Formula of Conversion Cost
Conversion Cost is the total cost incurred by a company to convert raw materials into finished goods. It includes all direct labor, overhead expenses, and other costs associated with the manufacturing process, excluding the cost of raw materials. The formula for conversion cost is:
Conversion Cost = Direct Labor Cost + Manufacturing Overhead Cost
Example:
Suppose we have a small furniture manufacturing workshop called “Woodworks Inc.” The company produces handmade wooden furniture, ranging from tables to chairs. Let’s break down how we can calculate the conversion cost using this example:
Direct Labor | At Woodworks Inc., skilled craftsmen directly contribute to the production process by crafting the furniture pieces. These craftsmen are paid wages for their work. Let’s say the company spends $12,000 per month on paying the craftsmen. |
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Manufacturing Overhead | Aside from direct labor costs, Woodworks Inc. also incurs expenses to keep the production running smoothly. This includes costs like rent for the workshop space, electricity bills, maintenance of woodworking machinery, and other overhead expenses. Let’s assume these overhead costs amount to $8,000 per month. |
Calculation |
To find the conversion cost for Woodworks Inc., we add the direct labor and manufacturing overhead costs:
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Explanation | The conversion cost of $20,000 per month represents the total amount spent by Woodworks Inc. to transform raw materials (wood) into finished furniture products ready for sale. This includes the wages paid to craftsmen for their labor and the various overhead expenses incurred to maintain the production environment. |
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