Understanding Work In Process
What is Work In Process?
Most auto body shops have jobs at the end of reporting periods for which they have incurred costs
(purchased parts, paid for labor, have a tow bill) but have not yet recorded any revenue because the job
was not completed yet. These jobs are considered Work in Process or WIP. WIP is an important
concept to understand, since the associated costs can cause misrepresented gross profits for the period.
To refresh, accrual based financial statements report revenue when earned (meaning when the job is
done/delivered, whether it has been paid for or not) and costs are reported when incurred (a bill has
been received for goods purchased whether it has been paid for or not).
At the end of a reporting period the costs for the repair order will frequently already have been
reported in the financials but the revenue may not have been, since the sale will not get recorded until
the completion of a repair. This causes the costs to be overstated as compared to the revenues, leading
to an understatement of gross profit for the period. A WIP journal entry entered at the end of a
reporting period causes the revenue from a repair order to be reported with the expenses associated
with that repair order in the same time period. By pulling those costs not associated with a sale out of
the costs for the time period and moving them to an account on the balance sheet (as an asset—these
are items that have been purchased by the business for the business), the costs are then decreased
leaving only those costs related to jobs that have been delivered/completed to be compared with the
revenues for those same jobs. In this way the gross profit will be accurately reflected for the completed
jobs.
The journal entry typically gets reversed at the beginning of the following reporting period, thereby
zeroing out the balance sheet WIP account and putting those costs back into the cost accounts. Some
costs may ultimately be included in WIP for more than one consecutive period if it takes several periods
for the repair to be completed, as with an extensive restoration or with a heavy hit.
To illustrate with an example let’s take a simplified look at three repair orders with their accounting
system expenses and revenues over a single period.
Accounting Figures Before WIP Adjustment
#1
#2
#3
Total
Revenues
$0.00
$800.00
$3000.00
$3800.00
Total Costs
$(2000.00)
$(500.00)
$(1500.00)
$(4000.00)
Gross Profit $
$(2000.00)
$300.00
$1500.00
$(200.00)
Gross Profit %
0%
37.5%
50%
-5.2%
A review of these three repair orders indicates that one of the three is considered work in process as
there have not been any revenues recorded for it yet. The second and third repair orders have been
completed and resulted in a gross profit of 37.5% & 50% respectively. If there was no adjusting journal
entry for WIP, the financial statement would report a loss as gross profit for the period, which doesn’t
make much sense since both of the completed repair orders had gross profits above 35%. By contrast if
we record a journal entry to reverse out the costs for the first repair order (since there are no
corresponding revenues to offset the costs) the resulting totals look as follows:
Accounting Figures After WIP Adjustment
#1
#2
#3
Total
Month 1 Revenues
$0.00
$800.00
$3000.00
$3800.00
Month 1 Costs
$0.00
$(500.00)
$(1500.00)
$(2000.00)
Month 1 Gross Profit
$0.00
$300.00
$1500.00
$1800.00
0%
37.5%
50%
47.4%
Gross Profit
As you can see, the resulting gross profit after removing the costs not associated with offsetting revenue
is an accurate reflection now of the completed repair orders for the period at 47.4%.
What Does the Entry Look Like?
In an auto body shop, most of the items that get reversed out include the following: All labor
categories; all parts categories; all sublet categories and towing. Some shops prefer to have multiple
accounts on the balance sheet for WIP, while others have just one account to accumulate all of the
components of WIP. At the end of the period, the entry to record WIP includes a debit to WIP (Balance
Sheet) and a credit to the various Cost of Goods Sold accounts (P&L). An example:
Account
Work in Process (Asset)
Debit
Credit
$2000.00
COGS – Labor
$1000.00
COGS – Parts
$800.00
COGS – Sublet
$100.00
COGS – Towing/Storage
$100.00
Total
$2000.00
$2000.00
The reversing entry on the first of the following month is a credit to WIP and a debit back to the COGS
accounts. This puts the costs back into the P&L and removes the asset from the balance sheet:
Account
Debit
Credit
COGS – Labor
$1000.00
COGS – Parts
$800.00
COGS – Sublet
$100.00
COGS – Towing/Storage
$100.00
Work in Process (Asset)
Total
$2000.00
$2000.00
$2000.00
Where Can Things Go Wrong?
Frequently business owners or bookkeepers use a WIP report from their management system to give
them the amounts to use in the journal entry. These amounts are only accurate if the following
statements about your management and accounting systems are true:
1.
I have closed out all jobs in the management system that have been completed for the period as
of at least the last day of the period.
2. None of the jobs that were completed this period are reported as revenue in either the
management system or in the accounting system in a prior period or in a future period.
