How to Calculate Work In Process Inventory
Demystify Work In Process (WIP) inventory calculation. This guide covers the essential inputs and steps to precisely value your in-progress production.
Work In Process (WIP) inventory represents the value of goods that have begun the manufacturing process but are not yet finished products ready for sale. These items are in an intermediate stage, requiring further effort to reach completion. Calculating WIP inventory is important for businesses, especially in manufacturing or custom production, as it provides a clear picture of current production costs, aids in accurate inventory valuation, and contributes to precise financial reporting.
Understanding the Cost Components of Work In Process
Work In Process inventory comprises three primary cost components: direct materials, direct labor, and manufacturing overhead. These elements represent all expenses incurred to transform raw materials into partially completed goods. Understanding each component helps accurately value WIP inventory.
Direct materials are raw materials that become an integral, traceable part of the finished product. For example, the wood used to build furniture or the fabric for clothing are direct materials.
Direct labor refers to the wages, salaries, and benefits paid to employees directly involved in converting raw materials into finished products. This includes individuals who physically work on the product, such as assembly line workers, machine operators, or welders.
Manufacturing overhead encompasses all indirect costs incurred in the manufacturing process that cannot be directly traced to specific products. This category includes expenses such as indirect materials (e.g., cleaning supplies), indirect labor (e.g., factory supervisors’ salaries), factory utilities, factory rent, and depreciation on factory equipment. These costs are necessary for production but are not directly linked to a single unit of output, and therefore must be allocated.
Gathering Data for Work In Process Calculation
Before calculating Work In Process inventory, specific financial data must be accurately collected. This information forms the basis for the WIP calculation. The data includes beginning WIP inventory, direct materials used, direct labor incurred, and manufacturing overhead applied or incurred.
Beginning Work In Process inventory represents the value of partially completed goods at the start of an accounting period. This figure is carried over from the previous period’s ending WIP balance and can be found in a company’s inventory records or financial statements.
Direct materials used refers to the cost of raw materials consumed during the production process within the current period. This is calculated by taking the beginning direct materials inventory, adding any direct material purchases made during the period, and then subtracting the ending direct materials inventory. Records like purchase invoices and inventory tracking systems provide the data for this calculation.
Direct labor incurred represents the total cost of direct labor expended during the period. This includes wages, salaries, and related benefits for employees directly working on the products. Payroll records, time cards, and labor rate schedules are documents for determining this cost.
Manufacturing overhead applied or incurred refers to the indirect manufacturing costs for the period. Companies often apply overhead using a predetermined rate based on an allocation base, such as direct labor hours or machine hours. Alternatively, actual overhead costs incurred can be used. Records like utility bills, depreciation schedules, and indirect labor payroll provide the figures for manufacturing overhead.
Executing the Work In Process Calculation
Calculating Work In Process (WIP) inventory involves a specific formula that integrates cost components and data gathered from various sources. This step combines financial information to determine the value of partially completed goods at the end of an accounting period. The core formula for ending WIP inventory is: Beginning Work In Process Inventory + Total Manufacturing Costs Incurred During the Period – Cost of Goods Manufactured = Ending Work In Process Inventory.
Total manufacturing costs are an input in this formula, representing the sum of the three main cost components added during the period. This is calculated by adding direct materials used, direct labor incurred, and manufacturing overhead applied or incurred. For example, if a business used $50,000 in direct materials, incurred $30,000 in direct labor, and applied $20,000 in manufacturing overhead, the total manufacturing costs would be $100,000.
Cost of Goods Manufactured (COGM) represents the total cost of products completed and transferred out of the WIP stage to finished goods inventory during the accounting period. When calculating ending WIP, COGM is a known value representing the outflow from the WIP account. It signifies the cost of items ready for sale.
To apply the formula, first identify the beginning WIP inventory. For example, if a company’s beginning WIP was $20,000, this is the starting point.
Next, calculate the total manufacturing costs incurred during the period, as detailed above. Assuming these costs totaled $100,000, the sum of beginning WIP and total manufacturing costs would be $120,000 ($20,000 + $100,000).
Finally, subtract the Cost of Goods Manufactured from this sum. If the COGM for the period was $95,000, then the ending WIP inventory would be $25,000 ($120,000 – $95,000).