WIP inventory is comprised of raw materials that are undergoing conversion into finished goods as part of the production process. The term is important from two perspectives. First, the accounting department must establish a WIP tracking system that can be used to assign costs to WIP items for period-end inventory reporting purposes. Second, management must understand the amount of cash invested in WIP inventory, with the usual result being an ongoing effort to reduce the amount of WIP through the application of just-in-time manufacturing principles.
From the perspective of assigning costs to WIP inventory, the full amount of raw materials required for conversion are assigned to the WIP classification up front, after which various conversion steps are performed to create finished goods. Given the presence of raw materials, the total amount of cost assigned to a WIP inventory item may be quite close to its final, completed cost.
One of the more difficult accounting tasks is assigning a factory overhead allocation to WIP inventory items, since the stages of completion are difficult to discern, and can result in fluctuating overhead allocations from period to period. The most efficient way to deal with overhead allocations to WIP is to create the simplest possible allocation method that is easily justified, so that minimal administrative time is wasted on this costing activity.
In order to make the accounting for WIP inventory easier, some companies shut down their production operations at the end of a reporting period, so that all WIP items can be completed and shifted to finished goods; the result is no WIP inventory at all. This option is not possible for products that require longer conversion periods, or which require ongoing process manufacturing systems.
From a manufacturing perspective, it is generally considered cost-effective to reduce the amount of WIP inventory, since it clutters up the production area and interferes with the flow of work. It also tends to hide quality problems, and can require the use of an excessive amount of square footage in the manufacturing area.
WIP inventory is also called work-in-progress inventory or work-in-process inventory.