Introduction of WIP Inventory
Work-in-progress (WIP) is the goods which is currently in the process of production (i.e.) in the intermediate stage of production in between raw materials and finished goods. It is considered as a part of the Inventory. The next step to WIP is the finished goods. WIP consists of the cost of raw materials, labor, and production overheads with respect to the level of completion. WIP does not include raw materials which is yet to be used for production nor the finished goods which is fully completed. It is considered as an asset of the business and grouped under Inventory. WIP is valued based on the percentage of completion. Proportionate cost with respect to completion is considered for the valuation of inventory.
Inventory needs to be valued at frequent intervals like biweekly, month end, quarterly, etc. based on the company’s policy. All goods will not be in a fully completed stage as on the cut off date of valuation as manufacturing is an ongoing process. Even partially completed goods need to be valued and reported. So, the concept of WIP arises in the manufacturing process, and the same needs to be valued and reported under inventory. The concept of WIP arises in industries like manufacturing, construction, consultancy, etc.
The Formula for WIP Inventory
- Raw Materials: It includes materials directly utilized in the process of production.
- Labor Cost: It includes the wages/ salary paid to workers and staffs who are directly involved in the production process.
- Overheads: It includes the cost of indirect materials, indirect labour, and other overheads directly linked to the production process.
Examples of WIP Inventory
Following are the examples are given below:
Y Corp is the business line of producing toys. It has opening Work-in-progress inventory of $10,000. During the production period the company incurs raw material cost of $25,000 used in production; Labour cost of $5,000 and other manufacturing cost of $10,000. At the end of the period, the finished goods produced is valued at $35,000.
The Closing Work-in-progress inventory is:
Closing WIP Inventory = Opening WIP Inventory + Total manufacturing cost – Cost of goods manufactured (Finished goods)
- Closing WIP Inventory = $10,000 (+) $25,000 (+) $5,000 (+) $10,000 (-) $35,000
- Closing WIP Inventory = $15,000
Zelon group is the business of manufacturing cars. It launches a new brand of car called Zen+. It does not have any unfinished car at the beginning of the period. In the current period it incurs the following cost:
- Raw materials cost (Car parts) – $500,000
- It started manufacturing Zen+ with a target of 10 cars to be completed by this month end, for which it required raw materials worth $200,000.
- Labour cost – $1,000 per month per labour. Totally 5 labors are involved in this manufacturing section.
- Other Manufacturing Cost and overheads per month is $5,000.
- Zelon group finally produced 8 cars at the end of the period which values at $168,000.
The remaining 2 Zen+ cars are in WIP stage which values at $42,000. ($200,000+$5,000+$5,000-$168,000)
Advantages of WIP Inventory
Some of the advantages are given below:
- Work-in-progress (WIP) inventory is in the process to become finished goods, it helps in earlier conversion to the finished goods and improves the turnaround cycle.
- WIP helps in the continuous process of the production of goods, if WIP inventory is not considered then it leads to some idle time in production as all inventories can either be in the state of raw materials or finished goods.
- It helps in meeting up the demand for the product as it contributes to better production cycle.
- As production is a continuous process, there will not be any idle raw materials procured and unused and it also helps in planning the production in accordance with the lead time in procuring the raw materials from suppliers.
- WIP Inventory is an asset to the business, not valuing the WIP will lead to undervaluation of inventory and cost of goods manufactured will be overstated to that extent, and it has an impact in bottom line.
- Tracking WIP helps in understanding the production process, as higher WIP indicates there can be some bottlenecks in production process, and there is no smooth flow of process. It helps in identification and resolving such issues.
Disadvantages of WIP Inventory
Some of the disadvantages are given below:
- Valuation of WIP inventory is a little complicated as we need to understand the progress and process at which the inventory stands. (i.e.) upto what level of completion, and the costing involved in the same as of the cutoff date.
- Goods need to be produced based on the available demands, as a result of continuous production, there can be inventory piled up which in turn locks the working capital, and the increases the storage cost.
- Tracking of inventory and insuring the same comes with some additional cost to the business.
- The risk of inventory getting outdated causes loss if the goods produced are more than demand in the market. (E.g.) Seasonal Goods.
Work-in-progress is an important element in inventory valuation. WIP inventory is the cost of partially completed goods at the end of the accounting/reporting period. It forms part of the company’s balance sheet along with raw materials and finished goods. Management tries to keep WIP inventory as low as possible, as there is no market for unfinished goods, and moreoverWIP tracking helps in monitoring production schedule and process. Keep inventory at a minimal level as per requirement helps in reducing the investment of the company. The production or the business manager must monitor the WIP constantly to allocate appropriate cost and for proper valuation of inventory.
This is a guide to WIP Inventory. Here we also discuss the introduction and examples of WIP inventory along with advantages and disadvantages. You may also have a look at the following articles to learn more –