Conversion cost

Conversion cost
See also
Direct expense Cost Product cost Cost element Indirect labor Costs and expenses Indirect material Operating expense ratio Functional budget

Conversion Costs - this term is connected with generation of costs during manufacturing process. Conversion costs consist of elements, which transform raw materials to completed goods. When manufacturers produce goods should take into account three key cost ingredients because it is essential to produce finished products, that are : direct materials, direct labour and manufacturing over head (Walther, Skousen 2009, pp. 26-27). Conversion costs for prepared products should contain all cost directly connected with the units produced, such as labor cost and overhead costs. Cost other than this and material cost are capitalized just to the range they are essential to redound products to their actually position and location (Wiley et al. 2015, p.142).

Cost Components

All companies know the three ingdredients of manufacturing costs and it consists of prime costs and conversion costs (Hart, Wilson, Fergus 2012,p.19):

• Prime costs = direct material + direct labour:

Factory outlay are classified in the regular way as indirect costs or overheads.

• Conversion costs = direct labour + overhead costs:

This type of outlay can be used where there are superior levels of automation in the manufacture cycle what result less direct labour costs and comparatively higher overheads. Service organizations have not materials costs but they have direct labor costs and overheads costs, which are suchlike to production organizations (Needles et al. 2010, p.864).

Elements of conversion costs

Conversion costs consist of direct labour and manufacturing overhead (Walther, Skousen 2009, pp. 26-27):

• Director labour – this item includes gross wages paid to those who work on the product being fabricated.
• Manufacturing overhead – this item includes cost of production but other than direct materials and direct labour, it indirect materials, indirect labor, factory connected deprecation, insurance, repair, conservation, property taxes, utilities etc.

Subdiviosion of the conversion cost - example

For example, in economics of staple yarn production conversion costs refer how the fibres affect to the mechanism and moreover it has commercial importance of its quality and costs, then primary divisions of conversion cost are (Lord 2003, p.301):

• direct labor costs
• overhead costs
• capital costs of machines
• space costs
• power costs

Cash conversion cykle

The cash onversion cycle of a firm is the term used to describe length of time among payment and receipt cash inflows. Cash conversion cykle includes activities such as (Whittington 2015, p.242):

• repay providers
• completed products and sell tchem
• assemble receivable

References

• Ajanović A. (2011). Biofuels versus food production:Does biofuels production increase food prices?, „Energy”, Issue 4, pp. 1-7.
• DeBald P.S., Dale M.E. (1991). Tree Value Conversion Standards Revisited, „Northeastern Research Station”, 645, pp.1-29.
• Hart J., Wilson C., Fergus Ch. (2012)., Management Accounting :Principles & Applications.
• Lord P.R. (2003)., Handbook of Yarn Production:Technology, Science and Economics.
• Miao R., Feng H., Hennessy D.A. (2014). Sodbusting, Crop Insurance, and Sunk Conversion Costs. „Land Economics”, 601- 622.
• Needles B.E., Powers M., Crosson S.V. (2010)., Principles of Accounting.
• Walther L.M., Skousen C.J. (2009)., Managerial and Cost Accounting.
• Whittington O.R. (2015)., Wiley CPAexel Exam Review 2015 Study Guide:Business Environment and Concepts.
• Wiley J., Chaudhry A.,Coetsee D., Bakker E., Varughese S.,Mcllwaine S.,Fuller C.,Rands E.,Vos N., Longmore S., Balasubramanian (2015)., Wiley Interpretation and Application of International Financial Reporting Standards.

Author: Marta Bartula