TL;DR. Contract type decides who pays when costs run over. Fixed price puts that risk on the contractor, cost-reimbursement on the government, and incentive types split it.
- New to this? Since 2026 the FAR calls fixed-price types the "default and preferred" choice. Moving toward cost-reimbursement takes a written justification, and big DoD deals need agency-head-level approval.
- Contractor PM? Cost-plus brings DCAA audits and timekeeping floor checks, so keep timesheets tidier than the break room.
- Government PM? Choose by how defined the requirement is, the technical risk, the market and your oversight capacity.
- Using an IDIQ? It is a vehicle, not a contract type. Each task order carries its own type.
Contract type is the single biggest lever in defense acquisition. It determines who pays if costs run over, how much oversight the Defense Contract Audit Agency (DCAA) exercises, what incentives your contractor has to perform, and how much documentation you'll be generating for the next decade. Get it right and the contract practically manages itself. Get it wrong and you're either overpaying on every invoice or watching a contractor spiral into a loss position.
This guide breaks down every major contract type used in DoD acquisitions, from the government's perspective (managing risk, oversight burden, and cost control) and the contractor's perspective (pricing strategy, financial risk, and DCAA compliance). For a broader introduction to the FAR framework, procurement thresholds, and how source selection fits in, see our Federal Contracting 101 guide.
The Big Picture: Fixed-Price vs. Cost-Reimbursement
FAR Part 16 divides contract types into two fundamental categories:
- Fixed-price contracts: The government pays an agreed price regardless of what it actually costs the contractor to perform. Contractor absorbs cost risk; government absorbs less financial exposure.
- Cost-reimbursement contracts: The government pays the contractor's allowable, allocable, and reasonable actual costs, plus a fee. Government absorbs most cost risk; contractor has less financial exposure but more administrative burden.
Between these two poles sit incentive-fee arrangements that try to share risk and create performance incentives. Time-and-Materials (T&M) contracts occupy a third category. They're not quite fixed-price (because total cost is open-ended) and not quite cost-reimbursement (because labor rates are fixed).
The FAR now names fixed-price types as "the default and preferred contract types" (FAR 16.102(b) in the overhauled text), following Executive Order 14402 of 30 April 2026. Contracting officers must document why they chose a type, and at DoD a cost-reimbursement, T&M or labor-hour contract above $100 million needs a written justification approved at the agency-head level (FAR 16.104 in the overhauled text).
Section numbers moved. This guide uses the FAR Part 16 numbers most references still cite. In the overhauled FAR Part 16 that DoD adopted through class deviations, some moved: fixed-price incentive is now 16.404 (was 16.403), CPFF is 16.304 (was 16.306), CPIF is 16.405 (was 16.304), and award-fee rules sit in 16.402. FFP (16.202), FP-EPA (16.203), T&M (16.601), labor-hour (16.602), letter contracts (16.603) and BOAs (16.703) kept their numbers.
Get the Acqlerate Acquisition Starter Kit (Free)
Key terms, ACAT levels, career roadmaps, and the 5 most common acquisition mistakes. Tailored to your role: USG, contractor, or career changer.
Fixed-Price Contract Types
Firm-Fixed-Price (FFP): FAR 16.202
The gold standard of government contracting. The government agrees to pay a set price, and that's it. No audits of actual costs, no adjustments based on what the contractor actually spent, no DCAA crawling through the books. If the contractor is efficient, it makes money. If it mismanages, it takes the loss.
Government perspective: Maximum price certainty. Minimal administrative burden. No cost monitoring. Budget this number and that's what you'll spend (unless you change the requirements).
Contractor perspective: Maximum financial risk, but also maximum upside. The spread between your actual cost and the fixed price is your profit. Strong incentive to innovate on process, reduce waste, and invest in efficiency.
DCAA involvement: Minimal. DCAA doesn't audit fixed-price contracts for cost allowability because the government isn't paying actual costs. DCAA may still audit forward pricing rates used to develop the price, or conduct an incurred cost audit if there's a cost-reimbursement element elsewhere in the program.
When DoD uses it: Mature programs buying known quantities of well-defined items: spare parts, ammunition lots, software licenses, vehicles, standard electronics. Also routine services with defined deliverables and stable labor markets.
For example (hypothetical): a military buying office purchasing a specific part number of engine components from an established manufacturer. Both sides know what the part costs, the supplier has made it before, and the market is competitive. FFP is the only logical choice.
