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 cost and manufacturing overhead costs. Examples costs that may be qualify as conversion costs are wages, rent, depreciation on plant and machinery, factory insurance, factory utilities, supervision, factory repairs 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 factory overhead. In such cases, it is time saving to calculate equivalent units and unit costs by combining direct labor and factory overhead instead of doing separate calculations for the two and theses two costs are termed as conversion costs.

Formula

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

Factory Overhead
= 5,000 + 1,000 + 6,500 + 2,000
= 14,500

Conversion Costs
= Direct Labor + Factory Overhead
= 38,000 + 14,500
= 52,500

Conversion Cost per unit = $52,500 = $1.05
50,000

Written by Irfanullah Jan