When you talk to manufacturers, they frequently use a term called ‘conversion costs’ and a few of them also use the term ‘Prime Costs’ (especially used by Chinese vendors). A typical manufacturer would look at charging you as below:
So, you could guess: Conversion Cost is the total cost that is borne by the manufacturer to convert the raw-material into finished goods. It includes all manufacturing costs except the raw-material cost i.e. all direct labor costs and manufacturing overheads. Prime Costs are all the costs that can be associated directly with the production of a unit, it comprises of all direct material costs and direct labor costs.
Typically, there are costs that are involved in the production of finished goods directly such as raw-material and costs that are not directly involved in the production of finished goods such as building rent. Therefore, there are direct costs and indirect costs. Usually, direct costs are variable costs in proportion to the production volume and indirect costs are usually fixed costs such as rent, electricity, etc. However, there can be exceptions sometimes.
Prime costs = direct materials cost + direct labor cost
Conversion costs = direct labor cost + manufacturing overhead costs
Chesters Furniture is a small furniture manufacturer. In the first week of June, they worked exclusively on an order to build 5 study tables.
Costs incurred are in the first half of the table, and the calculation of conversion costs are in the second half of the table.
Another Example of Calculation of Conversion Costs:
Hope this is helpful, thank you.