# Conversion: What Is a Conversion?

## Conversion: What Is a Conversion? The conversion price is set when the conversion ratio is decided for a convertible security. The conversion ratio can be found in the bond indenture (in the case of convertible bonds) or in the security prospectus (in the case of convertible preferred shares). During April, Company A has a total cost of \$50,000 in direct labor and related expenses, as well as \$86,000 in factory overhead costs. The conversion cost per unit for the month was thus \$6.80 per unit (calculated as \$136,000 of total conversion costs divided by the 20,000 units produced). ABC International incurs a total of \$50,000 during March in direct labor and related costs, as well as \$86,000 in factory overhead costs.

## What are conversion costs?

If shares never close above the conversion price, the convertible bond is never converted to common shares. The conversion price is set by management as part of the conversion ratio before the convertibles are issued to the public. The conversion ratio is the par value of the convertible security divided by the conversion price. The conversion price is the price per share at which a convertible security, such as corporate bonds or preferred shares, can be converted into common stock. Prime costs are all of the costs that are directly attributed to the production of each product. Prime costs aredirect costs, meaning they include the costs of direct materials and direct labor involved in manufacturing an item.

## What Is the Prime Cost Formula?

If the conversion ratio is 40, or 40 to 1, then each bond with a par value of \$1,000 can be converted into 40 shares of the issuing company. Convertibles are securities, such as bonds and preferred shares, that can be exchanged for a specified number of common shares at an agreed-upon price.

## Prime Costs vs. Conversion Costs: What’s the Difference?

Fixed costs and variable costs make up the two components of total cost. Direct costs are costs that can easily be associated with a particular cost object. For example, variable manufacturing overhead costs are variable costs that are indirect costs, not direct costs. Variable costs are sometimes called unit-level costs as they vary with the number of units produced. Any materials or labor whose direct association in the production process cannot be established must be excluded from the prime costs.

When convertible bonds mature, they can be redeemed at their face value or at the market value of the underlying common shares, whichever is higher. Convertibles can be converted at the option of the investor, or the issuing company can force the conversion.

If the bonds par value is \$1000, the conversion price is calculated by dividing \$1000 by 5, or \$200. If the conversion ratio is 10, the conversion price drops to \$100.

For example, factory overhead and administrative costs are not part of prime costs. From the investor’s perspective, bonds are safer, but they have a limited return. Equity provides an opportunity for share price appreciation, but no protection in case of company default. Convertible bonds, preferreds and debentures provide a hybrid option for companies and investors. Conversion costs include direct labor and overhead expenses incurred due to the transformation of raw materials into finished products.

• Prime costs aredirect costs, meaning they include the costs of direct materials and direct labor involved in manufacturing an item.
• Prime costs are all of the costs that are directly attributed to the production of each product.

Labor that is used to service and consult the production of goods is also included in prime costs. Direct labor examples might include assembly line workers, welders, carpenters, glass workers, painters, and cooks. Direct materials are one of the main components of prime costs and includeraw materialsand supplies that are consumed directly during the production of goods. For example, a bond has a conversion ratio of 5, which means the investor can trade one bond for five shares of common stock. The conversion price of the convertible security is the price of the bond divided by the conversion ratio.

So the market price has to catch up to the conversion price for the security to be converted. A higher conversion ratio results in a lower conversion price, just as a lower conversion ratio results in a higher conversion price. The conversion price is part of determining the number of shares to be received upon conversion.

Tangible components, such as raw materials, necessary to create a finished product, are included in direct materials. For instance, the engine of a car and the spokes of a bicycle are included in direct material costs because they are each necessary to complete production of that specific item. Prime costs and conversion costs are relied upon heavily in the manufacturing sector as a metric to determine efficiency in the production of a specific product. Prime costs are defined as the expenditures directly related to creating finished products, while conversion costs are the expenses incurred when turning raw materials into a product. The trust indenture of the bond specifies the conversion ratio, that is, the number of shares that each bond held can be converted into.

To generate a profit, the table’s price should be set above its prime cost. Variable costs are costs that change as the quantity of the good or service that a business produces changes. Variable costs are the sum of marginal costs over all units produced.

Consider a professional furniture maker who is hired to construct a coffee table for a customer. The prime costs for creating the table include direct labor andraw materials such as lumber, hardware, and paint. The materials directly contributing to the table’s production cost \$200. The furniture maker charges \$50/hour for labor, and this project takes three hours to complete. The prime cost to produce the table is \$350 (\$200 for the raw materials + \$150 in direct labor).

Therefore, the conversion cost per unit for the month was \$6.80 per unit (calculated as \$136,000 of total conversion costs divided by the 20,000 units produced). Conversion costs is a term used in cost accounting that represents the combination of direct labor costs and manufacturing overhead costs.

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Direct labor costs are the same as those used in prime cost calculations. Direct labor costs include the salary, wages, or benefits paid to an employee who works on the completion of finished products. Compensation paid to machinists, painters, or welders is common in calculating prime costs. Unlike conversion costs, prime costs do not include any indirect costs. The calculation for prime costs includes the total amount spent on direct materials in addition to direct labor.

### How do you calculate conversion cost?

Conversion costs is a term used in cost accounting that represents the combination of direct labor costs and manufacturing overhead costs. In other words, conversion costs are a manufacturer’s product or production costs other than the cost of a product’s direct materials.