Conversion costs are all the costs that are borne to convert raw material into finished goods. Both these costs can be used by the management to evaluate the efficiency of the production process in different ways. Prime costs ad conversion costs are different in their calculation, presentation and objective.

• Conversion costs include the direct labor and overhead expenses incurred as raw materials are transformed into finished products.
• Manufacturing overheads used in calculating conversion costs are the overheads that cannot be attributed to the production process or a single unit in production, for example, rent or electricity.
• For example, prime cost does not contain overhead charges that are applied in conversion cost.
• For instance, the engine of a car and the spokes of a bicycle are considered direct material costs because they are necessary to complete the production of those items.
• Prime costs and conversion costs include some of the same factors of production expenses, but each provides a different perspective when it comes to evaluating production efficiency.
• To conversion cost of the chair will neglect any costs related to the material that goes into the production of the chairs.

Tangible components—such as raw materials—that are needed to create a finished product are included in direct materials. The raw materials are considered direct material costs and are not included in conversion costs. Instead, these expenses are included in another category of production costs called prime costs. Rather, such expenses are considered as indirect labor which goes to the entity’s total manufacturing overhead cost (discussed later in this article). Examples of such expenses include the salaries of production supervisor and factory watchman etc. Conversion cost, as the name implies, is the total cost that a manufacturing entity incurs to transform or convert its direct materials into salable or finished product.

Omit ‘Indirect’ Costs

You must know what the conversion cost formula is so that you must know about the spending, PPC ROI and wastages happening in campaigns. To conversion cost of the chair will neglect any costs related to the material that goes into the production of the chairs. These include the $5 for wood, $4 for the frame of the chair and $3 for paint and other small materials. The electricity expense of the factory for a month is $5,000 of which $1,000 is attributed to the chair production process. Furthermore, the rent paid on the factory is $10,000 of which $2,000 is attributable to chair production.

• This can be used in pricing decisions when deciding the price of a product.
• A periodical review of the firm’s prime cost is crucial to ensure the efficiency of its manufacturing process.
• It is also commonly referred to as the cost of conversion or cost per conversion, the latter of which is commonly abbreviated as CPC don’t confuse it with cost per click.
• First, let’s understand some overview of the basic costs structures as below.
• Conversion Costs can be defined as the aggregated costs that include direct labor, and manufacturing overhead costs.

While the fully automated production does not need direct labor, it does need indirect labor in each step to ensure the machines are operating properly and to perform inspections (step 4). Conversion costs include all direct or indirect production costs incurred on activities that convert raw material to finished goods. The primary difference between the two is that the formula for conversion costs takes overhead into account. For this reason, it’s a more relevant number for operations managers, who may be looking at ways to reduce the indirect expenses of production.

Manufacturing overheads:

To complete a product, prime cost includes both direct material and direct cost, whereas conversion cost does not. For example, prime cost does not contain overhead charges that are applied in conversion cost. The prime cost’s major goal is to set the price of a product with the intended profits. The conversion cost, on the other hand, is estimated to total and resolve any production inefficiency. Although enrolled agent salary guide the prime cost is computed and given at the start of the cost sheet, there is a fixed standard that requires the computation of conversion cost until and unless the manager demands it. That is, if the prime costs are the set of expenses that are directly related to the manufacture of a product or the provision of a service, in this case the conversion costs are part of the manufacturing costs.

Consider a professional furniture builder who is commissioned to build a coffee table for a customer. The primary costs for making the table include both the cost of the furniture maker’s labor and the raw materials needed to build the table, such as lumber, hardware, and paint. Suppose that the cost of the raw materials—lumber, hardware, and paint—totals $200. The furniture maker charges $50 per hour for labor, and the project takes three hours to complete. Some costs, notably labor, are included in each, so adding them together would overstate manufacturing cost. Conversion costs are calculated in order to know the cost per unit, which assists the company in deciding a price for the product.

Cost of Goods Sold: Definition, Formula, Example, and Analysis

Conversion costs are restricted to direct labor and manufacturing overhead, which are needed to convert raw materials into completed products. Prime costs are the direct labor and direct materials costs incurred to build a product. Therefore, one difference between the two concepts is that manufacturing overhead is only included in conversion costs.

What is Operating Gearing? Definition, Formula, Example, and Usages

A cost unit is a product or service unit to which manufacturing costs can be assigned. For example, in the case of a phone manufacturer, the cost unit would be “per unit of phone.” It is critical to define cost units in order to accurately charge the costs incurred in all manufacturing processes. Conversion costs must be determined by each organization since they are critical for making significant business decisions and performing basic accounting procedures. It is calculated to determine the cost per unit, which aids the corporation in determining a price for the product. Operations managers use conversion costs to help identify waste within the manufacturing process.

What is Conversion Cost? Definition, Formula, Example, And Importance

Confirm that the landing page is relevant to the viewers and encourages them to complete the action that is your goal. For example, if your conversion metric is signing up for your email list, the signup form should be prominent. How to assess conversion cost if it is watching a video, the video should be prominent. Keep the pages simple, so viewers are more likely to perform the action you want. You use the cost per conversion to figure out how much you spend on getting each conversion. If your cost per conversion is less than your sales per conversion, great.

Other approaches related to Conversion cost

Learning about computing conversion cost is as simple as dividing the total amount spent on a marketing campaign by the number of conversions it results in. Once you assess conversion, you can use the information to better allocate your budget and improve returns. Or you can use the conversion cost to confirm that your changes to campaigns were effective. In the case of high conversion costs, there is always room for improvement. If you do not like what you see when you assess conversion costs, then you will want to see what steps you can take to reduce those costs.