Work-in-Process Inventory (WIP)

Work-in-process (WIP) inventory, also written work in progress, is the cost of goods that a manufacturer has started making but has not yet completed at a given date. It includes the direct materials already issued to production, the direct labor already spent on the goods and the share of manufacturing overhead applied to them so far. WIP is the middle of the three inventory stages in manufacturing, between raw materials and finished goods, and it is reported on the balance sheet among current assets, either separately or within total inventories with a breakdown in the notes.

Some businesses have very little WIP at any time, such as a bakery that turns flour into bread within hours. Others, such as shipbuilders, aircraft makers, whisky distillers and construction firms, can carry large WIP balances for months or years. In service businesses, the equivalent is unbilled work, such as hours an accounting firm has worked on a client engagement but not yet invoiced.

In a typical manufacturing cost system, WIP works as a collecting account:

• When raw materials are issued to production, their cost moves from raw materials inventory to WIP.
• Direct labor is charged to WIP as workers spend time on products.
• Manufacturing overhead is applied to WIP using a predetermined overhead rate.
• When products are completed, their accumulated cost moves out of WIP into finished goods inventory, and the total of these transfers is the cost of goods manufactured.

Labor and overhead together are called conversion costs. This flow reflects absorption costing, which US GAAP and IFRS require for external reporting, so that inventory carries its full production cost until sold.

A furniture maker has WIP of $45,000 on 1 April. During April it issues $120,000 of wood and hardware to production, incurs $80,000 of direct labor and applies $60,000 of overhead. Products costing $270,000 are completed and moved to finished goods.

Here each term is the amount for the month: $\text{Beginning WIP}$ is the opening balance, $\text{Materials}$, $\text{Labor}$ and $\text{Overhead}$ are the costs added to production, and $\text{Cost of goods manufactured}$ is the cost of units completed. Ending WIP is $45,000 plus $120,000, $80,000 and $60,000, minus $270,000, which equals $35,000. The journal entry for completed goods debits finished goods inventory and credits WIP for $270,000.

Valuing WIP is harder than valuing raw materials or finished goods, because partly completed items have no market price and their stage of completion must be estimated. Companies using job order costing track costs on a job cost sheet for each order, so WIP is the total cost of open jobs. Companies using process costing estimate the percentage of completion of units in progress and convert them into equivalent whole units to divide costs fairly. Errors in these estimates shift costs between WIP, finished goods and cost of goods sold, and therefore change reported profit.

WIP is subject to the same lower of cost and net realizable value test as other inventory. For WIP, net realizable value is the expected selling price of the finished product less the costs to complete it and sell it. Abnormal waste, such as abnormal spoilage, is expensed rather than added to WIP. For long-term contracts with customers, such as construction projects, revenue is often recognized over time under ASC 606 and IFRS 15, so costs may be recognized as contract costs rather than held in WIP.

High WIP ties up cash, takes up factory space and can hide bottlenecks and quality problems. Methods such as lean manufacturing and just-in-time manufacturing aim to keep WIP low by producing only what is needed and moving work smoothly through each step. Managers track WIP levels and cycle times, and auditors examine WIP closely because its estimates are a common source of misstatement in cost accounting.