Explain the difference between prime cost and conversion cost.

Explain the difference between prime cost and conversion cost.

• A. Prime cost = direct materials + direct labor; conversion cost = direct labor + manufacturing overhead.
• B. Prime cost = direct materials + overhead; conversion = direct materials + direct labor.
• C. Prime cost = manufacturing overhead + indirect materials; conversion = direct materials + indirect labor.
• D. Prime cost = direct labor + overhead; conversion = direct materials + direct labor.

Answer: (A)

Prime cost is the direct portion of manufacturing costs, consisting of direct materials and direct labor because these are costs that can be traced straight to the product. Manufacturing overhead is not included in prime cost since it comprises indirect or not directly traceable costs. Conversion cost, on the other hand, measures what it takes to convert raw materials into finished goods. That is direct labor plus manufacturing overhead. Overhead covers indirect materials, indirect labor, depreciation, utilities, and other costs needed to transform materials into a product, and these are allocated to products as part of conversion. So the pairing of direct materials and direct labor for prime cost, with direct labor plus manufacturing overhead for conversion cost, correctly distinguishes the direct inputs from the overhead-driven steps in production.

Prime cost is the direct portion of manufacturing costs, consisting of direct materials and direct labor because these are costs that can be traced straight to the product. Manufacturing overhead is not included in prime cost since it comprises indirect or not directly traceable costs.

Conversion cost, on the other hand, measures what it takes to convert raw materials into finished goods. That is direct labor plus manufacturing overhead. Overhead covers indirect materials, indirect labor, depreciation, utilities, and other costs needed to transform materials into a product, and these are allocated to products as part of conversion.

So the pairing of direct materials and direct labor for prime cost, with direct labor plus manufacturing overhead for conversion cost, correctly distinguishes the direct inputs from the overhead-driven steps in production.