The term "work in progress" (WIP) is a common term used by many businesses to describe the amount of work completed but not yet released or shipped to customers. It can also be referred to as "in-process inventory" and "inventory on hand."
When running your own business, it is vital to account for how much work you have done so far and the current completion percentage for each project. These financial insights help you plan for future projects and ensure you don't over-commit your business and finances.
Accounting for accurate construction projects requires calculating over/underbilling correctly. Over-billed expenses are short-term losses, and under-billed expenses are immediate gains. If they're wrong, the information is misleading.
Why is WIP Accounting important?
Three primary causes for contractors to experience cost overrun issues, including:
- Failure to accurately track field progress
- Up-front billing miscalculations
- Failure to accurately account for work in progress inventory
WIP is important because it represents the amount of money that's tied up in inventory that isn't generating any income. It's like having cash in a bank account that doesn't earn interest. If you don't want your company to become overstocked, you'll want to keep your WIP low.
It would help if you also considered how much WIP you carry at the end of each accounting period. If you have too much WIP, you risk running into problems when you try to sell your inventory later on.
What is WIP Inventory
WIP inventory includes all the raw materials, partially assembled products, and completed products. For example, you might have a few dozen widgets on the assembly line waiting to be packaged and shipped to customers. Those represent WIP inventory. You could also have several hundred thousand dollars’ worth of raw material inventory sitting around doing nothing. Those are WIP raw materials. Finally, you could have thousands of finished widgets on shelves, ready to ship out to customers. Those are fully valued finished goods.
In most cases, companies track WIP items separately from finished goods. They do this because WIP inventory isn't being used to generate revenue. Instead, they represent expenses that must be accounted for during an accounting period.
There are different ways to value WIP, depending on whether you're valuing it at the beginning or the end of an accounting cycle. You'll value WIP at the current usage level at the beginning of an accounting period. However, at the end of an annual reporting period, you'd account for the value of WIP at the usage level at the start of the previous accounting period.
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WIP Accounting Pricing
There are many ways to calculate WIP pricing. You can choose between three methods:
- Fixed Cost Method: A fixed cost method calculates WIP based on the total cost of all products made during a specific period.
- Variable Cost Method: A variable cost method calculates WIP by dividing the total cost of all items made by the total quantity produced.
- Percentage of Sales Method: A sales method calculates WIP by multiplying the total cost of all production by the ratio of sales to total revenue.
How Do You Calculate WIP?
Manufacturers typically use WIP to account for their raw material inventory costs plus manufacturing overhead. More complex operations, including large construction projects, may involve wages, subcontractor costs, and more.
That's why most manufacturers minimize their inventory levels before counting them at the accounting year's end. To accurately calculate WIP, you need to know two things:
- The total number of units of product that will be produced within a given time frame. This aspect of the calculation is called the production run.
- The average unit price per item.
Once you have these two pieces of information, you can figure out the total value of WIP using this formula
Value of WIP = Total Units x Average Unit Price
For example, if you were producing 100 widgets with an average unit price of $10, you would have 100 units of work in progress inventory. Each device costs $10, meaning the total value of WIP is $1,000.
If you had 500 widgets in stock and wanted to know their value, you'd use the same calculation. You'd multiply the total units by the average unit price in this case. So, 500 widgets x $10 = $5,000.
What Are Some Common Tools Associated with Calculating WIP Inventory?
- Cost of goods manufactured calculation: The cost of goods manufactured (COGM) is the amount of money that goes into making a product. COGM includes the direct costs associated with building a product and indirect costs such as labor, shipping, marketing, and other overhead.
- Direct costs: Direct costs are those related directly to the manufacturing of a product. These include purchasing raw materials, machinery, tools, equipment, and anything else needed to make a product. Indirect costs don't directly relate to the actual process of creating a product. Examples include insurance, utilities, rent, salaries, taxes, etc.
- Overhead costs: Overhead costs include everything not directly related to the creation of a product. This overhead could include administrative expenses, office space, employee benefits, etc.
- The flow of costs: The flow of costs is the movement of money from one part of a business to another. It's the money flow from the manufacturer to the retailer or wholesaler.
- Work in progress vs. Work in process: Both "work in progress" and "work in process" are commonly misinterpreted as referring to unfinished or incomplete inventory or projects. However, work in process is the term used to refer to unfinished goods, which are usually turned from raw materials into finished goods within a short period. On the other hand, work in progress is used to report on significant amounts of capital assets on longer schedules that are still to be completed. Work in process materials transfer to inventory and are used to calculate the costs of goods sold. Work in progress is reported as a capital asset and depreciates once complete.
Accounting Software to Help Calculate WIP
WIP (Work in Progress) software is an accounting solution for better managing finances, invoicing, and bookkeeping services for contractors, services, and manufacturing businesses.
Modern WIP accounting solutions are cloud-based applications that allow businesses to track and manage their work in progress (WIP) inventory, pricing, and finances. The WIP solutions help companies improve productivity, reduce costs, and provide better financial visibility to current and future projects. With WIP Software, you can eliminate the need to juggle multiple systems to manage workflow, inventory, and accounting.
For example, with Deltek ComputerEase, a cloud-based solution for construction firms, businesses can access financial and project data on any device, anytime, from anywhere.
