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Direct materials are $700, direct labor is $500 and factory overhead is $300. Why does adding prime cost to conversion cost overstate the total product cost?
AFactory overhead is counted twice in that sum
BDirect materials are counted twice in that sum
CDirect labor is counted twice in that sum
DPeriod costs are counted twice in that sum
Answer & Solution
Correct answer: C. Direct labor is counted twice in that sum
1. Prime cost is direct labor plus direct materials, which is $500 plus $700, or $1,200.
2. Conversion cost is direct labor plus factory overhead, which is $500 plus $300, or $800.
3. Adding the two gives $2,000, but the true total product cost is $700 plus $500 plus $300, or $1,500.
4. The $500 gap is exactly direct labor, because direct labor appears in both groupings.
5. Direct materials appear only in prime cost and factory overhead only in conversion cost, so neither is doubled.
6. Period costs are selling and administrative expenses and never enter either grouping.
_Source: Jonick, Principles of Managerial Accounting (UNG Press, CC BY-SA 4.0), section 1.2 Cost Terminology and Concepts_
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