A company’s production department is full of costs. Each cost represents a part of materials, labor or overhead needed to produce finished goods. Conversion costs include direct labor and manufacturing overhead. These items are necessary to convert raw materials into finished products. Companies often have different methods for computing these costs and applying them to produced goods. Cost accountants are the primary individuals for reviewing production data and calculating the conversion costs. This process continues in perpetuity until the company stops producing goods.
Track the labor needed to transform raw goods to finished products. Require all production employees to sign in and out on a time sheet document. Add up all the hours and multiply by the labor costs to determine aggregate direct labor costs for the project.
Identify all indirect costs associated with running the production department. These costs include maintenance, utilities, quality-control wares, production facility security, depreciation and minor supplies.
Total all the manufacturing overhead costs. A common method for this is to include all these costs for a certain time period, such as one month.
Add the total direct labor costs and the total manufacturing overhead costs.
Divide the total cost from Step 5 by the number of goods produced during the same time period. This represents the conversion cost per unit for all produced goods.
Both job order and process costing can use conversion costs for producing goods. Companies may be more willing to apply this concept to process costing, however, due to the inherent characteristics found in this production method.