2 an introduction to cost terms and purposes - Pearson Learning ...

Prime Costs and Conversion Costs
Two terms used to describe cost classifications in manufacturing costing systems are
prime costs and conversion costs. Prime costs are all direct manufacturing costs. For
Cellular Products,
Prime costs = Direct material costs + Direct manufacturing labor costs
= $ 76, 000 + $ 9, 000 = $ 85,
000
As we have already discussed, the greater the proportion of prime costs in a company’s
cost structure, the more confident managers can be about the accuracy of the costs of
products. As information-gathering technology improves, companies can add more and
more direct-cost categories. For example, power costs might be metered in specific areas
of a plant and identified with specific products. In this case, prime costs would include
direct materials, direct manufacturing labor, and direct metered power. Furthermore, if a
production line were dedicated to the manufacture of a specific product, the depreciation
on the production equipment would be a direct manufacturing cost and would be
included in prime costs. Computer software companies often have a “purchased technology”
direct manufacturing cost item. This item, which represents payments to suppliers
who develop software algorithms for a product, is also included in prime costs.
Conversion costs are all manufacturing costs other than direct material costs.
Conversion costs represent all manufacturing costs incurred to convert direct materials
into finished goods. For Cellular Products,
Conversion costs = Direct manufacturing labor costs + Manufacturing overhead costs
= $ 9, 000 + $ 20, 000 = $ 29,
000
Question: Do prime
costs + conversion costs
= total manufacturing costs?
Answer: Only under the twopart
classification: prime costs
= direct material costs, and conversion
costs = manufacturing
overhead costs (which include
direct manufacturing labor).
Under the three-part classification,
direct manufacturing labor
is both a prime cost and a conversion
cost, so the equation in
the question would doublecount
direct manufacturing
labor.
Note that direct manufacturing labor costs are a part of both prime costs and conversion
costs.
Some manufacturing operations such as computer-integrated manufacturing (CIM)
plants have very few workers. The workers’ roles are to monitor the manufacturing process
and to maintain the equipment that produces multiple products. Costing systems in CIM
plants do not have a direct manufacturing labor cost category because direct manufacturing
labor cost is relatively small and because it is difficult to trace this cost to products. In
CIM plants, the only prime cost is direct material costs, and conversion costs consist only
of manufacturing overhead costs.
Measuring Costs Requires Judgment
Measuring costs requires judgment. That’s because there are alternative ways in which
costs can be defined and classified. Different companies or sometimes even different subunits
within the same company may define and classify costs differently. Be careful to
define and understand the ways costs are measured in a company or situation. We first
illustrate this point with respect to labor cost measurement.
CHAPTER 2
42
Measuring Labor Costs
Although manufacturing labor cost classifications vary among companies, most companies
have the following categories:
■
■
Direct manufacturing labor (labor that can be traced to individual products)
Manufacturing overhead (examples of prominent labor components of manufacturing
overhead follow):
• Indirect labor (compensation)
Forklift truck operators (internal handling of materials)
Plant janitors
Plant guards
Rework labor (time spent by direct laborers redoing defective work)
Overtime premium paid to plant workers (explained next)
Idle time (explained next)
ISBN: 0-536-53243-5
Cost Accounting: A Managerial Emphasis, Twelfth Edition, by Charles T. Horngren, Srikant M. Datar, and George Foster.
Copyright © 2006 by Pearson Education, Inc. Published by Prentice Hall.