Conversion Costs
Conversion costs include all direct or indirect production costs incurred on activities that convert raw material to finished goods.
There are two main components of conversion costs: direct labor and manufacturing overheads. Examples costs that may be qualify as conversion costs are wages, rent, depreciation on plant and machinery, plant insurance, plant utilities, supervision, plant repairs and maintenance, etc. etc.
The term conversion cost is typically used in cost of production report of process costing where the percentage of completion of partially manufactured units at the end of an accounting period is typically same for direct labor and manufacturing overheads. In such cases, it is time-saving to calculate equivalent units and unit costs by combining direct labor and manufacturing overheads instead of doing separate calculations for the two cost items.
Formula
Conversion costs are the sum of direct labor and manufacturing overheads.
Conversion Costs = Direct Labor + Manufacturing Overheads
Since total manufacturing costs has three components: direct material, direct labor and manufacturing overheads, conversion costs may also be calculated using the following formula:
Conversion Costs = Total Manufacturing Costs – Direct Material
Example
Use the following information to calculate conversion cost per unit:
| Completed Units | 50,000 |
| Direct Wages | $38,000 |
| Indirect Wages | $5,000 |
| Direct Material | $29,000 |
| Indirect Material | $1,000 |
| Equipment Depreciation | $6,500 |
| Office Expenses | $10,000 |
| Factory Insurance | $2,000 |
Assume that there was no work in process inventory at the beginning and at the end of the accounting period.
Solution
Direct Labor = 38,000
Manufacturing Overheads = 5,000 + 1,000 + 6,500 + 2,000 = 14,500
Conversion Costs = Direct Labor + Manufacturing Overheads = 38,000 + 14,500 = 52,500
| Conversion Cost per unit = | $52,500 | = $1.05 |
| 50,000 |
by Irfanullah Jan, ACCA and last modified on