What are conversion costs?

Conversion costs are those costs required to convert raw materials into finished goods that are ready for sale.

Since conversion activities involve labor and manufacturing overhead, the calculation of conversion costs is:

Conversion costs = Direct labor + Manufacturing overhead

Thus, conversion costs are all manufacturing costs except for the cost of raw materials.

Examples of costs that may be considered conversion costs are:

• Direct labor and related benefits
• Equipment depreciation
• Equipment maintenance
• Factory rent
• Factory supplies
• Machining
• Inspection
• Production utilities
• Production supervision
• Small tools charged to expense

If a business incurs unusual conversion costs for a specific production run (such as reworking parts due to incorrect tolerances on the first pass), it may make sense to exclude these extra costs from the conversion cost calculation, on the grounds that the cost is not representative of day-to-day cost levels.

Example of Conversion Costs

ABC International incurs a total of $50,000 during March in direct labor and related costs, as well as $86,000 in factory overhead costs. ABC produced 20,000 units during March. Therefore, the conversion cost per unit for the month was $6.80 per unit (calculated as $136,000 of total conversion costs divided by the 20,000 units produced).

Related Questions

What is the cost of labor?
What is direct labor cost?
What is direct material cost?
What is manufacturing overhead?