executed job gets the specific amount of compensation or the way compensation will be distributed. Moreover, a construction contract is negotiated specifically for the construction of an asset or a group of interrelated assets.

According to IAS 11 "Construction contracts", a construction contract is a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use.

Types of construction contracts

The most common types of construction contracts used in engineering and construction industry include:

1. Unit price contract

This contract type is based on anticipated quantities of items which are counted in the project in addition to their unit prices. The final price of the project depends upon the quantities required to carry out the work.

Generally, this contract is suitable only for construction and supplier projects which involve accurate identification of different types of items, but not their numbers, in the contract documents.

2. Lump sum contract

Under this contract type, the engineer or contractor agrees to perform the specified and described project for a fixed price. This type of contract is also named as “Fixed Price Contract” and is very often used in engineering contracts.

A Lump Sum or Fixed Price contract is apt where scope and schedule of the project are defined sufficiently thus allowing the contractor or engineer to estimate the costs of the project.

3. Cost plus contract

The cost plus contract is an agreement which involves the buyer’s consent to pay the complete cost for material and labor in addition to the amount for contractor overhead and profit. This contract type is favored where the scope of work is highly uncertain or indeterminate in addition to the types of labor, material, and equipment being similarly uncertain in nature.

4. Incentive contracts

The incentive contracts feature compensation based on the contracting and/or engineering performance in accord with an agreed target – schedule, quality, and budget.

The two common categories of incentive contracts are:

i. Fixed Price Incentive Contracts

ii. Cost Reimbursement Incentive Contracts

5. Percentage of construction contracts

This contract type is common for engineering contracts. The compensation involved in these contracts is based on a percentage of the cost of construction. 

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