Fixed-Price with Economic Price Adjustment (FP-EPA): FAR 16.203
An FFP contract with a built-in adjustment mechanism for specific economic factors: labor rates tied to a published index, material costs pegged to commodity prices, or established wage rates. If the index moves, the price adjusts accordingly. FP-EPA protects both parties from extreme market volatility on long-term contracts.
When DoD uses it: Multi-year contracts for commodities with volatile underlying costs: fuel, certain metals, specialized labor in thin markets. Less common but appears in long-term supply agreements.
Fixed-Price Incentive (FPI): FAR 16.403
FPI contracts establish a target cost, target profit, and a ceiling price. The key mechanics are the share ratio and the point of total assumption (PTA).
The share ratio (e.g., 80/20) determines how cost overruns and underruns are split. If the ratio is 80/20 (Government/Contractor) and the contractor comes in $1M under target cost, the contractor earns an extra $200K in profit; the government saves $800K. If costs overrun, the government absorbs 80 cents of every dollar of overrun, and the contractor absorbs 20 cents, until the ceiling price is hit.
The Point of Total Assumption (PTA) is the cost level above which the contractor absorbs 100% of overruns because the ceiling price has been reached. At the PTA, FPI effectively converts to FFP at the ceiling price. Contractors must understand the PTA or they risk massive losses on a nominally cost-sharing contract.
DCAA involvement: Moderate to high. DCAA typically audits incurred costs and forward pricing rates. Final fee determination requires actual cost settlement.
When DoD uses it: Production phases of major weapon systems where the design is mature but some cost risk remains, such as F-35 production lots and Arleigh Burke-class destroyer construction.
Cost-Reimbursement Contract Types
Cost-Plus-Fixed-Fee (CPFF): FAR 16.306
The government reimburses all allowable costs (as defined by FAR Part 31) plus pays a fee that was fixed at contract award. The fee does not change based on actual cost performance. Spend more than estimated? Fee stays the same. Come in under cost? Fee stays the same.
Two flavors: Completion CPFF (contractor must complete a defined scope; if it overruns, it must finish the work at no additional fee) and Term CPFF (contractor delivers a best-effort performance for a stated period). Statute caps CPFF fees at 15% of estimated cost for experimental, developmental or research work and 10% for most other work (10 U.S.C. 3322; FAR 15.404-4).
Government perspective: Accepts near-total cost risk. Budget uncertainty is significant. Cost growth on CPFF contracts can be substantial. In exchange, the government can pursue truly uncertain technical work that no rational contractor would take fixed-price.
Contractor perspective: Minimal financial risk. It recovers all allowable costs plus guaranteed fee. The trade-off is significant administrative burden: DCAA-compliant accounting system required, timekeeping systems must be granular, indirect rates must be tracked and proposed, incurred cost submissions are due annually.
DCAA involvement: Maximum. Pre-award accounting system surveys for new contractors, forward pricing rate audits, floor checks of timekeeping practices, incurred cost audits at contract close.
When DoD uses it: Basic and applied research (6.1 and 6.2 budget categories), feasibility studies, early-stage technology development, and many SBIR/STTR Phase II contracts (Phase I awards are usually firm-fixed-price).
Cost-Plus-Incentive-Fee (CPIF): FAR 16.304
Cost reimbursement with a fee that floats within a defined range based on cost performance. Set a target cost and target fee. Establish minimum and maximum fees. Define a share ratio. If actual costs beat target, the contractor earns above-target fee (up to the max). If costs exceed target, the fee decreases (down to the min). Unlike FPI, there's no ceiling price where the contractor takes 100% of overruns. The government always pays allowable costs.
DCAA involvement: High. Same as CPFF: accounting system requirements, forward pricing audits, incurred cost submissions.
When DoD uses it: Engineering and Manufacturing Development (EMD) phases of major systems, when requirements are defined but technical risk is real. A natural fit for development on larger (ACAT I and II) programs.
For example (hypothetical): an EMD contract for a new shipboard combat system. The government knows what the system must do; it doesn't know exactly how hard it will be to achieve performance specs. CPIF lets both sides absorb the development risk together while preserving some contractor incentive to manage costs.
