The classification of costs in each of these categories is covered in the Building Blocks of Management

Accounting chapter. These costs determine the value of inventory until it is sold, at which time the
inventory is expensed as cost of goods sold. Although it may seem relatively straightforward,
management accountants can spend a significant amount of time and effort attempting to accurately
determine product costs. 5.1.1.1 Prime costs Management accountants refer to the direct costs used to
manufacture a product as prime costs. Therefore, for most manufacturing operations, prime costs
include direct materials and direct labour. Prime costs are particularly important in organizations where a
major component of a product’s total cost is material and labour — for example, in a craft operation
requiring expensive raw materials or in food processing industries. If the organization chooses to track
other resources that a product consumes during production, such as factory supplies and electricity,
these would also be treated as prime costs. Figure 5b: Prime costs Management Accounting Chapter 5:
Cost Behaviour and Job Costing 103 5.1.1.2 Conversion costs Accountants refer to all manufacturing
costs other than direct materials costs as conversion costs, because these costs are required to transform
direct materials into the final product. Conversion costs include direct labour costs, variable
manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs
Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually
exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a
direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of
converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that
accountants (financial or management) do not count as product costs. Financial accountants treat all
non-manufacturing costs, such as selling, administrative, and research and development costs, as period
costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs.
Period costs are expensed as incurred. Management accountants have some flexibility when classifying
costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the
cost object in a way that will assist in assessing those costs when making decisions. For example, a
management accountant might treat advertising designed to promote a company’s name as a period
cost but treat advertising designed to promote a specific product as a product cost. Period costs can be
referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or
operating expenses. Management Accounting Chapter 5: Cost Behaviour and Job Costing 104 5.1a Let’s
look at an example Troy & Troy Co. is a Calgary-based manufacturer of rolled-steel products from
recycled materials. In the month of June, Troy & Troy incurred the following costs: • commissions paid to
sales force • wages paid to workers • rent paid for factory equipment • steel used in a steel fabrication
plant • lubricants for production machines • plant manager salary • quality control in a factory • freight
paid for materials purchases Abed, the company’s management accountant, has been asked to classify
each of the costs as prime, conversion, or period costs, as follows: