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Work In Process Inventory Formula | WIP Inventory Definition

Thursday, October 15, 2020

Is your work in process inventory—or WIP inventory—minimized?

Supply chain and inventory management are established fields of expertise now. And one thing that these professions agree on is that it’s usually best to minimize work in process inventory.

The more WIP inventory you have:

  • The less storage space is available for your most profitable items
  • The more capital you have tied up in unsaleable items
  • The higher the risk of incomplete goods expiring or becoming obsolete

Figuring out WIP inventory is an involved process because it involves associating a cost with a percentage of completion. That’s not easy to do. And that’s why it’s standard practice to minimize WIP inventory before reporting. There’s less risk to assume and less uncertainty to wrestle with on the balance sheet.

The more you learn about WIP inventory, the easier it will be to bodyslam it into submission. Let’s get ready to rumble.

What Is Work In Process Inventory Generally Described As

Work in process inventory is generally described as a company’s unfinished goods waiting to be completed and sold. The standard work in process inventory definition is all the raw material, overhead costs, and labor associated with every stage of the production process.

Any raw material inventory that has been combined with human labor but is not yet finished goods inventory is work in process inventory. That makes it a part of manufacturing inventory. Think everything after raw material inventory and before finished product inventory. It’s all the production costs incurred for all partially-completed goods. Another title for work in process inventory is work in progress inventory (both abbreviated WIP inventory).

Why Does Work In Process Inventory Exist?

The above work in process inventory definition explains the what, but not the why. Why do companies have partially completed inventory? A few reasons.

The most obvious is that the items are in the process of being produced. They may be on a conveyor belt in the act of fabrication or they may be waiting in a queue for further processing. Either way, they are actively being created.

Another reason for work in process inventory is safety stock, buffer stock, or anticipation inventory. Some companies find it beneficial to hold on to goods at certain stages of production as insurance against shortages of supply or spikes in demand. VMI agreements are often helpful in determining the right purchase orders to protect against supply chain surprises.

Work In Process vs Work In Progress Inventory

Work in process inventory and work in progress inventory are interchangeable phrases, for the most part. Though some within supply chain management do make a small distinction between them. Some folks refer to work in process inventory only in the context of production operations that move along relatively quickly. They reserve work in progress for larger-scale projects like consulting or construction work.

Quiz: Work In Process Inventory Increases When …

Let’s see if you’ve fundamentally understood what work in process inventory is. Here’s a quiz.

Work in process inventory increases when:

  1. Products are finished and turned into goods in transit
  2. Raw materials are purchased
  3. Raw materials are used
  4. Finished products, or merchandise inventory, are sold

If you chose C, you’re correct. Nice work!

How to Calculate Work In Process Inventory

For the majority of manufacturers, WIP inventory is the raw materials plus labor and production overhead. For more complex operations—like big constructions projects—it can include wages, subcontractor costs, and more. Regardless, it takes time to figure out. Again, that’s why most manufacturers minimize WIP before they tally it up at the end of the accounting period.

How to Find Beginning Work In Process Inventory

Beginning work in process inventory is actually the same thing as ending work in process inventory, just for a different accounting period.

Businesses always calculate WIP inventory at the end of accounting periods, whether that be a quarter, year, or some other time period. This total WIP figure is the ending work in process inventory for that accounting period—and the beginning work in process inventory for the next accounting period.

This ending WIP inventory is listed as a current asset on your company’s current balance sheet. So, to figure out how to find work in process inventory you need the beginning work in process inventory. And to calculate that, you need the ending work in process inventory.

How to Calculate Ending Work In Process Inventory

The work in process formula is:

Ending WIP Inventory = Beginning WIP Inventory + Manufacturing Costs - Cost of Finished Goods

Let’s use a coffee roaster as an example.

Imagine BlueCart Coffee Co. has a beginning work in process inventory for the quarter of $10,000. This refers to all the bags, labels, beans yet-to-be-ground, and other raw materials waiting to be turned into finished bags of coffee ready for sale.

Over the next three months, the company incurs production costs of $75,000 roasting, grinding, and packaging coffee beans. The total value of the finished goods over the quarter is $72,000.

Ending WIP Inventory = Beginning WIP Inventory + Manufacturing Costs - Cost of Finished Goods
Ending WIP Inventory = $10,000 + $75,000 - $72,000
Ending WIP Inventory = $13,000

This means BlueCart Coffee Co. has $13,000 worth of inventory that’s neither raw material nor finished goods. For a perishable item like coffee, growing WIP inventory figures are a red flag unless they’re strategically kept as anticipation inventory.

Keep in mind that this work in process formula is an estimate. There are things it doesn’t consider, like waste, spoilage, downtime, scrap, and MRO inventory. To get a totally accurate WIP inventory is unreasonable. It would require combing through the production process and itemizing every little inevitability. In general, companies calculate estimated WIP inventory levels. It’s better than nothing.

Work In Process Inventory Journal Entry

Keeping tabs on your work in process inventory requires some bookkeeping. If you’re not an accountant, you may wonder how a work in process inventory journal entry looks. Here’s a simple example that shows how records shift from debits to credits throughout the production cycle.

Work In Process Inventory Journal Entry
Debit Credit
Raw Materials $5,000
Accounts Payable $5,000
WIP Inventory $5,000
Raw Materials $5,000
Finished Goods $5,000
WIP Inventory $5,000

In this example, your initial purchase of $5,000 of raw material which is debited to your raw materials inventory. You’d then credit your accounts payable for the same amount.

Once the raw materials enter the production cycle, that $5,000 debit is moved to the WIP inventory account and the raw materials account is credited with $5,000.

And, finally, once the WIP inventory becomes finished goods, the $5,000 is debited to the finished good account and $5,000 is credited back to the WIP inventory account.

Trust the Process

Understanding WIP inventory is crucial for monitoring and improving production capacity and inventory control. Unless you’re holding on to a substantial amount of WIP inventory is a part of a strategic anticipatory inventory management strategy. Otherwise, it’s not ideal to let it grow. 

That’s because a business’s sustained WIP inventory plays a big part in the valuation of their business. And approval of any loans they apply for. WIP isn’t immediately sales-ready and, while it counts as a current asset, isn’t very liquid. Loan companies are hesitant to consider WIP inventory as collateral.

“Large” and “small” aren’t good gauges of healthy WIP inventory. Consistency relative to sales is a better benchmark. If your WIP inventory remains consistent or contracts without resulting sales loss, it’s a sign that your production operations are smooth. But If it continually grows without an associated growth in sales, it’s a sign of inefficiency.