Prime Cost

by Obaidullah Jan, ACA, CFA

Prime costs are the cost of direct material and direct labor in any manufacturing process. Direct materials and direct labor costs are defined as costs that can be directly traced to each unit produced.

All the prime costs are variable costs and they are directly attributable. They do not include indirect variable costs and any fixed costs.

Prime costs are the core production costs which may form the basis of allocation of manufacturing overheads to different products.

Production costs can be broadly classified into direct material, direct labor, variable manufacturing overheads and fixed manufacturing overheads. Prime costs include only direct material and direct labor while conversion costs, a related concept, include direct labor and total manufacturing overheads.

Formula

Prime costs can be calculated using any of the following formulas depending on the information available:

$$ Prime\ Costs\ =\ Direct\ Materials\ Cost\ +\ Direct\ Labor\ Cost $$

$$ Prime\ Costs\ =\ Total\ Manufacturing\ Costs\ -\ Total\ Manufacturing\ Overheads $$

Example

Green Fuels is engaged in production of biofuels. At the start of financial year 2012, the company had a raw material inventory of $10 million. During the year it purchased $320 million of raw material. The raw material inventory at the end of 2012 amounted to $50 million. Out of the raw materials consumed $100 million went to manufacturing overheads. The company's total labor costs are $300 million. 20% of the labor is indirect.

Find prime costs.

Raw materials consumed = opening raw materials ($10 million) + purchases ($320 million) − ($50 million) = $280 million

Direct materials consumed = raw materials consumed ($280 million) − indirect materials ($100 million) = $180 million

Direct labor costs = 80% of $300 million = $240 million

Prime costs = $180 million + $240 million = $420 million