Work-in-process, or WIP, is an account on the balance sheet where all the costs referring to a product or asset in production are recorded. It covers costs related to direct labor, direct materials, and MOH (applied manufacturing overhead).
The “WIP” account is debited (increased) by direct materials used in production, direct labor involved in production, and by the amount calculated for MOH. When an asset goes through all the stages of the production process, it becomes a finished good that can be sold. When this happens, the amount associated with the respective product is credited to “WIP” and debited to “finished goods”.
Needless to say, any errors in calculating WIP will mess up the entire balance sheet, so it is important to pay attention to every step and number in the calculation process. The following steps should ensure an accurate WIP calculation.
How to Calculate WIP in 5 Steps
1. Find out the direct materials amount issued for production within the reported period. It is recorded as a debit to “WIP” and credit to “direct materials”. To calculate used direct materials, take the initial direct materials balance, add material purchases, and subtract the resulting balance in “direct materials”.
2. Find out the direct labor amount involved in the production process within the reported period. It is recorded as a debit to “WIP” and as a credit to “salaries/wages payable”. The salary/wage expenses related to the production within the reported period represent the direct labor amount.
3. Calculate the MOH amount for the reported period. It is an estimate used for calculating WIP. A cost driver is used to apply MOH. To calculate the overhead rate, take the overhead costs budgeted, and divide them by the estimated cost driver (e.g. machine or labor). Multiply the resulted overhead rate by the cost driver referring to actual production units. You will obtain the MOH amount that needs to be debited to “WIP” and credited to “overhead”.
4. Debit the MOH amount obtained at the previous step to the “WIP” account. The actual MOH costs cover indirect materials and labor, as well as other costs indirectly related to the production process. These are debited directly to “MOH”. In theory, the applied MOH credit will match the actual costs debited, and the amounts corresponding to applied and actual overhead will be the same. If a debit balance remains after you debit actual costs to “MOH”, it means overhead was under-applied. A remaining credit balance suggests that you over-applied the overhead. Adjustments become necessary when the amount corresponding to over/under-applied MOH has a material impact on the WIP balance and will impact further use of the information as well.
5. Calculate the ending balance in the WIP report on the balance sheet. Add the initial WIP balance to the amounts obtained at the first three steps. Subtract the finished goods inventory (debited to “finished goods” and credited to “WIP”). The result should be the final balance of the WIP account, and it should coincide with the reported amount on the balance sheet.
