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

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