External auditors dedicate significant time during fieldwork evaluating how organizations report work in progress (WIP) inventory. This focus is critical because accurately reporting WIP helps ensure transparency and reliability in financial statements. Auditors warrant special attention to evaluate whether WIP estimates seem reasonable.

Valuing WIP 

Organizations may report various categories of inventory on their balance sheets, depending on the nature of their operations. For organizations that convert raw materials into finished goods, a key element is WIP inventory. This refers to partially finished products at various stages of completion. Management uses estimates to determine the value of WIP. In general, the more materials, labor, and overhead invested in WIP, the higher its value.

Most experienced managers use realistic estimates, but inexperienced or dishonest managers may inflate WIP values. This can make a company appear healthier than it really is by overstating the value of inventory at the end of the period and understating cost of goods sold during the current accounting period.

Accounting For Costs

Organizations assign costs to WIP depending on the type of products they produce. When an organization produces large volumes of the same product, they allocate costs as they complete each phase of the production process. This is known as standard costing. For example, if a production process involves six steps, at the completion of step two the organization might allocate one-third of their costs to the product.

On the other hand, when an organization produces unique products — such as the construction of an office building or made-to-order parts — it typically uses a job costing system to allocate materials, labor, and overhead costs as incurred.

Auditing WIP

Financial statement auditors closely analyze how organizations quantify and allocate their costs. Under standard costing, the WIP balance grows based on the number of steps completed in the production process. Therefore, auditors analyze the methods used to quantify a product’s standard costs, as well as how the organization allocates the costs corresponding to each phase of the process.

With job costing, auditors analyze the process to allocate materials, labor, and overhead to each job. In particular, auditors test to ensure that costs assigned to a particular product or projects correspond to that job.

Recognizing Revenue 

Auditors perform additional audit procedures to ensure that an organization’s recognition of revenue complies with its accounting policies. Under standard costing, companies typically record inventory (including WIP) at cost, and then recognize revenue once they sell the products. For job costing, revenue recognition typically happens based on the percentage-of-completion or completed-contract method.

Get It Right

Under both the standard and job costing methods, accounting for WIP affects the balance sheet and the income statement. Contact us if you need help reporting WIP. We can help you make reliable estimates based on your organization’s specific production process.