The Impact of WIP on Manufacturing Efficiency
Posted by John George on January 14, 2025
In the manufacturing world, the term "work in process" (WIP) is frequently used, often interchangeably with "work in progress." However, in accounting, WIP has a distinct meaning. While "work in progress" typically refers to long-term or large-scale projects, WIP is more closely associated with production efficiency and inventory management.
Defining WIP
WIP generally refers to partially completed goods that are in the process of being manufactured. These items are usually mass-produced and standardized. For accounting purposes, WIP includes the costs of raw materials, labor, and overhead incurred up to that point in the manufacturing process. It does not include raw materials that are yet to be used or the projected value of the finished goods.
Financial Indicators of WIP
The costs associated with WIP are calculated using different percentages for each component. For example, the percentage for raw materials is typically higher than for labor because materials costs are incurred before labor can be applied. Overhead costs, such as rent, equipment maintenance, employee benefits, insurance, utilities, and depreciation, are allocated based on labor or machine hours.
WIP is similar to job costing, which is often used for custom manufacturing or discrete batches. Job costing allows for more precise tracking of costs for specific jobs or projects compared to WIP.
Operational Indicators of WIP
Monitoring WIP can help manufacturers identify areas for optimizing production processes, reducing cycle times, and improving inventory management. A high WIP may indicate inefficiencies in production and finances, as it involves storage costs and ties up capital that could be used elsewhere. Strategies to reduce WIP include adopting just-in-time production, addressing bottlenecks, and upgrading equipment.
Accounting for WIP
WIP appears on the balance sheet as a current asset within inventory. Once goods are completed and ready for sale, they are transferred from WIP to the finished goods account. Eventually, these items will be recorded in the cost of goods sold.
Manufacturers aim to minimize WIP on their balance sheets before preparing financial statements to avoid the complexity of estimating completion percentages. Reducing WIP can also lower storage costs and decrease the risk of obsolescence.
Adjusting WIP
It's crucial to adjust WIP to ensure that reported assets and earnings accurately reflect operations for the reporting period. Adjustments are particularly important for manufacturers with longer production cycles, where costs for WIP components can fluctuate due to supply chain disruptions, labor shortages, equipment breakdowns, technological advances, or changes in demand.
The Importance of Monitoring WIP
Failing to monitor WIP can lead to negative financial and operational outcomes. Keeping a close eye on WIP can help maximize production efficiencies, manage costs better, and ultimately improve profitability. If you have any questions, contact us.
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A member of the Firm’s audit and assurance department, John’s responsibilities include managing fieldwork, guiding staffing, coordinating efforts with management, risk analysis, and detail review of our procedures for audits, reviews, compilations, and examinations. John has several years of experience working with commercial businesses, including those in manufacturing, start-ups, and general service industries, along with school districts and governmental entities. Additionally, he has experience working on SEC engagements, including non-carrying broker-dealers. John is also a member of the Firm's Auditing Technical Committee.