Many business dictionaries have terms that are simple at first look but can be difficult to understand. However, these terms are essential to core functions in your business. One of them is WIP or “work in progress.”
In general, the term “work in progress” (or WIP) refers to a product or a piece of work that has been worked on but is not ready or finished. But in the world of business and accounting, what does WIP stand for? Does WIP have a different meaning in this industry?
What Does WIP Stand For?
So what does WIP mean?
In accounting and business, the meaning of Work-In-Progress is an accounting entry on your business’s balance sheet that refers to the money spent on labor, processes and materials to manufacture a product. WIP is an important component of your balance sheet’s inventory asset account section. Eventually, these costs are transferred to the finished product account before being moved to the cost of sales (COGS).
By definition, the WIP figure should only reflect the value of the products used in intermediate production stages. This doesn’t include the value of raw materials that aren’t incorporated (yet) into the products or items for sale. WIP also excludes the value of finished items stocked in inventory in anticipation of future sales.
A Better Understanding of the ‘Work-in-Progress’ Meaning
WIP is a concept that describes the flow of the manufacturing costs from one production area to another. The WIP balance represents all the costs incurred for goods that are still considered ‘works in progress.’ As mentioned above, the production costs include allocated overhead, labor used in making the products and raw materials.
Take the production of combs for example. When manufacturing cobs, the plastic falls under the ‘raw materials category.’ Next, labor is necessary to operate the molding equipment, so that adds to the costs. Since the combs are still incomplete, their costs are posted to WIP. Once the combs are finished, their costs will be moved from WIP to finished goods. When the combs are sold, the costs are moved from the inventory to the cost of sold goods (COGS). A part of the inventory is classified as WIP whenever they are mixed with labor but are not yet completed.
Like other inventory accounts, WIP can also be determined by different accounting methods used by different companies. Thus, it’s important for investors to determine a company’s measurement of its WIP. One business’s WIP is not always comparable to another’s. The allocation of overhead can be based on machine hours or labor hours.
It is also considered an important practice to minimize the WIP inventory amount before reporting since it is time-consuming and difficult to estimate an inventory asset’s percentage of completion.
What is Another WIP Example?
Here’s another example of WIP.
For instance, your restaurant uses materials costs, labor expenses and overhead costs to transform raw materials (i.e. the ingredients) into a meal. The money buys the meat, spices and vegetables needed to prepare the meal. As for the labor costs, this takes the form of salaries for your chefs (the people who cook the food) and waiters (the people who serve the food).
To keep the staff happy and protect the company from untoward incidents, the owners must also invest in health benefits and insurance.
Apart from labor costs and raw material expenses, the restaurant might also have capital costs via a mortgage or monthly rent payments for the maintenance of equipment and its premises. These expenses fall under the ‘overhead expenses’ category.
The restaurant’s WIP accounting balance sheet will be a summary of the entries for the costs of ingredients, employee salaries, facility expenses, insurance costs and benefits. However, the WIP accounting won’t include the costs for raw materials that haven’t entered the production assembly line. So, raw materials stocked in factories are not part of the WIP costs.
WIP accounting doesn’t also include costs for finished products, which are classified as finished goods, especially once they move past the production floor.
Since the production process is made up of constantly moving parts, accurately accounting and calculating WIP costs for each product can be tricky.
How Do You Calculate Work-in-Progress (WIP)?
To calculate the amount of partially completed goods in WIP, calculate the percentage of the total material, overhead and labor expenses incurred by the business. For example, a construction company may bill a business based on the different stages of the production.
Why Does WIP Matter?
Now, that we know what WIP stands for and what it means, now it’s time to ask another important question: how is this information useful?
WIP inventory numbers measure the metrics related to the manufacturing process. This gives production managers a better view of their progress, as well as the opportunity to calibrate the output of their assembly lines. Managers can also use these numbers to determine if they should increase or tamp down production (based on the availability of materials).
WIP is also helpful in determining supply chain health. If there are too many items under the WIP category, it’s a sign of inefficiency. This could also lead to more costs on the balance sheet since WIP products incur warehousing and storage expenses. You can’t move these numbers or re-invest them in other departments. This is why businesses should aim for lower WIP numbers.
If you want a better grasp of your business expenses, it pays to pay attention to WIP.
What is the Difference Between WIP vs. WIP?
In the accounting industry, work-in-progress isn’t the only WIP. There is also “work-in-process.”
Work-in-process (also WIP) represents partially completed goods, which are also referred to as ‘goods-in-process. For some businesses, this WIP refers to goods that have moved from raw materials to finished products in a short time frame. Manufactured goods may fall under the work-in-process category.
On the other hand, work-in-progress refers to assets that require an amount of time to complete, such as construction or consulting projects. These differences between the two WIPs aren’t necessarily the norm, so people can use either term to refer to unfinished manufactured goods.
How About Work-in-Progress vs. Finished Goods?
The differences between these two terms depend on the inventory’s current stage of completion. This means saleseability. WIP refers to the inventory stage in which the goods have started their progress from raw materials to assembled goods before transforming into the final product. On the other hand, finished goods refer to the inventory’s final stage, in which the manufactured goods have reached their completion stage. The next stage is often the sales part.
Work-in-progress may be a technical term in business, but it is an important one that requires your time and understanding. If you need more guidance or information, speak with an accountant about WIP and its meaning.