ACCA MA: materials, labour and overheads explained
This outcome asks you to classify costs by element (materials, labour, expenses) and by function (production, administration, selling, distribution). The examiner likes it because one misplaced cost changes prime cost, conversion cost or production overhead, so it tests precision with simple numbers.
The rule
Prime cost = direct materials + direct labour + direct expenses. Conversion cost = direct labour + direct expenses + production overhead (it excludes direct materials). Production overhead is only indirect cost incurred in the factory; administration, selling and distribution costs sit outside production cost. Direct materials used = opening inventory + purchases - closing inventory.
Worked example
A factory has: opening materials $8,000, purchases $52,000, closing materials $6,000 (all direct); direct wages $30,000; royalty on units produced $4,000; indirect factory wages $9,000; factory power $5,000; office salaries $7,000.
Direct materials used = 8,000 + 52,000 - 6,000 = $54,000.
Prime cost = 54,000 + 30,000 + 4,000 royalty = $88,000.
Production overhead = 9,000 + 5,000 = $14,000 (office salaries are administration, so excluded).
Conversion cost = 30,000 + 4,000 + 14,000 = $48,000.
Total production cost = 88,000 + 14,000 = $102,000.
Remember: a royalty on units produced is a direct expense and belongs in prime cost, while conversion cost never includes direct materials.
Where candidates lose marks
Using purchases instead of materials used (opening inventory + purchases - closing inventory) when calculating direct materials.
Adding indirect wages and factory power to prime cost instead of treating them as production overhead.
Calling direct materials + direct labour + overhead 'conversion cost' when it is actually total production cost.
Including office salaries, sales commission or delivery vehicle costs in production overhead.
Try it: 4 questions
Aqua Vale Co, a water utility, produced the following figures for 20X5. Opening raw materials were $8,000, purchases $52,000 and closing raw materials $6,000, all of which are direct materials. Direct wages were $30,000. A royalty of $4,000 was payable on the units produced. Factory indirect wages were $9,000 and factory power cost $5,000. What is the prime cost?
Answer: C. Prime cost = direct materials + direct labour + direct expenses. Direct materials used = 8,000 + 52,000 − 6,000 = $54,000. Prime cost = 54,000 + 30,000 + 4,000 royalty = $88,000. $84,000 omits the royalty, which is a direct expense. $86,000 uses purchases ($52,000) instead of materials used. $102,000 wrongly adds indirect wages ($9,000) and power ($5,000), which are production overheads.
A trainee at Brightbox Toys Co calculates conversion cost for the period as: direct materials $40,000 + direct labour $25,000 + production overhead $15,000 = $80,000. There are no direct expenses. Which statement correctly identifies the error and the correct conversion cost?
Answer: A. Conversion cost is the cost of converting materials into finished goods: direct labour + direct expenses + production overhead. Here that is 25,000 + 15,000 = $40,000. The trainee included direct materials, which are not a conversion cost. $65,000 (direct materials + direct labour) is prime cost, and it wrongly excludes overhead. $55,000 wrongly excludes direct labour. $80,000 is total production cost, not conversion cost.
A city council runs a workshop making sports equipment for its leisure centres. Monthly costs are: factory depreciation $6,000, factory heating $2,000, office salaries $8,000, sales staff commission $3,500, delivery vehicle running costs $2,500, factory supervisor $4,000, finance director's salary $7,000. What is the total monthly production overhead?
Answer: A. Production overhead includes only costs incurred in the factory: depreciation $6,000 + heating $2,000 + supervisor $4,000 = $12,000. Office salaries and the finance director's salary are administration costs. Sales commission is a selling cost and delivery vehicle running costs are distribution costs. $14,500 wrongly adds delivery costs. $20,000 wrongly adds office salaries. $33,000 adds every cost listed.
Marlow Boats Ltd builds fibreglass and timber boats. Which TWO of the following are classified as production overheads?
Select the two that apply (each shows on its own).
Answer: B, D. Production overheads are indirect materials, indirect labour and indirect expenses incurred in the factory. Glue and screws are indirect material: they do become part of the boats, but the amounts are insignificant and not worth tracing to each boat. Factory rent is an indirect production expense. Wrong options: marine-grade timber is a direct material because it is easily traced to each boat; this is the 'physically part of the product' reasoning. Hull fitters' wages are direct labour. The sales manager's salary is a selling cost, not a production cost, so it is outside production overhead.
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What is the difference between prime cost and conversion cost?
Prime cost is direct materials, direct labour and direct expenses. Conversion cost is direct labour, direct expenses and production overhead, so the two share labour and expenses but only prime cost includes direct materials.
Is a royalty a direct or indirect cost?
A royalty payable per unit produced is a direct expense, so it is included in prime cost. It is not an overhead.
Which costs are included in production overhead?
Only indirect costs incurred in the factory, such as factory depreciation, heating, power, indirect wages and supervisors' salaries. Administration, selling and distribution costs are excluded.