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Calculating WIP

Calculating WIP

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I am having a memory blank at the moment and cannot remember the simple formula for calculating WIP.

Please see my example below, if anyone can remind me of the formula I would appreciate it!

Contract Contract £ Est Cost £ Profit Act Revenue Act Cost Commitments Total Spend to date WIP / Provision
abc  £ 10,000.00  £ 8,000.00  £ 2,000.00  £ 2000.00  £ 3,000.00  £             500.00  £          3,500.00  ????? 

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By marks
03rd Jan 2012 13:06

Would it not be a case of looking at what the total cost to date as a % of the total estimated cost is and recognising that % of profit.

In your example 43.75% of costs have been incurred (3500/8000).  Therefore should recognise 43.75% of turnover ie £4375 (43.75% x £10k).  As £2k has already been realised then the WIP is the difference ie £2375 (£4375 - £2k).

Which will mean you have recognised £4375 turnover and £3500 costs ie £875 profit or 43.75% of total expected profit of £2k

 

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Chris M
By mr. mischief
03rd Jan 2012 19:41

formula

The above is true in terms of strict calculation on simple contracts.  It's worth remembering that it's really the amount of project completion you're looking to assess.  On long term projects it is common to spend a big chunk in procurement early doors, which hasn't really done much in terms of project completion especially if it has yet to even be delivered never mind installed.

The most extreme example was a large project where most of the project outturn profit risk was associated with the final stage of the project, in terms of how the final product was going to be dealt with by a third party.

So on that one although over 90% of the cost had been incurred we only booked 40% of the profit by the year-end and did a detailed account of why this was for the auditors.  In other words, a formula is not a substitute for commercial judgement.

 

 

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By marks
04th Jan 2012 08:52

Agree with mr mischief

Agree with Mr Mischief that in the real world commecial judgements should be recognised rather than simple arithmetical calculations and therefore each "real life" contract would be judged on a case by case basis.

 

However i think the original query was just looking for the theoretical calcuation which i believe would be the correct way to show.

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By blok
04th Jan 2012 10:06

.

Pedantic!

Is this not technically "amounts recoverable on long term contracts" rather than WIP.  WIP being a stock item rather than a debtor/income item? 

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By David Carter
04th Jan 2012 23:01

question from a non-accountant

As an IT person rather than an accountant, can I ask a question on this?

A few years back I installed my first Job Costing system and it seemed very complicated, as with the current system all costs were posted to the Balance Sheet, then recharged to the P&L when the job was finished.  

WIP in the Balance Sheet was an amorphous mass of transactions and recently the accountant had got into trouble because he found some WIP which should have been recharged earlier and hadn't, and was now going to knock down the company's profits for the year.   

 

Anyhow, we decided to stop posting to the Balance Sheet and post all costs to the P&L. At the end of the month we simply ran a report of all costs incurred on UNCOMPLETED jobs and posted this as a once-off figure to the Balance Sheet.  

To an IT-person like myself, on a common-sense view it was the same principle as running a physical stocktake to calculate Closing Stock.   And it saved a vast amount of time re-recharging from Balance Sheet to P&L. 

The accountant seemed quite happy with it, but I've always wondered if this was OK in terms of accounting principles.  And all the job costing systems I've sent subsequently, people are still posting costs first to the Balance sheet, then bringing them down to the P&L later. 

So can I ask the wise men out there:  were we OK in posting straight to the P&L, rather than Balance Sheet first?  

 

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Chris M
By mr. mischief
05th Jan 2012 12:05

Yes!

Someone in another part of the large company I worked for got into a real mess using exactly the same system you've suggested, where SAP had been specified to post into the balance sheet.  Two years later the inevitable big write-off followed.

Meanwhile I had not been susing that SAP module, all project costs were going straight to the P&L.  This meant that anything going to the balance sheet meant doing work, which in turn meant that in 10 years of accounting for fixed price projects with annual sales of £10m to £50m per year in total I never had a single accounting write-off.

This included 7 years of running all the projects the person who messed up had been doing.  Following the write-off, she was invited to move on and all her stuff came into my area of the business.

The key point here is that it is easy for your staff to "go to sleep" on the balance sheet, to assume there is something to back up these balances.  If the system is set up to auto-post to the balance sheet it is even easier to fall into this trap.  

 

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By David Carter
09th Jan 2012 19:59

Thanks

 

Many thanks mr.mischief !

Some good arguments here.  I will feel much more confident when suggesting this approach in future.

 

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By Brend201
13th Jan 2012 19:37

Reconcile your balance sheet accounts

Many stock control systems (e.g. for bought in stock in discrete quantities) specify that the purchase price should be coded to a balance sheet account.  Yes, there is always a risk that the cost of sales released to P&L won't clear out all the relevant costs.  However, the answer is often to have a detailed reconciliation on an ongoing basis of the balance sheet account, and indeed of every balance sheet account.  There are many accountants who have come a cropper arising from the reconciliation at year end of control accounts that have had differences building up throughout the year and which have caused major adjustments to previously reported figures.

Always keep on top of balance sheet reconciliations, not just stock/WIP accounts! 

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By adam.arca
16th Jan 2012 10:42

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In answer to David's query, I would say WIP can be handled in monthly accounts either way.

My personal preference, having previously fallen foul of the issue of unexpected B/S write offs (I'll hold my hands up!), would be to handle the matter as Mr Mischief has suggested. That way, the accountant is forced to look at the issue properly every month and justify whatever value is carried forward to the next period. This method is also easier for non accountants to understand (no insult intended).

However, particularly where there are lots of individual items of cost to carry forward and the transfers to P&L are subject to their own independent calculation (a house builders would be an example), I can see the sense of posting all WIP to the B/S in the first instance. From personal experience, this is the riskier approach, though, and I'd second the last poster's suggestion that a rigorous reconciliation is required....but human nature being what it is, there's always the temptation not to do that.

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