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Definition

Conversion Cost

What is Conversion Cost?

Conversion Costs consist of the sum of labor costs and overhead costs. These are mixed costs since it is manpower plus overhead that joins to transform raw ingredients into a completed piece. 

Understanding Conversion Cost

In costing systems, the notion is used to determine the price of closing stock, which is subsequently reflected in the financial accounts. We can also use it to calculate the additional cost of an item and it can be beneficial for price-fixing.  

The budget manager, as well as other supervisors, utilize conversion costs to analyze the quality and productivity of the two expenses rather than just evaluating the inventory for accounting reasons. 

The Two Costs

  • Manufacturing Overheads: These are costs that may be precisely ascribed to every single material or activity. These include things like power costs, rents, amortization, equipment coverage, machine renovations, etc.
  • Direct labor: The expenditures which are connected with the people who are producing the goods. Wage rates, worker healthcare expenses, pension scheme payments, incentives, and any other expenses linked with the hired laborer participating in the production line may be included.

Formula

Because converting procedures need manpower and industrial expenses, conversion costs are calculated as follows:

Conversion Cost = Direct labor + Manufacturing Overhead Costs

Practical Example

In other words, both the dry and liquid ingredients (materials) are added at the beginning of the process to make Eggo Waffles. The conversion costs (labor and overhead) related to the mixing of these ingredients were incurred uniformly and are 70% complete. The ending work in process is 100% complete as to materials cost and 60% complete as to conversion costs.

In Sentences 

  • Functional managers frequently use conversion costs to discover where wastage potentially exists in the process of production.

 

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