What it means
Any business that takes time to make something has some work in progress at any given moment. A furniture maker has half-built tables, a builder has partly finished houses, and a software house has projects that are underway but not delivered.
The costs of those items are recorded as an asset rather than as an expense. The costs in WIP usually fall into three groups.
Direct materials are the raw items used, direct labour is the pay of the people working on the product, and manufacturing overhead is a share of indirect costs such as factory power and supervision. Together they show how much has been invested in unfinished output.
When the work is finished, its accumulated cost moves out of WIP into finished goods, and when the goods are sold, the cost moves to cost of goods sold. The movement is recorded through a manufacturing cost statement, which shows how WIP changes over a period.
WIP matters because it ties up cash. A business with large or slow-moving WIP has paid for materials and wages long before it can invoice the customer, which puts pressure on working capital (the money needed for day-to-day operations).
Long projects raise a related question about revenue. Under contract accounting rules, a business may recognise revenue progressively as work is done, in which case the unfinished project is shown as a contract asset instead of simple WIP.
Managers watch the ratio of WIP to sales, how long items spend in production and how much WIP is stuck. Reducing it through better scheduling and shorter production times frees cash without any new sales.
Auditors check that the reported amounts are supported by time records and records of materials issued.
In practice
Real-world examples
Example 1
A boat builder has three hulls under construction at the end of the quarter. It has spent $210,000 in materials, wages and overhead on them so far. That amount is reported as WIP, not as an expense or a sale.
Example 2
A printing company has half-finished jobs on the presses at month end, with paper, ink and labour already used. The finance team values the jobs at cost and includes the total in inventory. Next month, when the jobs are finished and delivered, the cost moves to cost of goods sold. Profit therefore appears only when the work is complete and sold.
Example 3
A construction firm builds an office block over two years. Instead of reporting only WIP, it recognises revenue as the building progresses, based on the share of work completed. The costs incurred and the revenue earned are matched each period. Any costs for work not yet done stay on the balance sheet.
Think of it
Work in Progress is like a cake half-baked in the oven. It has value because you bought flour and eggs, but you cannot serve it to customers yet.
Formula
Calculation
Ending WIP = Beginning WIP + Direct materials + Direct labour + Manufacturing overhead - Cost of goods manufactured
A manufacturer starts the month with WIP of $40,000. During the month it uses $90,000 of direct materials, $60,000 of direct labour and applies $30,000 of manufacturing overhead. The cost of goods manufactured, which is the cost of items completed and moved to finished goods, is $190,000. Total costs to account for = 40,000 + 90,000 + 60,000 + 30,000 = $220,000. Ending WIP = 220,000 - 190,000 = $30,000.Case study
Seen in the real world
Calderbrook Cabinets is an illustrative, fictional kitchen maker whose cash was short even though orders were strong. The owner could not understand why, until the accountant analysed the balance sheet and found that WIP had risen from $120,000 to $310,000 in six months.
Cabinets were waiting for doors from a supplier, so many kitchens sat unfinished for weeks. The extra WIP of 310,000 - 120,000 = $190,000 represented cash spent on wood and wages that could not be invoiced.
In the illustrative result, the owner changed supplier and scheduled production so that doors arrived before the cabinets were started. WIP fell back to $150,000 within three months, releasing $160,000 of cash without selling a single extra kitchen.
Watch out
Common mistakes
- Treating work in progress as an expense when the costs are paid, when it is an asset until the goods are finished and sold.
- Leaving out manufacturing overhead, which understates the value of WIP and overstates profit in the period.
- Ignoring old or stalled WIP, which may be worth less than its cost and might need to be written down.
Questions
People also ask
Is WIP the same as finished goods inventory?
No, WIP covers items still in production, while finished goods are completed products waiting to be sold.
How is WIP valued?
At the cost of materials, labour and overhead used so far, and it should be reviewed for items that are damaged or unlikely to be completed.
Do service firms have WIP?
Yes, firms such as law practices and consultancies have unbilled work, often called work in progress, representing time spent but not yet invoiced. Partners track it closely because unbilled time is cash the firm has not yet collected.