What are Prime Costs?

Prime costs are the costs directly incurred to create a product or service. These costs are useful for determining the contribution margin of a product or service, as well as for calculating the absolute minimum price at which a product should be sold. Prime costs include direct materials (the raw materials and components used in the production of goods) and direct labor (the wages paid to workers who are directly involved in manufacturing or assembling a product).

What are Conversion Costs?

Conversion costs are those production costs required to convert raw materials into completed products. These costs include direct labor and factory overhead, but not raw materials. Examples of conversion costs are production line labor, equipment maintenance, factory rent, inspection costs, and small tools charged to expense.

Comparing Prime Costs and Conversion Costs

The difference between the two cost classifications is that prime costs only relate to direct material and direct labor costs, while conversion costs only include direct labor costs and factory overhead costs. Thus, the essential difference is that prime costs do not include the factory overhead costs that are included in conversion costs, while conversion costs do not include the direct material costs that are included in prime costs. Conversion costs can be considered to layer on top of prime costs, where they are needed to convert raw materials into finished goods.