Prime Costs and Conversion Costs
Prime costs are all the direct costs of a product i.e. those costs that can be traced conveniently to each unit. These include direct materials cost and direct labor cost. On the other hand, conversion costs are all manufacturing costs other than direct materials cost. These include direct labor costs and manufacturing overhead costs.
Direct material and direct labor costs are prime cost because they are the main incremental costs of a product. The greater the proportion of prime costs in total costs of a product, the more reliable is the cost estimate of the product. Conversion costs are the costs that are incurred in converting direct raw material into finished goods and hence the name.
Prime costs and conversion costs have direct labor cost as an overlapping item.
Prime costs and conversion costs can be calculated using the following equations:
Prime costs = direct materials cost + direct labor cost
Conversion costs = direct labor cost + manufacturing overhead costs
Manufacturing overhead costs are all indirect manufacturing costs.
Elite Furniture is a small furniture manufacturer. In the first week of December, they worked exclusively on an order to build 5 conference tables. Costs incurred are as follows:
|Opening stock of timber||$50|
|Timber purchased during the week||2,000|
|Closing stock of timber||250|
|Glass purchased for table tops||500|
|Labor hours worked||100|
|Wages per hour||40|
|Design engineer salary allocated to the job||2,500|
|Indirect materials and utilities cost allocated to the job||3,000|
Timber consumed = opening stock + purchases − closing stock = $50 + $2,000 − $250 = $1,800
Other direct materials used (glass) = $500
Total direct materials cost = $1,800 + $500 = $2,300
Direct manufacturing labor cost = hours worked × hourly wage = 100 * $40 = $4,000
Manufacturing overhead costs = design engineer salary + indirect materials and utilities = $2,500 + $3,000 = $5,500
Prime costs = direct materials cost + direct labor cost = $2,300 + $4,000 = $6,300
Conversion costs = direct labor cost + manufacturing overhead costs = $4,000 + $5,500 = $9,500