Prime Cost and Conversion Cost

Two more cost categories are often used in discussions of manufacturing costs—prime cost andconversion cost.  Prime cost  is the sum of direct materials cost and direct labor cost.  Conversion cost is the sum of direct labor cost and manufacturing overhead cost. The term conversion cost is used to describe direct labor and manufacturing overhead because these costs are incurred to convert materials into the finished product.

Exhibit 2–1  contains a summary of the cost terms that we have introduced so far.

EXHIBIT 2–1 Summary of Cost Terms

IN BUSINESS: THE CHALLENGES OF MANAGING CHARITABLE ORGANIZATIONS

Charitable organizations, such as Harlem Children’s Zone, Sports4Kids, and Citizen Schools, are facing a difficult situation. Many donors—aware of stories involving charities that spent excessively on themselves while losing sight of their mission—have started prohibiting their charity of choice from using donated funds to pay for administrative costs. However, even the most efficient charitable organizations find it difficult to expand without making additions to their infrastructure. For example, Sports4Kids’ nationwide expansion of its sports programs drove up administrative costs from 5.6% to 14.7% of its total budget. The organization claims that this cost increase was necessary to build a more experienced management team to oversee the dramatically increased scale of operations.

Many charitable organizations are starting to seek gifts explicitly to fund administrative expenses. Their argument is simple—they cannot do good deeds for other people without incurring such costs.