# Difference Between Prime Cost and Conversion Cost

The key difference between prime cost and conversion cost is that prime costs are the costs that can be directly traceable to production units whereas conversation costs are the other related costs of production that cannot be conveniently recognized against a unit of output. Knowledge of the classification of such costs is important for management decision making as well as for cost control.

CONTENTS
1. Overview and Key Difference
2. What is Prime Cost
3. What is Conversion Cost
4. Side by Side Comparison – Prime Cost and Conversion Cost
5. Summary

## What is Prime Cost?

Prime costs are the direct product costs (costs that can be directly traced back to a unit of output) and consist of,

• Direct Material Cost
• Direct Labor Cost

Prime Costs = Direct Materials Cost + Direct Labor Cost

Prime costs are utilized by operations managers to ensure that the production process of the company is efficient. The calculation of prime costs also helps companies to set prices at a level that produce an acceptable amount of profit.

E.g. LMN Ltd is a wrist watch manufacturing company. Consider the following costs.

 Direct material cost per unit \$ 8 Direct labor cost per unit \$ 15 Variable overhead cost per unit \$ 10 Total variable cost per unit \$ 33 Fixed overhead \$ 175,400 Fixed overhead per unit \$ 11 (rounded) Number of units produced 15,500

Direct material cost (\$8* 15,500)                     = \$124,000

Direct labor (\$15* 15,500)                                = \$232,500

Total prime cost                                                 = \$356,500

## What is Conversion Cost?

Conversion costs are the summation of direct labor costs and manufacturing overhead costs. In other words, these are manufacturing or production costs necessary to convert raw materials into finished products. Overhead costs are not directly traceable to the output, however, are necessary in order to facilitate production. Rent, electricity and other utilities are categorized as manufacturing overheads. Direct labor is both a prime cost and a conversion cost.

Conversion Costs = Direct Labor Cost + Manufacturing Overheads

Continuing from the above example,

e.g.

Direct labor (\$15* 15,500)                               = \$232,500

Variable overheads (\$10* 15,500)                   = \$155,000

Fixed overheads (\$11* 15,500)                        = \$170,500

Total conversion costs                                      = \$558,000

Profits will be calculated after deducting both prime and conversion costs. Assume the entire batch of 15,500 wrist watches was sold at a price of \$52 per unit. The resulting profit is,

Revenue (\$52* 15,500)                                      = \$ 806,000

Cost (\$8+\$15+\$10+\$11 *15,500)                       = (\$ 682,000)

Profit                                                                    = \$ 124,000

Figure 1: Manufacturing expenses consist of direct material, direct labor and overhead costs

## What is the difference Between Prime Cost and Conversion Cost?

### Primary Cost vs Conversion Cost

Prime costs are the costs that can be directly traceable to production units. Conversation costs are other related costs of production that cannot be recognized by a unit of output.
Components
Prime cost contains direct material cost and direct labor cost. Direct labor cost and manufacturing overheads are included in conversion cost.
Formula
Prime cost is calculated as (Prime costs = direct materials cost + direct labor cost). Conversion cost is calculated as (Conversion costs = direct labor cost + manufacturing overheads).

## Summary – Prime Cost vs Conversion Cost

The difference between prime cost and conversion cost is mostly applicable to manufacturing organizations. This difference is mainly dependent on whether the respective costs can be directly traceable to the output and whether they are support costs incurred to produce the output. Managing prime and conversion costs effectively enable wider benefits ranging from controlling costs, reducing waste and better pricing decisions.

Reference:
1.”What are conversion costs? | AccountingCoach.” AccountingCoach.com. N.p., n.d. Web. 21 Mar. 2017.
2.Horton, Melissa. “What is the difference between prime cost and conversion cost?” Investopedia. N.p., 07 May 2015. Web. 21 Mar. 2017.
3.Obaidullah Jan, ACA.”Prime Costs and Conversion Costs.” Prime Costs and Conversion Costs | Formulas | Examples. N.p., n.d. Web. 21 Mar. 2017.

Image Courtesy:
1. “Prime expenditure divisions of a factory” By Clinton Edgar Woods – Organizing a factory: an analysis of the elements in factory organization… The System Company, Chicago. 1905. (Public Domain) via Commons Wikimedia