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,
As we have already discussed, the greater the proportion of prime costs (or direct costs) to total costs, the more confident managers can be about the accuracy of the measured 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 as a direct cost of specific products. Furthermore, if a production line were dedicated to manufacturing 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,
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. The 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 a CIM plant, the only prime cost is the cost of direct materials. The conversion costs for such a plant largely consist of manufacturing overhead costs.