Learning Outcomes
- Differentiate between prime and conversion costs
We’ve previously learned about period and product costs and also direct and indirect costs. Products costs may also be further categorized, as follows:
- Prime cost = direct labor + direct materials
- Conversion costs = direct labor + factory overhead
In a labor-intensive process, prime costs will be large. In an automated process, conversion costs will be large. This information helps managers know where to focus their attention when planning, directing and controlling costs.
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
Now, check your understanding of the difference between prime and conversion costs:
