conversion cost accounting

conversion cost accounting

The Significance of Conversion Cost Accounting in Modern Business Operations

1. Introduction to Conversion Cost Accounting

Introduction to the conversion cost accounting system was first referred to by Cynthia Y. Lovell in 2003. The purpose of this article is to provide a managerial and mathematical visual of production operations and the costing methodology used for conversion cost accounting in a full absorption-cost environment. The following procedure is used to illustrate the principles of conversion cost accounting: review the major principles of conversion cost accounting.

Historically, what is now referred to as cost accounting was used at the management level in the early days to assist with decision making, but it mainly was used as construction accounting. In 1910, the concept of a work-in-process control account was first used as an auxiliary control account within the cost ledger. Industrial organizations did not uniformly adopt cost accounting until 1925. Then, with the advent of the Great Depression in the 1930s, organizations began using cost accounting for cost purposes to control operations. Now, in 2008, we are using cost accounting, especially conversion cost accounting, to control and manage business operations. Product costing and cost accounting are now such an integral part of modern business operations that, because it has become ingrained in day-to-day operations, we generally equate the characteristics of businesses to product costing and cost accounting.

2. Key Components of Conversion Cost Accounting

To perform well, conversion cost analysis must depend on and intersect with four other types of accounting and information activities. A clear sense of the nature and purpose of each of these five segments of activity will reveal the special nature of conversion cost analysis. Recognition of the dependence and intersection of these five information functions will assist in proper design for them. The five necessary components are: accrual accounting for production costs, profits, and losses; budgetary planning and cost accounting for production costs; standards and budgeting for work effort; capacity measures and controls; used in combination and projected to future operations. Each of these functions rests on the base of cost accounting for historical production costs, a point that is stated and restated. Each component, adjusted to depend more heavily on production cost data of in any case, does its job because of this dependence and the particular perspective that frame its methods and techniques.

The most basic purpose of conversion cost accounting is to determine the costs of making a product ready for sale. In modern business, this accounting practice exists as industrial and business activity becomes more diverse and entailed. Although every team of production specialists and business executives must attend to converting specific costs or solving some difficulty connected with them, practices for recording and accumulating manufacturing or production costs remain relatively simple. This system is inflexible and unresponsive to the increasingly diverse needs and requirements of the management of production and marketing. Such services within the general accounting framework could make a contribution of notable significance. Such accounting services do not exist on a consistent and comprehensible basis in business and accounting practice. Their inability to meet actual business needs is an important factor in the general dissatisfaction that exists with the present state of manufacturing and production accounting and other types of business accounting.

3. Benefits and Challenges of Implementing Conversion Cost Accounting

Although this system is beneficial for companies, pharmaceutical businesses that are using the system also encounter challenges to efficiently implement it. These authors mentioned that it is costly to implement conversion costing for commercial companies because they need to justify the indirect expenses incurred on each product, line, or unit of production within a generally accepted accounting framework. Different problems are encountered during the implementation of the system, such as a lack of a proper cost allocation method to assign manufacturing overhead to products or services promoted. Among other problems, companies also face the challenge of how rejected products are to be priced considering their fixed costs. The system also fails to identify the difference in cost in products or processes where varying grades of quality are manufactured in the same plant.

4. Case Studies and Practical Applications of Conversion Cost Accounting

This research stresses the idea of the scope of conversion cost accounting and its directions, and demonstrates case studies and practical applications too. Some basic information required for the qualitative and quantitative decision financed by conversion costs should also be recognized, approved, and modified. The economic necessity for financial indicators and standards is also proved. All links in the chain of general and factory conversion costs, as well as links to protection and operational activity, should be used. Tracking and defining the components of each conversion cost, as well as studying the properties of conversion operations and conversion products, should lead to the efficiency and profitability of state-of-the-art economic systems.

Conversion cost accounting procedures are currently utilized in national and international manufacturing and service industries, where the general business activities include a sequence of consecutive operations, such as agriculture (growing fruit and vegetables), zoology industry (poultry farming), great economics (central bank minting), forestry industry (timber cutting), fishing industry (fish preserving), mining industry (mineral beneficiating), chemistry (all chemically kind of processing), food industry (flour milling, fruit cannery), woodworking industry (veneer and plywood making), building and publishing industry (printing house book printing). There are also liberal professions, such as dentists, veterinarians, and notaries.

5. Future Trends and Innovations in Conversion Cost Accounting

Secondly, improvements in the assessment of these costs, helping management evaluate the contribution made by all resources, fully including human capital. Improvements in laying open the resources’ consequences of alternative strategies and products, further developments in the assessment of core competence and other competitive difference makers, and developments in the management of intangibles, complementing, however, not replacing, the conversion cost approach.

Firstly, space in the cost partition is here to stay and should remain an important input into control judgments and decisions. This account is likely to remain in existence for many years to come and continue as a designing, planning, cost determination, control, and value improvement measure.

In order to assess what the future holds for conversion cost accounting in view of the global business environment, industry, and management practices, various emerging trends and innovations can be discernible. Some of the most important future features of this control tool can be briefly outlined.