Accounting Corner

the advantages of unit price contracts

By: rich higgins, cpa, mccarthy & company

Heavy construction contractors can benefit from unit price contracts, which are typically used for public construction projects. Unit price contracts are best suited for construction work consisting of repetitive and quantifiable tasks such as the removal or placement of soil, rock, or concrete. Unit pricing may be incorporated in the pricing for alternates or for specific portions of the project.

This type of contract is not good for most private building projects unless it is part of a lump sum or cost-plus contract, applied to select component of the job. Unit price contracts also do not work as well for complex projects that involve the coordination of multiple trades.

Public Works Projects

A unit price public works contract is when a local government contracts for an unknown number of small public works projects over a fixed period of time. It can also mean that a larger job has been broken down into units of work that are priced out individually.

Public works contracts are typically awarded for specific projects within a budgeted total dollar value. In this case, unit price contracts are not associated with a project. Instead, the public agency agrees to pay a defined unit price for certain types of work over a certain period.

The prices for different public work tasks can be based upon different units such as: • Weight, such as tons • Surface area, such as square feet or acres • Volume, such as gallons or cubic yards • Length/depth, such as linear feet or vertical linear feet • Time, such as hours • Quantity of items

• Lump sum per task

Pros and Cons

The advantages of unit price contacts are that owners carry minimal risk; the cost is anticipated, and contractors might make more profit if it takes less manpower and materials to complete the project than anticipated. The pros also include the flexibility to adjust the project’s scope and the fact that it is not necessary to know the complete design when bidding on the job.

The cons of this type of contract include the unknown cost to complete the entire project and a potentially inaccurate determination by the contractor of the quantities needed.

Identifiable Costs

Under a unit price contract, the contractor provides the owner with a specific price for one or more tasks or a section of the overall work that is required on the project. The owner then agrees to pay the contractor for the units that the contractor expends to complete the project.

The costs that are commonly factored into unit prices include, but are not limited to: • Labor costs • Material costs • Overhead costs • Profit • Taxes

• Permit and Inspection Costs

In addition to regional multipliers, contractors must adjust labor rates for unexpected work conditions which could delay a job such as bad weather.

Breaking down a job into its smallest elements provides the most accurate estimated job costs. Even so, it takes a lot of time to determine the per unit cost, which could cut into profits. Contractors should complete a material takeoff and use a com-

Advantages

The advantage of unit price contracts is that if more materials or extra work is required on the job, it can be factored into the price as more units instead of being absorbed into the overall job estimate. This reduces the risk of a contractor losing money on the project.

Unit pricing benefits the owner, because it is relatively easy to verify if the price being charged for goods or services is reasonable. It is beneficial for the contractor because it mitigates the risk of inaccurate estimates of uncertain quantities for key tasks. Because unit pricing contracts have costs that are broken down, owners can compare an invoice with the estimated price of project units. It is easy for contractors to bill for unit price contracts because the price per unit is determined before the actual work is done.

There are also tax advantages associated with unit price contracts. Unit price contracts are not required to be reported for federal income tax purposes on a percentage of completion basis. This is a significant opportunity to defer substantial tax dollars for contractors. In order to comply with the IRS guidelines, contractors must obtain approval to complete this election. There are steps that must be followed to comply with the requirements, but once complete, unit price contracts can help contractors improve tax planning.

About the Author. . . . Richard Higgins, CPA is the managing principal of the New Jersey office of McCarthy & Company, PC. He is a NJCPA member. Rich can be contacted at (732) 341-3893 ext. 17 or Richard.Higgins@ MCC-CPAs.com