Posted in Finance, Accounting and Economics Terms, Total Reads: 256
Definition: Prime Cost
Prime Cost is the cost of raw materials and labour used in the production of final goods and services. Prime Cost is helpful in determining selling price of a product. For example, Prime Cost for making one table would include the cost of raw material like plywood, tools, kills and nails, glass, adhesive, transportation cost and the cost of labour.
Prime Cost doesn’t include overhead cost. In the above example, Prime Cost would not include electricity charges and other overheads. Prime Cost is used to determine the contribution margin. But profit made by taking into consideration only prime cost will not be accurate. Because overheads are not taken into consideration while calculating total production cost.
Prime Cost = Direct Labour Cost + Direct Material Cost
Green Fuels is engaged in production of biofuels. At the start of financial year 2013, the company had a ₹10 lakh of raw material inventory. During the year it purchased ₹320 lakh of raw material. The closing raw material inventory for 2013 was ₹50 lakh. Out of the raw materials consumed ₹100 lakh was for manufacturing overheads. The company's total labour costs are ₹300 lakh. 30% of the labour is indirect.
Raw materials consumed = opening raw materials (₹10 lakh) + purchases (₹320 lakh) − (₹50 lakh) = ₹280 lakh
Direct materials consumed = raw materials consumed ($280 million) − indirect materials ($100 million) = $180 million
Direct labour costs = 70% of ₹300 lakh = ₹210 lakh