CIA Question of the Day: Contract Types in Procurement

Quiz Yazan Ibrahim
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CIA exam practice question — CIA Question of the Day: Contract Types in Procurement

CIA exam practice question: daily practice for the Certified Internal Auditor (CIA) exam — domain: Part 3: Business Knowledge for Internal Auditing.

Question

A company's procurement team is negotiating a three-year contract to build a new manufacturing facility. Management asks the internal auditor which contract type will most clearly transfer the risk of cost overruns to the contractor. Which contract type is most appropriate if the organization wants to minimize its exposure to unexpected increases in total project cost?

  • A. Enter into a fixed-price contract with the contractor that specifies a set total price for the work
  • B. Use a cost-plus contract that reimburses contractor expenses and adds a fee or percentage for profit
  • C. Use a time-and-materials contract that bills labor and materials as incurred and reimbursed
  • D. Negotiate a unit-price contract that pays a set amount per unit of work or quantity completed
Show the answer and explanation

Correct answer: A. Enter into a fixed-price contract with the contractor that specifies a set total price for the work

A fixed-price contract places responsibility for cost overruns on the contractor because the contractor agrees to deliver the specified scope for a set total price; therefore the buyer's exposure to unexpected increases is minimized. A cost-plus contract reimburses actual costs plus a fee, so the buyer bears cost escalation risk. A time-and-materials contract similarly reimburses actual labor and materials as incurred, leaving cost uncertainty with the buyer. A unit-price contract shifts some pricing risk but still leaves quantity and scope risk with the buyer—if quantities exceed estimates the buyer can face higher total costs—so it does not transfer risk as clearly as a fixed-price agreement.

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