At the end of each accounting period, accountants who use managerial or cost accounting must finalize the accounting records for the designated financial period. Part of the recordkeeping practices involve calculating the value of all inventories at the close of the period. WIP is one of the three inventories calculated.
Only manufacturers or companies that make products keep track of these inventories. WIP items are enumerated separately from the company's other inventories
At the end of each accounting period, inventories are taken on three types of goods:
- Raw materials -- materials used to make the products
- Work in process also known as work in progress -- not quite finished goods
- Finished goods -- products ready for sale
The value of these inventory items are added to the accounting records at the close of the accounting period. For example, raw materials are valued based on the price paid for them during the period, while finished goods are valued based on the cost calculation of all the materials and labor to make the product.
WIP Valuation Formula
WIP items are assigned a value based on the status of the product at the end of the period. The basic formula for calculating the WIP in a particular period is as follows: Beginning WIP, plus Manufacturing Costs, minus the Cost of Goods Manufactured.
Note the calculation as follows:
- Beginning WIP inventory: $5,000
- Plus manufacturing costs: $10,000
- Subtotal: $15,000
- Less Cost of Goods Manufactured: -$ 5,000
- Equals final WIP number: $10,000
To calculate the cost of goods manufactured, add direct material costs, direct labor costs and manufacturing overhead to equal the manufacturing costs; add it to the beginning WIP and subtract ending WIP for the period to get the costs of goods manufactured.
Assigning a value to WIP items is a fluid and changing process from accounting period to accounting period, as the results may not be entirely accurate due to production errors, scrap material, spoilage and reworking.
Line Items Summarized
While a detailed breakout on the accounting records might show raw materials, WIP and finished goods as separate line items, these usually are summarized on the monthly financial reports.
How each individual company handles its WIP accounting in its financial records may differ from its peers. Many companies find it problematic to come up with an accurate WIP cost, because there are usually too many WIP items at various points of manufacture; some companies elect to transfer all WIP items into their finished goods inventory so that there is no individual WIP line item. Other companies may choose to assign a percentage of completion to all WIP items, averaged over a larger number of the finished products.
While lenders look at inventories for determining loan amounts, most of them won’t consider WIP, because there are no guarantees these items will be completed. The value of finished goods inventory, however can be used by a company to obtain loans.