Prime Cost Formula

Prime Cost Formula (Table of Contents)

• Formula
• Examples
• Calculator

What is the Prime Cost Formula?

The term “prime cost” refers to the direct cost of production incurred during a given period of time. In other words, it is the aggregate of all variable costs that can be directly attributed to the manufacturing process, which primarily includes raw material cost and direct labor cost. Prime cost is also known as ‘direct cost’, ‘flat cost’ or ‘first cost’.

The prime cost formula is simply expressed as a summation of raw material cost and direct labor cost incurred during the given period of time. Mathematically, it is represented as,

Examples of Prime Cost Formula (With Excel Template)

Let’s take an example to understand the calculation of Prime Cost in a better manner.

Prime Cost Formula – Example #1

Let us take the simple example of a company that incurred $25.50 million in raw material cost and $15.25 million as direct labor cost during 2018. Calculate the prime cost incurred by the company in 2018.

Solution:

Prime Cost is calculated using the formula given below

Prime Cost = Raw Material Cost + Direct Labor Cost

• Prime Cost = $25.50 million + $15.25 million
• Prime Cost = $40.75 million

Therefore, the company incurred a prime cost of $40.75 million in 2018.

Prime Cost Formula – Example #2

Let us take the example of a company engaged in manufacturing a sofa in the city of Chicago, US. According to the accounts department of the company, the following information is available:

Compute the company’s prime cost during the given period on the basis of the given information.

Solution:

Raw Material Cost is calculated using the formula given below

Raw Material Cost = Cost of Timber + Cost of Foam + Cost of Cloth

• Raw Material Cost = $12500,000 + $6,250,000 + $10,000,000
• Raw Material Cost = $28,750,000

Direct Labor Cost is calculated using the formula given below

Direct Labor Cost = Direct Labor Rate * Direct Labor Hours

• Direct Labor Cost = $50 per hour * 200,000 hours
• Direct Labor Cost = $10,000,000

Prime Cost is calculated using the formula given below

Prime Cost = Raw Material Cost + Direct Labor Cost

• Prime Cost = $28,750,000 + $10,000,000
• Prime Cost = $38,750,000

Therefore, the prime cost incurred by the company during the given period was $38.75 million.

Prime Cost Formula – Example #3

Let us take the example of consolidated financials of Samsung Electronics Co. Ltd. for the year 2018. From the annual report, the following information is available:

Compute the prime cost incurred by Samsung Electronics Co. Ltd. during the year 2018 based on the above information.

Solution:

Raw Material Cost is calculated using the formula given below

Raw Material Cost = Raw Materials Used and Merchandise Purchased + Changes in Finished Goods and Work in Process

• Raw Material Cost = ₩79,808,215 million – ₩5,484,269 million
• Raw Material Cost = ₩74,323,946 million

Direct Labor Cost is calculated using the formula given below

Direct Labor Cost = Wages and Salaries + Post-Employment Benefit

• Direct Labor Cost = ₩22,727,468 million + ₩958,793 million
• Direct Labor Cost= ₩23,686,261 million

Prime Cost is calculated using the formula given below

Prime Cost = Raw Material Cost + Direct Labor Cost

Prime Cost = ₩74,323,946 million + ₩23,686,261 million

Prime Cost = ₩98,010,207 million

Therefore, Samsung Electronics Co. Ltd. prime cost of ₩98,010,207 million during the year 2018.

Explanation

The formula for prime cost can be derived by using the following steps:

Step 1: Firstly, determine the cost of raw material incurred in the finished good production during a specific period of time. In most cases, companies report the raw material cost as a separate line item under of cost of goods sold.

Step 2: Next, determine the cost of direct labor, which is the total wages paid to the manpower that are directly involved in the production process. It is also usually reported as a separate line item under the cost of goods sold.

Step 3: Finally, the formula for the prime cost incurred during the given period can be derived by adding the raw material cost (step 1) and the direct labor cost (step 2), as shown below.

Prime cost = Raw material cost + Direct labor cost

Screenshot of income statement used for calculation

Source Link: Samsung Inc. Balance Sheet

Relevance and Use of Prime Cost Formula

It is important that you understand the concept of prime cost because it is a crucial component of the cost of goods sold and, as such, impacts the gross profit of a company. Prime cost is also used by companies in the computation of contribution margin, and subsequently, the pricing of the finished product is decided. The prime cost as a percentage of sales can be used as metrics for peer comparison to draw useful insights about companies operating in the same industry. Theoretically, the lower prime cost is always desirable for better profitability.

Prime Cost Formula Calculator

You can use the following Prime Cost Calculator