Many folks looking at a contract for the first time will notice strings of words, often adjectives, accompany terms such as licenses (see, for example, this blog entry), limitations on liability (e.g., indirect, incidental, special, consequential, exemplary, punitive), and others. Today, we are going to take a look at the meaning of words that often precede cost terms in contracts. Knowing the differences between these words (and being able to recognize which are missing) can empower developers and creatives to know what costs can be deducted from the payments they hope to receive.

Development agreements, publishing deals, and revenue shares are full of cost language. Typically, payouts are based on net revenues, not gross revenues (the latter is usually the money that actually comes in, while net revenue or profits equal gross revenues less deductions for costs and any other agreed-upon amounts). Costs get deducted before profits are split, recouped before royalties are paid, or reimbursed on top of a fee. But terms like “direct costs,” “out-of-pocket expenses,” and “actual costs” are often used as if they mean the same thing. They don’t, and the difference can change who gets paid and how much. Each term usually answers one of four questions.

Did real money leave?

Actual costs are amounts really spent. The contrast is an implicit or imputed cost, which is value assigned to something that didn’t require a payment, like a founder’s own time or a slice of the office lease. “Actual” can also be set against “estimated” or “budgeted” costs. Allowing the deduction of “estimated” or “budgeted” costs could mean surplus funds for the party deducting costs if those budgeted costs are more than actual costs, or a loss if actual costs exceed budgeted costs (rare).

Who got paid?

Out-of-pocket costs are generally amounts paid to third parties, such as contractors, software licenses, or ad spend. There’s no true opposite term, but internal costs (a company’s own staff time and overhead) are the usual contrast. One important note, though: if a party deducting costs is large enough to have subsidiaries and/or affiliates, the other party may want to contract around that so that “out-of-pocket” costs aren’t just moving money from one sister company to another at the other party’s expense.

Can it be traced to the project?

Direct costs are tied to a specific game or project. Indirect costs, also called overhead, are shared across the business and then allocated to the business’s various projects.

When is it a cost?

A cost is incurred when the obligation arises and paid when the money leaves. A clause that allows deduction of costs “incurred” may reach unpaid invoices. One limited to costs “paid” will not. The adverb “actually” often accompanies “paid.”

Defining these terms is more precise than hoping a single word does the work. For example: “documented out-of-pocket costs actually paid to unaffiliated third parties and directly attributable to the Game.” Each phrase answers one of the questions above, and “unaffiliated” prevents payments to a related company from becoming internal costs in disguise.

Have questions? Reach out!