Prime cost also called the direct cost is made up of direct raw material cost and the direct labor cost to convert raw materials into finished products. Although the finished product includes indirect costs and overheads that are absorbed on a per unit basis, the basic cost is the prime cost.
The prime cost is a way of estimating the selling price after adding an element of profit to it. When the direct material cost and direct labor costs are fixed and applicable on per unit basis it is very easy for managers to estimate how much each unit will cost and what each unit will be earning as a profit.
Assume to make a shoe the raw material is leather that costs $2.50 that will be stitched by the expert shoemaker in 30 minutes that costs at a rate of $20 per hour. In this case, the prime cost per unit will be:
Prime cost = Direct material cost + Direct Labor cost
Prime cost per unit = $2.50 + $20 x (30 min/ 60 min) = $12.50
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