Prime Costs and Conversion Costs Formulas Examples

Manufacturing cost is the cost that company spends to support the production process but they cannot allocate to each product. They are the indirect cost that incurs to support the manufacturing, but it is very challenging to apply the cost to each production unit. Direct materials is the basic physical ingredient, matter or substance which the company processes to make a salable product. Plastic, rubber, steel, iron, timber and many agricultural outputs like sugarcane, sugar beets, jute and cotton etc. are examples of direct materials that are processed to produce salable finished products. As can be seen, labor is the cost that mainly determines the transformation or conversion process, then from here on there must be costs of a similar nature or of a similar impact.

• In a typical manufacturing process, direct manufacturing costs include direct materials and direct labor.
• Direct materials are the actual raw materials that make up the finished product.
• Compensation paid to machinists, painters, or welders is common in calculating prime costs.
• For example, prime cost does not contain overhead charges that are applied in conversion cost.
• Suppose that the cost of the raw materials—lumber, hardware, and paint—totals $200.
• Once you assess conversion, you can use the information to better allocate your budget and improve returns.

The furniture maker charges $50 per hour for labor, and the project takes three hours to complete. Prime costs are reviewed by operations managers to ensure that the company is maintaining an efficient production process. For instance, the engine conversion cost formula of a car and the spokes of a bicycle are considered direct material costs because they are necessary to complete the production of those items. In manufacturing, raw materials might include metals, plastics, hardware, fabric, and paint.

What is Conversion Cost? Definition, Formula, Example, And Importance

A complete production cost report for the shaping department is illustrated in Figure 5.6. In addition to the equivalent units, it is necessary to track the units completed as well as the units remaining in ending inventory. A similar process is used to account for the costs completed and transferred.

Direct labor costs should also include all of the expenses necessary to hire and retain an employee who physically works to turn the raw materials into a product. To make the frames for the glasses, workers must cut the appropriate length of material and then shape the material into the frame with the help of a frame mold. Once the nose piece is attached and the frame is completely assembled, the frames get sent to the lens station where workers place the appropriate lens inside the appropriate frames and then fasten them with small screws. At the end of every year, after the firm’s inventory count, the firm looks at production costs. The primary difference between the two is that the formula for conversion costs takes overhead into account. For this reason, it’s a more relevant number for operations managers, who may be looking at ways to reduce the indirect expenses of production.

Conversion Cost Formula

Like prime costs, conversion costs are used to gauge the efficiency of a production process, but conversion cost also takes into account overhead expenses that are left out of prime cost calculations. The pay, wages, or perks provided to an employee who works on the completion of all final items are considered direct labor costs. Prime costs are frequently calculated using compensation provided to machinists, painters, or welders. Please keep in mind that depreciation charges, insurance expenses, cost expenses, and electricity expenses are all considered manufacturing overhead. The two components of prime cost formula are direct materials and direct labor.

• The manufacturing sector analyses both prime costs and conversion costs to measure efficiency in the production of a product.
• Say we are looking to find Lotsa Fabrication’s conversion costs for a widget.
• Conversion costs include all direct or indirect production costs incurred on activities that convert raw material to finished goods.
• Conversion Costs can be defined as the aggregated costs that include direct labor, and manufacturing overhead costs.
• A cost unit is a product or service unit to which manufacturing costs can be assigned.

The cost of labor and payroll taxes used directly in the production process are part of prime costs. Labor that is used to service and consult the production of goods is also included in prime costs. Direct labor examples might include assembly line workers, welders, carpenters, glass workers, painters, and cooks. Direct labor includes only wages paid to workers who directly contribute to the formation, assembly, or creation of the product. Direct labor would not include, for example, salaries for factory managers or fees paid to engineers or designers. These employees are involved in the creation of the product concept and the day-to-day operation of the business rather than the hands-on assembly of items for sale.