The prime cost is the set of costs that are incurred during the manufacture of products or provision of services of a company.
Prime costs vary depending on what the business does. This, since in companies whose ordinary activity is based on services, direct costs of raw materials are not used, for example.
Regarding other direct costs, they can be from costs derived from the labor itself or raw material that directly affect the cost of the product or service, to cyclical costs that are needed to carry out the service or sell. the product.
An example of this are the plastic, glass or cardboard packaging of products and the materials that may be needed for the correct provision of services.
Objectives of calculating the prime cost
The calculation or determination of the prime cost tries to find out what sources of expenses are directly related to the production or provision of services of the company in question. With this, it is intended in the matter of internal accounting to analyze the following data:
- Identification and origin of each prime cost.
- Number of costs involved in or making up the prime costs.
- Nature and function of each.
- Weight of each prime cost.
- Detect inefficient or unnecessary costs.
With the data set obtained, it will be possible, among other things, after analyzing the situation, to develop a new strategy if any flaw or inconsistency is found in cost accounting.
Prime cost formula
The prime cost formula tries to add up all those costs that are directly involved in the manufacturing process, so special attention will have to be paid to all expenses and analyze whether they have a direct impact or not.
Then, in general, the formula to calculate the prime costs is the following:
Therefore, making the formula correctly is not an easy task unless the company has a small repertoire of expenses and the production activity itself is very simple. Examples of a complicated case and a more affordable one would be a business oriented to the assembly of vehicles, and on the other hand there would be the business of production and marketing of fruit juice.
In the first case, there is a very wide amount of different costs only in product components. In the second case, the step from having fruit to turning it into juice is a less complex process.
Prime cost example
Given a situation in which a company that provides cleaning services in schools and hospitals, what expenses of those to be exposed can be part of the prime costs?
- Salary of all company employees
- Salary of cleaning workers
- Office supplies for the company's accounting department
- Company headquarters supplies
- Financial expenses arising from company liabilities
- Material needed for cleaning: gloves, cleaning products, etc.
Of the six expenses that have been mentioned, only in the case that is established in the statement would the salary of the cleaning workers and the material necessary for the cleaning form part of the prime costs.