What is a Work-in-Progress (WIP)?
Work-in-progress (WIP) is a term that describes products that are partially finished and at various stages of the production chain.
Work-in-progress (WIP) is a part of a company’s product inventory. It consists of products that the company has partially completed. WIP appears on the balance sheet and accounts for the cost of the raw materials, labor, and overhead that have gone into getting the product to where it is in the chain of production. WIP doesn’t include finished products that the company is holding as inventory or raw materials that the company hasn’t yet used for production. As a product moves through the supply chain, it’s production costs generally increase. The increase in production costs increases the WIP cost for that item. When a company completes a product, the product moves from WIP to finished inventory — and eventually from finished inventory to cost of goods sold when someone buys it.
Fictional table-making company Tables R Us is filing its quarterly balance sheet. At any given time, Tables R Us has tables at various stages of the production chain. When filing its balance sheet, Tables R Us breaks down its inventory into raw materials (those that the company has not yet used for a product), works-in-progress (WIP), and finished goods. When it comes to WIP, Tables R Us reports every cost that has gone into each table so far. Tables R Us reports the WIP inventory as part of its assets regardless of where each table is in production.
Works-in-progress on a balance sheet is like a progress report…
It tells investors how much the company has currently in production in relation to the number of finished goods they have on hand, as well as in relation to the costs of goods sold each period.
Work-in-progress (WIP) is a component of a company’s balance sheet (the financial statement where a company reports its assets, liabilities, and equity). WIP represents any products that are currently in the process of production. It helps companies keep track of which stage of manufacturing a product is now in and how quickly products are moving from one step to the next. WIP is generally a combination of raw materials, human labor, and overhead. Overhead includes indirect expenses such as the cost of rent and utilities.
Work-in-progress does not include raw materials that a company hasn’t yet used in the production of a given product. It also doesn’t include finished goods that have made their way through the production process and are ready to sell. Work-in-progress is an in-between stage between raw materials and finished goods.
Work-in-progress often refers to products that take a while to complete and have a lot of material and labor that go into them. A similar term, work-in-process, also describes products that the company hasn’t yet completed. The terms often appear interchangeably, but most often, work-in-process refers to products that move through the production process from raw material to finished goods fairly quickly. Ultimately both terms apply to partially completed products.
Work-in-progress consists of goods that have entered the production process (meaning they’re no longer just raw materials) but aren’t finished yet. A defining characteristic of work-in-progress is that the company can’t sell these goods yet.
Finished goods, on the other hand, consists of products that have made their way through the entire production process and are ready to sell. Products typically all go through the same general production process:
Raw Materials > Work in Progress > Finished Goods
It’s important to note that the difference between raw materials and finished goods is entirely subjective — based entirely on how a company uses the item. For example, let’s say a company produces and sells nails. For that company, a nail is a finished good that is ready to sell. But for a company that uses nails to create the product they sell, a nail is a raw material. How a company defines a product on a balance sheet is entirely relative to what the company does with the product.
Work-in-progress appears on a company’s balance sheet as a current asset, usually as a subsection of inventory. A current asset is anything that a company should be able to convert into cash within one year. Since most products can generally be produced and sold in less than one year, inventory is recorded as a current asset.
When a company first purchases the raw materials they need to produce a good, those raw materials typically appear on the balance sheet as their own separate subcategory of inventory.
Once a company has used the materials in the production of a good, those materials are moved on the balance sheet to the work-in-progress category. And once the company has finished the product and its ready to sell, it appears on the balance sheet as a finished good (another subcategory of inventory).
To calculate work-in-progress, you have to calculate the sum of all the costs that have gone into getting the product to where it is in the production process. The total cost would include the price of the raw materials, the price of labor, and the cost of the factory overhead that went into the production. That calculation looks like this:
WIP = Cost of Raw Materials + Cost of Labor + Cost of Overhead
Remember that the cost of the work-in-progress will vary depending on where a product is in the supply chain. For example, a good that has just begun production will probably have a lower WIP than a product that is almost finished, because more materials, labor, and overhead have gone into the product that is almost finished.
The total cost of work-in-progress will also vary from one company to another, and from one industry to another. Some industries are more labor-intensive, while others have a lot of raw materials that go into their products. Companies will generally have their accountant calculate work-in-progress for products not yet completed, so they can accurately include it on their balance sheet.
Before a company makes a profit on a product, it often spends a lot of time and money creating the product. Including work-in-progress on a balance sheet allows the company to account for inventory that, while not completed just yet, will soon bring in additional revenue.
Work-in-progress products are worth more than raw materials because they are closer to being ready to sell, and the company has invested human labor into the product. Finished goods are worth more than work-in-progress products because they are ready to sell. A product becomes more and more valuable the further it moves through the production chain.
Investors and analysts can also use work-in-progress when they are looking at a company’s production process. Imagine that a company has more products in work-in-progress than it usually does, but its sales haven’t increased. This increase might be a sign that there are bottlenecks in the production process, and things aren’t running smoothly — or that the business has reason to believe sales are going to spike soon.
More products in work-in-progress could also be a good thing if the company has already increased its sales. In this case, the increase in work-in-progress could be a sign to investors that the company is moving in a positive direction and a sign to the company that it can invest more in labor and overhead.
As you can see, knowing the context behind a change in work-in-progress is essential for being able to really understand what it means for the company.
Job costing and process costing are two different accounting methods a company might use to calculate the cost of its products. Job costing tracks the cost of making a specific product. Companies use this type of costing in industries where each good or service sold is its own separate unit. Nothing is mass-produced — Job costing is typically for custom work.
One example when a company might use job costing is when they provide a service rather than a good, such as a mechanic. Car repairs are not mass-produced. Each time a mechanic works on a car, the costs that go into the job are specific to that project. Another example of when a company might use job costing is if they create high-end, custom products. If a company is building custom furniture, they know the specific costs that went into each piece of furniture.
A company will use process costing if it is producing a lot of a single product. Think about a company that mass produces clothing. To determine the cost of making one shirt, the company would take the total cost of fabric, the total cost of labor, and the total cost of overhead and divide it by the number of shirts they produced. They aren’t calculating the cost of each individual shirt as they go. That just wouldn’t be a productive use of time.
When you consider how each type of costing works, it’s easy to imagine what kinds of companies would use each type of costing. If you’re starting a company, you can quickly determine which type of costing to use depending on whether you provide custom goods and services or mass-produced products.
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