| In cost classification, accountants identify costs as | | | | attribute to a product |
| direct or indirect costs. The term "prime cost" | | | | Prime costs (PC) and production overheads constitute |
| represents the amalgam of direct costs associated | | | | the production or manufacturing cost-relating to a |
| with producing a product, service or unit. These are | | | | product or service. Production overheads are indirect |
| further subdivided into direct materials, direct labour and | | | | costs (those that are not directly traceable to a |
| direct expenses. | | | | product, service or department). PC is calculated as |
| To understand "prime cost", you first have to grasp | | | | follows: |
| what direct costs are (any that can be attributed | | | | PC = Direct materials + Direct wages/labour + Direct |
| directly to a product). For example, if you were | | | | expenses |
| producing a wooden chair, you would need wood, | | | | The prime cost is then used as data to calculate |
| someone to make the chair and maintenance of tools | | | | production costs using the following formula: |
| for the production of the chair. The aforementioned | | | | PC + Production overhead = Production cost |
| expenses represent direct materials (wood), direct | | | | It is important not to use Production Overhead and |
| labour (carpenter) and direct expenses (tool | | | | Production Costs interchangeably, since overheads |
| maintenance). Those are all part of the total direct | | | | form part of the total product/ service charges. |
| costs of producing a chair. | | | | Overheads are indirect charges associated with |
| Further examples of direct material costs include:a) | | | | producing the goods or service. In calculating Total |
| Parts of a productb) A laptop needed for an insurance | | | | Costs, the formula-including prime costs-is: |
| sales representative to conduct field visitsc) Packaging | | | | PC + Production overheads + Total other costs = TC |
| for the product itself (not boxes or containers that | | | | Even though prime costs are directly traceable to a |
| they are transported in) | | | | product, they might have to be imputed. For instance, |
| Further examples of direct labour include:a) Direct | | | | you might have to pay for electricity for machinery in a |
| labour includes wages and overtime spent on labour | | | | factory; that is needed to produce the product. |
| on the product itself or product line.b) Quality control | | | | However, it is unlikely that this direct expense will be |
| specialistsc) Supervisors and foremen | | | | separate from other functions that exist. Accountants |
| Direct expenses also include:a) Rent of equipment or | | | | would have to estimate or impute it (for stepped |
| space to perform a particular jobb) Maintenance of | | | | costs) in order to determine the prime cost. |
| fixtures and fittings or machinery that you can directly | | | | |