What is Prime Cost
Prime costs are the total direct costs spent throughout the production of a product. These costs include raw materials and direct labor in the manufacturing process but do not include indirect costs, for example, factory rent or the manager’s salary.
It is an important component of total production costs. The costing and effective price of items are essentially controlled by their basis.
Examples of Prime Cost
The scenarios below are prime cost examples:
An automobile production line charged with installing door handles on pickup trucks. The price of the metal used to make the door handles is a primary cost since it is directly related to the price of the raw materials.
The same door handle installation firm pays its employees $20 per hour to install door handles. Because it is tied to direct labor expenditures, this is a primary cost. Direct labor costs include those incurred on an assembly line or at a manufacturing facility.
Managers salaries are not considered primary expenses since their work is not directly tied to product manufacture.
Components of Prime Cost
Prime costs are direct costs that are directly related to each unit of manufactured product. These costs often include the following:
- Direct material
- Direct labor
- Direct expenses
Direct Material
Direct materials are materials and resources utilized during the manufacturing of a product and are directly associated with that product. Items categorized as direct materials are typically recorded in a product’s bill of materials file.
The bill of materials lists the unit quantities and standard costs of all materials used in the production of a product and may also contain an overhead allocation.
Direct materials do not include any materials utilized as a part of a company’s general overhead. For example, air filters used in a manufacturing facility’s ventilation system are not direct materials; instead, they are included in production overhead. Direct materials, on the other hand, are wood used to make furniture that will be sold.
Direct Labor
Any employee who is directly involved in the manufacture of a product is considered direct labor. If your company makes bicycles, the people who make the bicycles are considered direct labor.
Assemblers, welders, painters, and machinists are all examples of direct labor. Direct labor expenses are usually variable costs since they fluctuate with production costs.
The expenses paid by paying the wages of your direct labor employees are referred to as direct labor costs. For example, if you work for a vehicle company and your job is to paint the automobiles when they are finished, your wage is considered a direct labor cost.
Direct Expense
Direct expenses are those that are directly related to the production of the product sold or the performance of the service, and they vary based on the kind of business, such as manufacturing, construction, or service.
They are a component of a company’s financial statement record that is used to keep track of its expenditures. These costs are always considered while determining the pricing of a product or service.
These costs vary with production level, but they are stable for each unit of output and are often regulated by the department manager. It is up to the company that manufactures its own goods and services to choose the rate for selling them as direct expenditures.
These costs are used to determine the company’s gross profit. These expenditures are necessary to calculate the major cost of a product. They are used to categorize and manage departmental expenses.
Examples of direct expenses include the cost of raw materials, sales commissions, manufacturing supplies, and so on.
Prime Cost Formula
Prime Cost = Direct Material Cost + Direct Labor Cost
How To Calculate Prime Cost
A single unit of the final product – Product ‘X’ – needs 700 raw material units and 6 hours of work to manufacture. Each unit of raw material costs $5. The manufacturing workers are paid $25 per hour by the corporation.
The Prime Cost of producing 1 unit of ‘X’ can be calculated as follows:
Prime Cost = Direct Material Cost + Direct Labor Cost
= (700 units x $5 per unit) + (6 hours x $25 per hour)
= $3,500 + $150
= $3,650
Importance of Prime Cost
The following are the Importance of prime cost:
Aids in the Determination of Selling Pricing: Prime cost can be a useful metric in assisting the company in determining the price of its products. Typically, no corporation would desire to sell its items at less than the cost of production. As a result, a profit margin would be applied to the production cost. To get at a feasible selling price, the corporation may add a specific profit margin to the Prime cost of manufacturing a product.
Can be Used for Cost Control and Cost Reduction: Because prime cost is comprised of direct costs incurred in the manufacture of a product, it assists in the calculation of product-wise profitability and so can be a good measure of cost control and cost reduction.
Overhead Allocation: Overheads can be distributed to different goods based on their respective Prime costs.
Conclusion
The total of all direct expenses of making a product, including direct raw materials and direct labor, is known as the prime cost. It is a simple measure of a product’s production expenses. However, because prime cost excludes indirect manufacturing expenses, it does not represent the complete cost of creating a product.
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