Work in progress or work in process (WIP) is a way of calculating the value of all the goods on your factory floor that are not quite finished. These goods are more valuable than raw materials because you've incurred some labor and overhead, but less valuable than finished goods that are ready for sale. As WIP will eventually convert to revenue, it's an asset for the business. You record it as such on the company's balance sheet.
Understanding Work in Progress
Say that ABC Corporation manufactures washing machines. It takes two weeks to make a washing machine. At the end of the month, the company counts its inventory. It has 5,000 completed washing machines ready for shipping and 2,000 partially completed machines. Once finished, the partially completed machines will be ready for sale and will convert to finished goods inventory. Until then, they are recorded as an asset under the heading "work in progress" on the company's balance sheet, similar to raw materials and inventory.
How to Calculate Work in Progress
To calculate the value of your work-in-progress inventory, you simply add together the cost of all the components you have consumed to reach this point in your production. Different businesses have different costs but generally, an accountant would compile all the raw material costs, direct labor costs and factory overhead associated with the work. The WIP entry is then recorded as a sum of these costs.
Breaking It Down
ABC Corporation, for example, might have raw materials such as washing machine parts, drums, motors, circuit boards and the pallets it uses for shipping. To find the raw materials component of their WIP, the company would take its raw materials inventory at the beginning of the last accounting period, add any raw materials purchased during the current period and subtract the ending raw materials inventory. The resulting figure is the number of raw materials that ABC is currently using in production.
Direct labor is all the labor that's been invested by ABC Corp. on the factory floor to assemble the washing machines. For example, it would include the salaries of production-line workers who assemble the components, welders who weld the washing machine structures together and electricians who program and test the circuit boards.
Manufacturing overhead includes all the costs that are not directly related to manufacturing the washing machines such as manager salaries, administrative expenses, rent, utilities, taxes, insurance and marketing expenses. Most companies rely on accountants to calculate an appropriate proportion of these costs.
Why Work In Progress Matters
Work in progress sits in the middle of your manufacturing process between raw materials and finished product. It clearly isn't worth as much as finished goods which are valued at your sales prices, but it is worth more than raw materials because you have incurred some overhead. While the bare WIP figure will not tell you very much, changes in WIP from one period to the next can reveal some key information about your company.
For example, an increase in WIP suggests one of two things: that you have more orders coming in, or that it's taking too long to get your products off the production line and into the hands of consumers. The former is a sign of business growth and managers may need to hire additional labor or raise capital to cope with demand; the latter suggests that your production process is not running smoothly. Customers do not buy partially completed goods so it's in a company's best interest to keep work in progress inventory as low as possible.