Cost-Plus-Award-Fee (CPAF): FAR 16.305
The contractor earns a base fee (which may be zero or very small) plus an award fee determined periodically by an Award Fee Board based on subjective evaluation of performance. Evaluation criteria typically include technical performance, management effectiveness, schedule adherence, and cost management.
Critical legal point: FAR 16.401(e)(2) makes the award amount, and the method for setting it, "unilateral decisions made solely at the discretion of the Government" (16.402 in the overhauled text). That makes a low award-fee rating very hard to challenge.
DCAA involvement: High. Same cost accounting requirements as CPFF and CPIF.
When DoD uses it: Complex, long-duration services contracts where quantitative performance metrics are difficult to define upfront: large-scale base operations support, complex logistics programs, certain IT services contracts.
Time-and-Materials and Labor-Hour Contracts
Time-and-Materials (T&M): FAR 16.601
T&M contracts pay fixed hourly rates for specified labor categories (those rates include direct labor, overhead, G&A, and profit; they're loaded rates) plus actual material costs at cost. The rates are fixed, but the number of hours is not. What caps the total is the ceiling price, which every T&M contract or order must include and which the contractor exceeds at its own risk.
The FAR is blunt about T&M: it "provides no positive profit incentive to the contractor for cost control or labor efficiency" (FAR 16.601(c)(1)). Contracting officers must determine in writing that no other contract type is suitable.
DCAA involvement: Moderate. DCAA doesn't audit cost allowability on the labor portion (rates are fixed), but it reviews whether labor categories are being properly applied. Material costs are subject to audit.
When DoD uses it: Situations where scope is truly undefined: emergency facility repairs, certain IT help desk and support services, early-phase analysis or studies.
Labor-Hour (LH): FAR 16.602
Identical to T&M except there are no materials, just labor. Common for professional services, consulting, and advisory support.
IDIQ Contracts: FAR 16.504
IDIQs are delivery vehicles, not contract types in the traditional sense. Each task order or delivery order issued against an IDIQ will itself be a specific contract type: FFP task orders, CPFF task orders, T&M task orders. The IDIQ just establishes the overarching terms, rates, and vehicle through which orders are placed.
Key IDIQ mechanics: the government must order at least the guaranteed minimum (small, but required to be more than nominal). The government is not obligated to order up to the ceiling. Task orders must be awarded using fair opportunity procedures unless an exception applies.
Major IDIQ vehicles DoD buyers use: OASIS+ (GSA, professional services), NASA SEWP (IT products; SEWP V was extended through 31 January 2027, and SEWP VI has been awarded with its period of performance anticipated to begin 1 November 2026), Alliant 2 and its successor Alliant 3 (GSA, IT services; first Alliant 3 awards February 2026), 8(a) STARS III (GSA, 8(a) IT), SeaPort NxG (Navy, engineering/technical services).
Full Contract Type Comparison
| Type | Risk Allocation | DCAA Involvement | Fee/Profit | Best Used When | Government's Burden |
|---|---|---|---|---|---|
| FFP | Contractor bears cost risk | Minimal (forward pricing only) | Built into price; contractor keeps efficiency gains | Requirements well-defined, market stable | Low: set it and monitor delivery |
| FP-EPA | Shared on indexed factors | Minimal | Built into price with adjustment mechanism | Long-term buys with commodity/labor volatility | Low to moderate |
| FPI | Shared by share ratio; contractor at risk above ceiling | Moderate (incurred cost audits, rate audits) | Varies with cost performance; max/min bands | Production with design maturity but remaining cost risk | Moderate: must track costs and negotiate final settlement |
| CPFF | Government bears essentially all cost risk | Maximum (accounting surveys, floor checks, ICS audits) | Fixed at award; does not change with costs | R&D, feasibility, truly uncertain scope | High: continuous cost monitoring, invoice review |
| CPIF | Primarily government; contractor incentivized within fee band | High | Floats within min/max based on cost performance | EMD phases, defined scope with real cost uncertainty | High |
| CPAF | Government bears cost risk; award fee at government's discretion | High | Base fee + discretionary award fee (not disputable) | Complex long-duration services with qualitative performance | High: must administer award fee process and board |
| T&M | Government, up to the ceiling price (no efficiency incentive) | Moderate (labor category compliance, material costs) | Built into labor rates | Undefined scope, emergency work, short-duration support | Moderate: must actively monitor hours and labor categories |
| LH | Government (same as T&M, no materials) | Moderate | Built into labor rates | Professional/advisory services with undefined scope | Moderate |
| IDIQ | Varies by task order type | Varies by task order type | Varies by task order type | Recurring needs with uncertain quantity/timing | Moderate upfront; low per-order once vehicle is established |
DCAA: The Cost Watchdog You Need to Understand
The Defense Contract Audit Agency (DCAA) is an independent DoD agency that provides audit and financial advisory services. DCAA's job is to ensure that costs claimed on cost-reimbursement contracts are allowable (permitted under FAR Part 31), allocable (properly charged to this contract vs. others), and reasonable (what a prudent businessperson would pay).
