Introduction

Prime costs and conversion costs are used in the analytics of the manufacturing sector as a key metric to determine the efficiency in the production of the specific product.

Prime costs are expenses directly related to creating finished goods while conversion costs are used in the conversion of raw materials into finished goods i.e. a complete product.

Prime costs and conversion costs include costs of factors of production, providing a varied perspective of production efficiency.

Prime Costs

Prime costs include the expenditure incurred on direct materials in addition to direct labor.

Physical components also called tangible components such as raw materials are needed to create the finished products.

For example, wooden planks are needed to make furniture and are included as direct materials because they are necessary to complete the production of the furniture.

Direct labor, on the other hand, includes wages, salaries and other employee benefits paid to the employee who is directly liable for the completion of the product.

For example, employee expenses made to machinists, foreman and direct supervisors are common in calculating prime costs. Prime costs only include direct costs, unlike conversion costs.

or example: employee expenses made to machinists, foreman and direct supervisors are common in calculating prime costs. Prime costs only include direct costs, unlike conversion costs.

Prime costs are calculated by factory managers and reviewed by operational managers to ensure that the production process has completed efficiently and effectively.

The prime cost helps to set prices of a product at an acceptable level so that the desired profit can be generated.

Related article  Cost of goods sold on an Income Statement

Conversion costs

Conversion costs include direct labor and overhead expenses incurred due to the transformation or conversion of raw materials into finished goods.

Overhead expenses are those expenses that cannot be directly allocated or traceable to the production process but are necessary for operations.

Overhead expenses include utility expenses such as electricity and other expenses required to keep the factory or unit operational throughout any working day. On the other hand, direct labor costs are the same as explained under prime costs.

The objective of calculating conversion cost is to depict or measure the efficiencies in production processes while taking into account overhead costs which are excluded from prime cost calculations.

This is computed and reviewed by operational managers to determine whether wastages or inefficiencies exist in the manufacturing process.

Differences at Glance

The differences between prime costs and conversion costs can be studied with the help of the following table at a glance:

Basis of ComparisonPrime cost Conversion Costs
DefinitionPrime costs are the costs that can be directly traceable to production units.Conversion costs are other related costs of production that cannot be recognized by a unit of output.
ComponentsThe prime costs include direct materials and direct labor. Few practicing cost accountants also include direct expenses as prime costs.Direct labor costs and manufacturing overheads are included in conversion costs.
FormulaPrime cost is calculated as Prime cost = Direct materials cost + Direct labor costsConversion cost is calculated as, Conversion cost = Direct labor costs + manufacturing overheads
Presentation in the cost sheetIt is computed at the beginning of the cost sheet.It is not shown exclusively in the cost sheet. It is calculated separately as required by the managers or company.
ObjectiveThe primary objective of the prime cost calculation is to set the price of the product at an acceptable level to obtain the desired level of profit.The main objective here is to gauge inefficiencies with the manufacturing process and control by meeting the standards set.
ExampleFor furniture, examples include costs related to wooden planks, wages of labors and so on.For furniture, examples include wages of labors, paints required for furniture, screws required to hold tight of planks and so on. Although manufacturing overheads are not major costs but are necessary for the completion of the product.