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Prime Costs

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177 views

Prime Costs

Uploaded by

dark rose
Copyright
© © All Rights Reserved
Available Formats
Download as RTF, PDF, TXT or read online on Scribd
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Prime Costs

‫التكاليف االولية‬
What is prime cost?
The prime cost definition is the expense of purchasing raw materials and paying
laborers to actually manufacture a product. Knowing prime cost helps a business
to measure its production costs and project the price needed to break even or
make a profit.

It is the total cost of production. Essentially, a prime cost refers to the cost of a
manufactured product. These are calculated to make sure that the company is
experiencing the best profit margins possible.

The prime cost calculates the direct costs of the raw materials that are used when
producing a good. It also takes labor into account. Direct costs only include what is
known as a direct expense. They don’t include any indirect expenses, such as
administrative costs and advertising.

Raw materials are the most basic materials that make up a manufactured product.
The raw materials then undergo some type of manufacturing or processing to
become a finished product that can be used. For instance, cotton is a raw
material, and clothing is a finished product. Cocoa is the raw material, and a
chocolate candy bar is the finished product.

Direct labor is the labor that goes directly into producing a product, and it varies
with production levels. Direct labor includes those working on an assembly line or
operating machinery in a plant. Indirect labor, however, is not included in the
prime cost formula.

***
· A prime cost is the total direct cost that is associated with production.

· This includes labor and raw materials.

· Indirect costs are not included in prime costs. This is costs such as manager
salaries, delivery costs, and utilities.

· It’s important to calculate the prime cost of each product to make sure that
they are making a profit.

Prime cost formula

Prime cost = direct materials cost + direct labor cost

note: ** Direct labor cost = Pay rate * Time to complete a task or project.**

Components of prime cost


Direct materials - Direct labor - Direct expenses

What happens if prime costs are too high?


If your prime costs are too high, your production costs are also too high.

How do you calculate prime cost?


Prime cost is calculated by adding the cost of raw materials to the cost of direct
labor. The prime cost can then be used to find the price a business needs to
charge in order to break even or make a profit.

Is Salary a Direct Expense?


Salary is considered an indirect expense as it is not directly involved in a
manufacturer’s production.

What are prime costs examples?


An example of prime cost is if a company that makes footballs pays $100 for the
material that covers the football and pays one employee to make the footballs.
The employee makes $10 per hour, and it takes two hours to make each football.
Prime cost = $100 + ($10 * 2) = $120.

What is the difference between prime cost and overhead cost?


Prime costs refer to the costs directly associated with producing a product,
namely, raw material and labor costs. Overhead costs are costs indirectly
associated with producing a product, such as rent and utilities.

Prime cost vs. conversion cost

Conversion costs are the expenses to turn, or convert, your raw materials into
finished goods. It’s the sum of direct labor and manufacturing overhead.

Formula:
Conversion Costs = Direct Labor + Manufacturing Overhead

Prime costs ignore manufacturing overhead, while conversion costs leave out
direct materials. Businesses use both cost formulas to assess profitability and
labor efficiency.

Example:

A chair manufacturing firm incurs the following costs: $50,000 for wood, $100,000
for production workers, $50,000 for production manager, $100,000 rent for
manufacturing building. Total conversion costs are $250,000.

Conversion costs = direct labor + manufacturing overhead

Conversion costs = $100,000 production workers + ($50,000 production manager


+ $100,000 rent for manufacturing building)

Conversion costs = $250,000

Example:

A manufacturing company produces kitchen cabinets. Direct materials include


wood, hinges, and hardware. Direct labor is the cost of wages of factory
employees who assemble the cabinets. Factory overhead includes expenditures
for electricity and water bills, insurance premiums, roof repair, depreciation of
machinery, materials used to build shelves in the factory, and wages of factory
workers to assemble those shelves.

Assume that direct materials cost $700, direct labor is $500, and factory overhead
is $300 for cabinets that have been manufactured.

Prime costs = $700 + $500 = $1,200

Conversion costs = $500 + $300 = $ 800

Total cost = $700 + $500 +$300= $1,500

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