Last edited 11 Feb 2016

Disallowed cost

Under cost reimbursable contracts, the contractor is paid their actual costs, calculated based on their accounts and records, rather than a pre-determined rate or price. However, not all costs can be accurately determined on a project-specific basis, some costs have only been incurred due to the contractor’s inefficiency, and not all costs are recoverable under the contract.

Options (C, D, E and F) of the NEC (New Engineering Contract), EEC contract (Engineering and Construction Contract), describe the costs that can be recovered by the contractor as the ‘defined cost’, whereas the costs that cannot be recovered are described as the ‘disallowed cost’. The disallowed cost does not have to be paid by the employer and so is borne by the contractor. As a result this is a common area of dispute.

Very broadly, the defined cost includes payments due to subcontractors and the cost of components for other works (such as plant, equipment, people and so on), minus the disallowed cost.

The disallowed cost may include costs that appear to fall within the definition of defined cost, but that have been incurred as a result of the contractor’s failure or default.

This includes:

  • Amounts that should not have been paid to a subcontractor.
  • Amounts that are not justified by the contractor’s records.
  • Resources that were not used.
  • Costs incurred because the contractor did not follow the proper procedure.
  • Failure to give early warning of anything that may delay the works, or increase costs.
  • Defects corrected after completion.
  • Preparation for adjudication.

Some defects corrected before completion are not disallowed, however, if a target cost (pain/gain) contract is being used, this will increase the defined cost, and so the potential ‘gain’ for the contractor is reduced, and the likelihood of ‘pain’ is increased. As a result the contractor may in fact still end up paying for some of the costs of the defect.

The project manager decides whether a cost is disallowed. This must be done in accordance with the contract, and a reason must be given for each disallowed cost through the certification process.

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