Many companies sell physical products, which constitute their primary income source. Some companies may manufacture these products while others acquire them from an external source. Usually, companies also keep their stock in hand so they can meet customer demand when it arises. These may include raw materials, finished goods, or work-in-progress inventory.

Every type of inventory mentioned above has its own definition. Raw materials usually include the materials that go into the final product produced by a company. These materials also require conversion costs to come to their final form. Finished goods are the products that companies manufacture or sell. In contrast, work-in-progress inventory is complex. Before understanding what it is, it is crucial to look at inventories in general.

What is Inventory?

The term inventory refers to assets that companies use in production or to sell. It includes raw materials used in production, goods produced that are available for sale, or goods still in process. For companies that sell physical products, inventory is one of the most crucial assets with fixed assets. These inventories also form a significant portion of a company’s current assets in some cases.

A company’s inventory usually includes items that they expect to sell in the next 12 months. It is why these assets fall under a company’s current assets in the balance sheet. Companies can classify these assets into various categories. Based on usage, however, inventories fall into three categories. These include raw materials, finished goods, and work-in-progress inventory.

For companies, it is crucial to keep inventory at hand to meet customer demand. Some companies may also keep low stock or none at all. However, most other companies keep enough inventory on hand to sell while they produce further finished goods. At the end of each accounting period, these inventories get reported on the balance sheet.

Raw materials and finished goods usually constitute the largest portion of inventories. For most companies, these are the only items that will appear under stock on the balance sheet. Sometimes, however, companies may also have a continuous production process. As a result, they will also have some inventory in production at the time of reporting. This stock comes under work-in-progress (WIP).

What is the Work-In-Progress (WIP) Inventory?

Work-in-progress (WIP) inventories include goods that are still in the production process at the reporting date. These inventories exist for companies that have a continuous production process or one which has various steps. When a company reports its inventories in the financial statements, they may still be under production. Therefore, they will fall under the work-in-progress inventories categorization.

As mentioned, raw materials include products that go into the production process. During this, companies also incur conversion costs, which include direct labor and manufacturing overheads. Once the materials go through the process, they get converted into finished goods. Work-in-progress inventory falls in between both these inventories. WIP inventories aren’t in the raw form, yet they aren’t finished goods either.

WIP inventories are a part of a company’s balance sheet and fall under the inventories or stock heading. It reflects the value of products that is in an intermediate production stage. It excludes the cost of raw materials that still haven’t entered the production process. It also does not include the costs of products ready for sale and falls under finished products.

WIP inventories include the cost of raw materials, labor, and manufacturing overheads for each stage in the production process. For companies that have several steps during manufacturing, WIP inventories may come from all these stages. Usually, companies calculate a percentage of completed work to separate these items from others.

How to calculate Work-In-Progress Inventories?

Companies report work-in-progress inventories on their balance sheet. However, it will also include a cost in the income statement. Usually, companies can calculate the value of WIP inventories by using the following formula.

Work-In-Progress = Opening WIP + Manufacturing Costs – Cost of Goods Converted to Finished Goods

In practice, however, calculating the value of WIP inventories is more complex. Companies go through a costing technique known as process costing to determine the WIP in each process. The above WIP formula will also apply to that process. However, companies will also carry over some WIP inventories from one process to another.

When WIP inventories get transferred from one process to another, they still remain work-in-progress. The closing carried over value from one process becomes the opening value for the next.

This process continues until the inventories become finished goods. At the end of each period, some balances will remain in each process. Companies can aggregate these to reach a work-in-progress value for the balance sheet.

Example

A company, ABC Co., had a closing WIP of $100,000 in the previous period. During the accounting period, the company incurred production costs of $300,000. Furthermore, the total cost of the items converted into finished goods for the period was $250,000. Based on this information, the company’s closing work-in-progress inventories balance will be as follows.

Work-In-Progress = Opening WIP + Manufacturing Costs – Cost of Goods Converted to Finished Goods

Work-In-Progress = $100,000 + $300,000 – $250,000

Work-In-Progress = $150,000

What is the Difference Between Work-In-Progress and Work-In-Process?

Due to their similar names, people often get confused between work-in-progress and work-in-process. Sometimes, these terms can also get used interchangeably. However, both have some differences. Usually, work-in-progress refers to the costs of unfinished goods that are still undergoing manufacturing. In contrast, work-in-process represents the materials that companies can convert into goods within a short period.

Work-in-process inventory usually doesn’t go through several stages in the production process. These goods get converted into finished goods readily or with little processing. These goods don’t go through a complex production cycle. Instead, companies need to process them to convert them into finished goods. However, work-in-progress inventories are not the same.

Work-in-progress inventories include items that need a lengthy process to reach the finished goods stage. However, the usage of both terms may differ from one company to another. For some companies, a specific inventory item may be work-in-progress, while for others, it is work-in-process. A company’s production process also plays a role in the categorization of inventories.

What is the importance of Work-In-Progress?

The work-in-progress inventories account is crucial for companies for various reasons. Firstly, it allows them to classify goods that haven’t completed the production cycle separately. Through this, the company can present its raw materials, finished goods, and work-in-progress inventories more accurately. Therefore, it promotes better presentation and disclosures in the financial statements.

Work-in-progress also allows companies to monitor production capacity utilization. Since all production goes through the WIP inventories account, it presents an overall picture of a production process. This account can also help in various management accounting models. Internally, it is a highly crucial account.

Work-in-progress can also help companies obtain loans. Some lenders may take a company’s work-in-progress as collateral. Furthermore, they will require the company to maintain a specific level of inventory in this account. Some lenders also use this account to assess a borrower’s creditworthiness. Therefore, WIP also plays a role in helping companies raise finance.

Conclusion

Work-in-progress represents a company’s inventory that is still in the production stage. It comes between raw materials and finished goods. Usually, it includes the cost of raw materials, direct labor, and manufacturing overheads.

Work-in-progress differs from work-in-process primarily due to how quickly companies can convert them into finished goods.