Example: If a job is closed out in the management system as of the 30th but has not been
reported in the accounting system until the 1st, no costs will be included as WIP on the WIP
report meaning that they will not be reversed out and will be counted as costs in the current
period. However, the revenue is going to be reported in the following period. You now have
costs in one period and revenues in another period, leading to understated gross profit in one
period and overstated gross profit in the next. To fix this problem, make sure that revenues
are dated the same in both the management and accounting systems.
3. If I use my management system to calculate labor costs, all of these costs have been recorded in
the accounting system during the same period. Example: If your payroll is paid on a later date
than the date on which it is calculated, this will need to be accounted for. For example, if you
calculate labor expenses of $500 in the management system as of the 27th of the month but you
don’t actually pay it to your employees and/or record it in your accounting system until the 3rd
day of the next month, there is essentially nothing to reverse on the 30th of the month since the
expense won’t be recorded until the 3rd. Your WIP report however will show $500 as a labor
cost to be reversed which is technically incorrect because it hasn’t been recorded yet. If you
actually do include this $500 in the WIP journal entry, labor costs will end up being understated,
which will overstate gross profit. This is not an accurate reflection of gross profit either. To fix
this problem, deduct the amounts paid in the next period from the WIP costs of the current
period (as calculated on the WIP report) to calculate the labor WIP amount. An alternative fix
would be to record an accrual for payroll (liability on the balance sheet) on the 27th.
4. I enter bills from vendors with the same date in both my management system and my
accounting system. Example: As in the example above with labor, if a bill is entered in the
management system as of the 30th of the month but it isn’t dated until the 1st of the next month
in the accounting system, there is nothing to be reversed in the accounting system, which will
again understate costs and overstate gross profit. The reverse could also be true where the
expense is in the accounting system but not in the management system, leading to an
understatement of gross profit as the expense won’t be reversed out. To fix this problem,
make sure that all bills are dated the same in both the management and accounting systems.
5. I am sure that the categories used in my management system match the accounts in my
accounting system. Example: If the bill in the management system is recorded as a
remanufactured part but in the accounting system the part is recorded as an aftermarket part,
the WIP report will have the journal entry reduce the COGS - Remanufactured Parts account
when the cost is actually sitting in the COGS – Aftermarket Parts account. While this error will
have no effect on Gross Profit overall, for those businesses using classes to track gross profit by
class (profit center), the gross profit numbers by class will be inaccurate. To fix this, be sure
that account coding is consistent between the management and accounting systems.
The bottom line is make sure your dates in the management and accounting systems match and be
sure that there is actually a recorded cost in the accounting system before reversing it out at the end
of the period.
Other WIP Considerations
Many independent auto body shops count their Paint and Material and Stock Parts inventory only at
year-end, or perhaps quarterly. Because of the nature of P&M and Stock Parts purchases, generally
there is no WIP adjustment made for Paint and Materials and Inventoried Stock Parts. If an actual count
of this inventory is performed at the end of a reporting period, then the inventory amount for Paint and
Materials and/or Stock Parts can be adjusted on the balance sheet up or down to reflect the actual value
of the inventory. The offsetting entry would be to the COGS – P&M or COGS – Stock Parts account. For
example if the P&M Inventory value increased by $1000.00 and Stock Parts Inventory increased by
$500.00 from the prior reporting period, the adjusting entry would be as follows:
Account
Inventory (Asset)
Debit
$1500.00
COGS-P&M
$1000.00
COGS-Stock Parts
Total
Credit
$500.00
$1500.00
$1500.00
Typically, if Inventory is carried on the balance sheet, the adjusting entry is not reversed so that the
adjusted inventory balance remains on the balance sheet. Inventory is not zeroed out at the beginning
of the next period. When the inventory is counted again, another adjusting entry will be made at that
time to adjust the value up or down.
Why Do I Need to Worry About WIP?
The question often asked is, “Can’t I get gross profit numbers out of my management system? Why do I
need to worry about the numbers in my accounting system?” The answer is, yes you can get gross profit
numbers out of the management system for individual jobs and in summary. However, the
management system does not typically allow you to track the other expenses of your business. To get
the most accurate picture of how your business is doing for a specific time period, you should be
reviewing both gross profit numbers—to see where you need to make improvements in sales and cost
numbers, as well as net profit numbers—to see where you need to make improvements in all of the
other expenses in your business. When your gross profit numbers are overstated in one month and
understated in the next month because the timing of costs and revenues has not been managed
properly, the overall picture is very difficult to see and you may get either a false sense of security or an
incorrect picture of doom. The proper reporting of costs and revenues and expenses in the same period
consistently gives the business owner a clear picture of true fluctuations in the business without the
numbers being influenced by timing issues between receipts and costs. You will be better able to see
when problems arise and address the issues more quickly.