1. Work in progress (WIP) inventory, which includes raw materials and components that have begun processing but are not finished goods, must be accurately accounted for. 2. Calculating WIP involves adding direct labor costs and overhead costs such as indirect labor, utilities, and depreciation to the value of raw materials based on a bill of materials. 3. Accurate WIP accounting is important for taxation, cash flow and financing, and production planning. Inaccurate WIP values can lead to production errors, tax issues, and lost financing opportunities.

1. WORK IN PROCESS
INVENTORY ACCOUNTING

2. Every manufacturing company must deal with inventory. It is part of doing
business. And whether the counting and reconciling of inventory for raw
materials or components versus finished goods is done manually on paper, on
spreadsheets, or by using connected software platforms and scanners, the
calculations are straightforward. Materials in, a calculated Bill of Materials and
waste as a guide, and finished goods out should produce a correct starting and
ending inventory.

3. Regardless the size and complexity of a manufacturer’s raw and finished goods,
where many factories struggle is with the taking and accounting of WIP
inventory. WIP, or “Work in Progress” is a part of a company’s overall inventory
that has begin being processed but is not yet finished. As raw materials and
components are consumed, they gain value because they have incurred some
labour and overhead. And each subsequent sub-process throughout the factory
adds additional value. And while both raw materials and finished goods can be
values at their actual cost, WIP calculations for accounting purposes must
include the additional value added to be accurate.

4. Calculating WIP Inventory
As materials move from the warehouse to the production floor, labor is accrued
at every move. This may include fork lift operators as well as line operators,
stagers, and finish labor. It will also include the labor required to transport and
store the finished goods in the finished goods warehouse or dock.
In addition to direct labor, there are overhead costs as well. Overhead costs
include items such as:
• Indirect labor
• Utilities
• Insurance
• Taxes
• Depreciation

5. Now, look into the future. The worn out, fully depreciated automobile ends up in
a junkyard. People needing replacement parts for their current vehicles go to
the junkyard to find them. The guy who owns or manages the business removes
the part from one of the old cars and sells it as a replacement part. In theory, he
could remove practically any usable part and sell it so that someone else can re-
use it.

6. All direct and indirect costs must be added to the WIP to ensure accurate
valuation. This requires an accurate Bill of Materials (BOM) that apply each line of
direct and indirect costs in the right proportion and against the produced
volume. If the BOMs are correct for all WIP within a factory, the estimated number
may be considered a close enough estimate for accounting. It is also possible to do
a manual WIP count but the process is often labor intensive and therefore
expensive and reserved for yearend inventory valuations.

7. WIP Accounting
Usually, a company takes a WIP count at an established accounting period. This
may be monthly, quarterly or yearly. The ending WIP count for the end of one
period becomes the beginning WIP inventory for the next and again the raw
materials and BOMs used should match the number of finished units
completed. The frequency and method of WIP count may also depend on the
type of manufacturer. Private companies have fewer reporting requirements but
must value certain things correctly for taxation purposes depending on the locality
or country. On the other hand, public companies often have stricter and more
detailed reporting guidelines in addition to taxation reporting.

8. Regardless the type of company, all companies must produce the most accurate
WIP count possible because fortaxation purposes, WIP is considered a current
asset. Current assets are any items that could be converted into cash in less than a
year, which includes WIP. Current assets are then listed with all other assets on the
“Operating Activities” part of the cash flow statement. The value should only
include raw materials, overhead and direct laborspent so far. Projected costs for
finishing the goods are not included as they will be listed under the “Expense” line
of the next cash flow statement. Once the WIP is calculated, valued and listed in
the Operating Activities line of the cash flow statement as a Current Asset, the WIP
is now considered an asset within the company.

9. Why Accurate WIP Accounting is Important
All companies are intensely focused on their cash flow statement and overall
financial health. But while larger companies can absorb a few more errors due to
scale and averaging, small to medium sized companies often have little to no room
for error. There are three important reasons why accurate WIP accounting is a
must.
1.Taxation – No one wants to be audited by their country’s tax service for
inaccurate taxes. As a current asset, WIP is a taxable entity and underestimating or
inaccurate accounting can result in hefty fines. The opposite is also a danger as
overestimating can make manufacturers responsible for higher taxes when they
aren’t required.

10. 1.Cash Flow and Financing – Many companies use short-term financing, including
WIP Inventory Financing, to address short term cash flow issues. Requirements for
this type of financing always includes accurate WIP accounting and valuation and
an incorrect valuation may lead to discontinuation of short-term financing
agreement. Accurate values are also used when assessing a company’s health for a
longer-term loan as well.

11. 1.Production Impact – Inaccurate WIP accounting can also lead to production
errors. By overvaluing or undervaluing one segment of WIP, upstream processes
may be triggered to make up a perceived loss or idled to allow a perceived overage
to deplete. If the WIP calculation and valuation was wrong, the factory may
become out of balance, impacting delivery schedules and leading to negative
financial misfortunes from the reduction of future sales. Inaccurate accounting can
also send the wrong demand signal to raw materials purchasing who will then over
order materials and tie up cash flow with overstock, or in underordering which
drives up costs through equipment stoppage or through expediting of freight to
bring in the required material once the error is discovered.

12. Correctly Managing WIP
Accurate WIP is an important part of any company’s total inventory. And keeping
that inventory accurate is important for large and small factories. And while
manual counting and reconciliation or spreadsheet-based inventory keeping may
have started as a necessity for small to medium companies, as growth and scale are
realized, these methods can become impractical and error-prone quickly.

13. The most effective solution for overall inventory management is software. Using an
appropriately sized and customizable platform, factories can deploy MRP or ERP
solution that fits small to medium sized companies with the same capabilities – and
accuracies – found in large manufacturers of scale. These platforms allow not only
accurate inventory accounting but also include labor planning and tracking, shop
floor scheduling, Bill of Materials listings and where used query capability to tie all
the production in a factory together.
You may also like MRP vs. ERP: Which Solution is Right for You?

14. There are several reasons why a factory manufacturing software can improve WIP
accuracy and accounting:
•Even if a company has a small WIP footprint, and a short production cycle, manual
and spreadsheet-based programs become unwieldy as a company grows.
•Human beings are prone to make mistakes, and mistakes in raw materials
inventory (which may also be manual), or mistakes in BOM calculations will multiply
the errors in WIP as the error echoes through the system. Most platforms integrate
with modern RF scanning to ensure not only accurate counting and valuation, but
also to allow tracking so that inventory does not move from raw material to WIP
too soon and so that WIP can be listed as a finished good in real time and not
unnecessarily tie up asset value in WIP.

15. •As an asset, inventory aided by software will help to properly value WIP as an
asset reducing the chances of taxation dilemmas or cash flow issues. And as the
software is tied into the MRP/ERP system.

16. As supply chains and manufacturing become more complex with the increase in
globalization, factories are tasked with honing production and inventory accuracy
across their enterprise to stay competitive. It no longer makes sense for small to
medium companies to remain stuck in a manual, spreadsheet world. Modern
platforms not only allow tracking, accurate data and analysis, increased agility and
a high degree of customization. They also are on par in capabilities and
functionality with larger MRP/ERP programs that can ties inventory, production and
finance together and prevent small and medium companies from finding
themselves one bad WIP valuation away from disaster.

18. https://manufacturing-software-blog.mrpeasy.com/2019/03/12/work-in-
process-inventory-accounting/
https://www.mrpeasy.com/