For contractors, DCAA shows up in a few specific ways:
- Pre-award accounting system surveys: Before DoD awards a cost-reimbursement contract to a contractor that hasn't had one before, DCAA evaluates whether the contractor's accounting system meets DFARS 252.242-7006 requirements.
- Forward Pricing Rate Audits: DCAA reviews the indirect rates (overhead, G&A, fringe) that contractors use to price proposals. DCAA issues Forward Pricing Rate Recommendations (FPRRs) or negotiates Forward Pricing Rate Agreements (FPRAs).
- Incurred Cost Submissions (ICS): Contractors must submit annual incurred cost proposals within six months of their fiscal year end (FAR 52.216-7). DCAA audits these to reconcile actual rates against provisional billing rates.
- Floor Checks: DCAA visits your workplace and talks to employees to verify that timekeeping practices match what's being charged to contracts.
Contractor survival tip: If you're pursuing your first cost-plus DoD contract, get your accounting system reviewed by a third party before DCAA shows up. An inadequate accounting system at award can delay your contract or result in withheld payments. Think of DCAA compliance as table stakes, not an optional burden.
Choosing the Right Contract Type: A Decision Framework
When you're sitting in a pre-solicitation meeting trying to decide what contract type to use, work through these questions:
- How well-defined are the requirements? If a clear SOW can define exactly what's needed, move toward fixed-price. If requirements will evolve, move toward cost-reimbursement.
- What's the technical risk? High risk of technical failure or unexpected scope growth pushes toward cost-reimbursement. Mature technology with proven solutions supports fixed-price.
- What's the market like? If multiple contractors regularly perform this work, fixed-price competition will produce fair pricing. If only one or two contractors can do it, their pricing power may push you toward negotiated cost-plus arrangements.
- Can you handle the oversight burden? Cost-plus contracts require significant government oversight. If the program office doesn't have that capacity, cost-plus can become a management nightmare.
- What incentives do you want to create? Fixed-price creates the strongest incentive for contractor efficiency. Incentive fee arrangements let you dial in specific motivations.
Frequently Asked Questions
Can a single contract have multiple contract types?
Yes, and this is common on complex programs. A contract might have an FFP line item for a defined deliverable, a CPFF line item for a study, and a T&M line item for incidental support. Each Contract Line Item Number (CLIN) can carry its own contract type. DCAA audit requirements apply to cost-reimbursement CLINs even if other CLINs are fixed-price.
What is a letter contract and when is it used?
A letter contract (FAR 16.603) is a preliminary written instrument authorizing the contractor to begin work immediately, before the final contract is negotiated. It's used in urgent situations where waiting for full negotiation would delay critical work. Letter contracts must be definitized (converted to a final contract) as quickly as possible. There are statutory limits on how long they can remain open.
How does contract type affect proposals?
Significantly. On an FFP competition, your price is fixed and your proposal is evaluated on technical merit and price. On a CPFF or CPIF, your proposal includes cost estimates and fee, but the government is evaluating your technical approach and your cost realism: whether your estimate reflects your actual understanding of the work. An unrealistically low cost estimate on a cost-plus proposal can hurt you. The evaluator may conclude you don't understand the scope.
Why can't the government always use fixed-price to protect taxpayers?
Because forcing a fixed-price contract on truly uncertain work creates its own risks. Even EO 14402, which makes fixed-price the default, allows other types when they're justified. A contractor that takes an FFP on work it can't estimate accurately will either build in enormous contingency (the government pays for risk that may never materialize) or underbid to win and then go into financial distress mid-program.
A contractor in financial distress on a critical defense program is a national security problem, not just a business one. The contract type selection is about matching risk allocation to the actual state of knowledge, not reflexively protecting one party.