Updated: Jul 5
Not every construction project can be quantified up front as the design is not complete. In such instances, an item rate or an item rate contract is used. Instead of establishing a fixed–lump sum project price, an item rate contract divides and prices individual distinct components of the entire project into quantifiable "units." A contractor will work as items are executed, usually on a monthly basis.
Common types of construction contracts?
There are a variety of construction contracts. Two of the most commonly used contracts are item rate contracts and lump sum contracts. Alternatively, pricing methods like time and materials contracts and cost-plus contracts take a blended approach. A time and materials contract might have different hourly rates for labor deployed to the project. A cost-plus contract adds a profit and overhead on top of the cost incurred, e.g, cost of labor and materials plus 20%.
What Is an Item rate Contract?
A construction company estimates the cost of the entire project by quoting rates for discrete units or segments of the work under an item rate contract. The price for each unit is calculated considering materials, labor, equipment, miscellaneous expenses, overheads, and profits. Units may be added or subtracted if the project's scope changes over time. A project with an unfinished scope of work and those that require repetitive tasks and resources benefit greatly from the use of an item rate contract, which is often utilized for public construction projects. When a project is being executed under an item rate contract, the number of units of work that will be required to finish it is not known in advance. Consider a construction firm that is constructing an industrial building. Costs items can be cubic meters of concrete, a square meter of formwork or painting or a running meter of electrical cables.
Difference between Lump Sum and Item Rate Contract:
There are some significant distinctions between item rate and lump sum contracts, particularly in terms of price flexibility. With item rate contracts, businesses estimate the cost of individual activities without committing to a final total price. In the end, the total billed and paid represents the work done based on the quantification of individual activities. You can utilize an item rate contract for all or a portion of a project. A client decides on a predetermined price for the entire project in a lump sum contract. Usually, 100% engineering-designed projects with little expected revisions employ this sort of contract. With a lump sum contract, cash flow is simpler to forecast. In India, Item rate contract is common.
The item rate contracts are used on projects with activities or tasks clearly defined, and the cost per item is calculated accordingly.
Cost per item considers the price of labor, materials, and overhead.
A project where the complete scope of the work is not defined benefits from using an item rate contract.
Usually used where design is not complete, maintenance and renovation type projects.
Item Rate Pricing Cost Components
Contracts with item rates need a detailed analysis of all costs related to a given unit of work. It takes effort to describe units and expenses upfront, but doing so creates a level of clarity that makes billing easy, especially if a project's scope expands. Furthermore, it guarantees a contractor still makes money. These costs are covered via item rate contracts.
Labor: Craft labor such as carpenters, electricians, masons, tile fitters, construction project managers, equipment operators, civil engineers, and a host of other workers are involved in a project.
Material: Perhaps the easiest cost to estimate is the cost of the materials needed for a unit of work. One square meter of painting can serve as a unit for finishing. Materials for more complicated projects like an industrial projects would include concrete, reinforcement, aggregates, electrical, mechanical, and other items.
Overhead costs: All construction businesses have overhead costs — the non-revenue-generating costs of staying afloat. These include rent, supplies, utilities, fuel for company vehicles, insurance, taxes, and personnel costs for roles like accountants, marketers and maintenance staff. Overhead costs, which can be tricky to calculate per unit, are typically determined for the overall project and spread across the units.
Equipment: Each project requires machinery, tools, and tackles, to get work done safely and efficiently. There are costs associated with operations and maintenance to be considered too.
Profit: All businesses aim to turn a profit on the work they complete, and this should also be taken into account when determining the unit cost. This will frequently be a % markup, however, it may alternatively be a flat price.
A contract with an item rate bases cost projections on definable, predefined units of work. An item rate comprises profit as well as labor, material, equipment, and overhead costs. If a project's scope expands, the contractor can continue to make money by billing for more units. For public building projects that need labor-intensive, repetitive work with lots of resources, item-rate contracts are frequently used. Additionally, it helps projects where the final extent of the task is somewhat hazy. You may track project expenditures, maintain proper billing, and get assistance with other elements of project accounting by using financial management software, particularly as part of an ERP platform.