## Cost of Conversion
Applies to manufactured goods (converting RM → FG). Includes:
1. Direct Costs: Direct Material + Direct Labour + Direct Expenses
2. Variable Production Overheads: Allocated based on actual capacity used
3. Fixed Production Overheads: Allocated based on normal capacity
## Fixed Overhead Allocation — The Core Rule
$$\text{Fixed OH Rate} = \frac{\text{Fixed OH}}{\max(\text{Normal Capacity, Actual Production})}$$
Why: Normal capacity prevents low-output periods from inflating unit cost. But if actual > normal, using normal would over-absorb (more than 100%), so we cap at actual.
### Three Scenarios:
| Situation | Divide By | Absorbed into Inventory | Balance to P&L |
|---|---|---|---|
| Actual \< Normal | Normal capacity | Rate × Actual units | Remaining (loss) |
| Actual = Normal | Normal capacity | Full Fixed OH | NIL |
| Actual > Normal | Actual capacity | Full Fixed OH (lower rate) | NIL |
Unabsorbed fixed overhead (when actual \< normal) is treated as a period expense — charged to P&L, NOT carried forward in inventory.