Work in process inventory, also known as WIP inventory, refers to the inventory of partially completed products in a manufacturing or production process. This type of inventory is an essential aspect of accounting for manufacturing and production businesses as it helps to determine the cost of goods sold.
In simpler terms, work in process inventory is the value of raw materials, labor, and overhead that have been used to create unfinished goods. These goods are not yet ready to be sold as they require additional work before they can be considered finished products.
Here’s a closer look at work in process inventory, including how it’s calculated and why it’s important for businesses:
What is work in process inventory?
Work in process inventory refers to any partially completed products that are still undergoing the manufacturing or production process. This type of inventory includes any raw materials, labor, and overhead costs that have been incurred in the production process up to the point that the goods are still considered unfinished.
For example, consider a furniture manufacturer that produces custom tables. Work in process inventory for this business might include partially finished tables that have been sanded and stained, but still need legs attached and a final finish applied.
How is work in process inventory calculated?
To calculate work in process inventory, businesses need to account for all the costs that have been incurred up to the point that the goods are still considered unfinished. This includes any raw materials, labor, and overhead costs that have been used to partially produce the goods.
The formula for calculating work in process inventory is as follows:
Beginning work in process inventory + Total manufacturing costs during the period – Ending work in process inventory = Cost of goods manufactured
The beginning work in process inventory is the value of any partially completed goods that were already in production at the start of the period. Total manufacturing costs include all direct materials, direct labor, and factory overhead costs incurred during the period. The ending work in process inventory is the value of any partially completed goods still in production at the end of the period.
What are Equivalent Units?
Equivalent units refer to the units of production that are partly complete at the end of a period. In other words, they are the partially completed units of products that are in the process of being manufactured. When determining the cost per unit for work in process inventory, it is necessary to determine the equivalent units of production for both materials and labor. This is because not all units are equally complete at the end of a period, and the degree of completion must be factored in when calculating costs. Equivalent units help to provide a more accurate measure of production costs and enable businesses to make informed decisions about pricing, production volumes, and other key factors that can affect their profitability.
Why is work in process inventory important?
Work in process inventory is important for several reasons. For one, it helps businesses keep track of the costs associated with producing goods. This allows businesses to better understand the cost of goods sold and helps them make decisions about pricing and profitability.
In addition, work in process inventory is an important component of cash flow management. Businesses need to have enough cash on hand to cover the costs associated with producing goods before they are sold. By tracking work in process inventory, businesses can better anticipate cash flow needs and plan accordingly.
Conclusion
Work in process inventory is an essential aspect of accounting for manufacturing and production businesses. It refers to the value of partially completed products that are still undergoing the manufacturing or production process. By calculating work in process inventory, businesses can better understand the costs associated with producing goods and make informed decisions about pricing and profitability.