All manufacturing companies require a WIP-based product costing system because work in process is the core set of activities performed by a manufacturing business. When your accounting system is not WIP-based, time consuming, inefficient, and inadequate workarounds are required to address WIP accounting issues.
Non-WIP systems are one-dimensional
Manufacturing consists of two dimensions – “material”, meaning the components that comprise each item, and “process”, which involves the labor and subcontract processes that comprise each item. Non-WIP systems only address the material dimension and ignore the vitally important process dimension.
Three of the four major cost elements are ignored
Manufactured items consist of four major cost elements – material, labor, subcontract services, and manufacturing overhead. Non-WIP systems only deal with the material cost element and ignore the other three.
Item costs are not GAAP or IRS compliant
Without all four cost elements, the inventory cost of individual items can never be GAAP or IRS compliant, which requires that the cost includes labor and overhead.
Labor and overhead cannot be applied at the item level
Ideally, labor and manufacturing overhead costs should be applied to each item you make so that you have an accurate cost profile for pricing decisions and an accurate cost of goods sold for profitability analysis. With non-WIP systems, however, there is no good way to apply these costs at the item level.
Labor and overhead can only be applied to overall inventory at period end
Even though non-WIP systems are inherently not GAAP or IRS compliant for manufacturing, companies using such systems must comply with reporting requirements within the limitations of the software. This requires accountants to make period end adjustments to overall inventory whereby direct labor and manufacturing overhead cost totals are added to total inventory value and then beginning and ending inventory values are compared to calculate a theoretical cost of goods sold.
WIP inventory cannot be separated from inventory on hand
Work in process is actually a separate inventory and should be tracked with its own GL account. In non-WIP systems, however, no means is provided to isolate the value of WIP from inventory on hand.
Assembly builds do not isolate issued materials
Most non-WIP systems use assembly builds that deduct components after the fact when finished items are received to inventory. Because components are deducted when items are completed instead of at the time they are issued to the shop floor, there is no way to know at any given time how much component stock is actually on hand or has been issued to jobs.
Issued materials must be accounted for manually
Because non-WIP systems do not account for issued materials, whenever an accurate on hand inventory profile is required, it can only be achieved by manually adjusting inventory to account for materials issued to jobs. This often requires counting components in process out on the shop floor, which can be extremely difficult when components are already incorporated into manufactured items.
Non-WIP systems are inadequate, inefficient, and time consuming
Using a non-WIP system in a WIP-based business is inadequate, inefficient, and time consuming, for these reasons:
•You cannot make sound pricing decisions when you do not know what your items cost to make.
•You cannot assess item profitability without an accurate cost of goods sold.
•You can never operate with a reliable and accurate on hand inventory without separate tracking of WIP.
•Stock counts are much more complicated and time-consuming when materials in WIP must be manually accounted for.
•Without a reliable inventory, shortages, high expediting costs, and over-stocking are unavoidable consequences.
•Time consuming and error prone period end adjustments are required to reflect labor and overhead in overall inventory value and cost of goods sold.
WIP-based product costing solves all these problems
As you shall see in the rest of this guide, WIP-based product costing in DBA solves all these problems.
•Estimated item costs are broken out into four major cost elements – material, labor, subcontract services, and manufacturing overhead – so that you have an accurate cost profile for making pricing decisions.
•Labor, subcontract service, and manufacturing overhead costs are absorbed into the inventory cost of the items you make so that you get an accurate cost of goods sold at the item level.
•Components are deducted from inventory in real time when they are issued to jobs so that on hand inventory is always accurate and cleanly separated from materials in WIP.
•Stock counts can be freely performed without any consideration of materials in WIP.
•WIP and inventory accounts are self-adjusting and require no period end adjustments.
