What is Conversion Cost?
Conversion cost is the combined cost of direct labour and manufacturing overheads incurred to convert raw materials into finished products. Unlike prime cost, it excludes the cost of direct materials and reflects the effort and resources needed for the conversion process itself.
How It Works
- Identify direct labour for the production period.
- Add manufacturing overheads (indirect materials, supervision, utilities, depreciation of factory assets).
- Divide by units produced to get conversion cost per unit.
- Use it to assess process efficiency and to set inventory values under IAS 2.
Saudi Context
Saudi industrial cities such as Jubail and Yanbu rely on conversion cost analysis to monitor productivity in petrochemical and heavy-industry plants. Industrial Modon-licensed factories often track conversion cost monthly as a KPI for plant managers.
Example
A Dammam plant pays SAR 80,000 in direct labour and SAR 120,000 in overheads to produce 10,000 units. Conversion cost per unit is SAR 20 (SAR 200,000 / 10,000), which the company adds to direct materials to value its finished inventory.