It means all the costs that a company incurs in its production process for converting raw materials into finished goods. There can be two situations, either the complete conversion process -raw materials to finished goods happens within the factory itself. Or the raw materials move out to another factory for the purpose of conversion. The conversion cost calculator considers all the costs up to the level of manufacturing cost or production cost. But this does not include the cost of materials. Because the concept of conversion cost says that all the costs incurred in the process of converting raw material into finished goods. Hence, it is not a part of the process and it is the next level of costs. Raw materials are the products on which the processing happens.
Importance and Use
This cost is of particular importance where the company has to send their products outside the factory for converting them into finished goods due to some unavoidable reasons. These circumstances may be a breakdown of machine or equipment, to supply goods more than the installed capacity, etc. This will help the company to estimate the price it will have to pay for outsourcing the process of conversion.
Similarly, the company may take up the work of providing services, by way of converting raw material into finished goods, of any outsider. In other words, the company may be a job contractor and the customers would like to get processed their raw materials through it. This may be because of the existence of idle capacity or it is set up with a clear objective to concentrate on production only. And leave the other headaches to the other companies like selling, distribution, arrangement of raw materials and so on. Hence, the company would be able to determine the cost it will charge for providing such services by adding its margin in the conversion cost.
This concept will also help in arriving at the cost of finished goods.
We add up the cost of direct labor and manufacturing overheads in order to calculate conversion cost. Mathematical representation of same is as follows:
Conversion Cost = Direct Labor Cost + Manufacturing Overheads
One more way to calculate conversion cost is by deducting the amount of direct material from the total manufacturing cost. A representation of the same is as follows:
Conversion Cost = Total Manufacturing Cost – Direct Material
How to Calculate using Calculator?
The conversion cost calculator requires the following two variables to be entered into it.
Direct Labor Cost
It is the cost that can be directly attributed to the products. It includes payments made to workers or employees directly engaged in the production of such goods.
All the indirect expenses incurred in the processing of raw materials into finished goods that one cannot assign directly to such finished goods produced comprises manufacturing overheads. These include rent of factory building, depreciation of assets engaged in the production process, power & fuel, etc.
Let us take an example for more clarity. X Ltd manufactures 2500 units of an article for which it buys raw material of $14,000. Direct wages: $7,500, and manufacturing overheads totaled $5,600.
The conversion cost for the article is as below:
Conversion Cost = $7,500 + $5,600 = $13,100
Conversion Cost per Unit = 13,100/2500 = $5.24