ShmoopTube

Where Monty Python meets your 10th grade teacher.

Search Thousands of Shmoop Videos

Cost Accounting: What is Work in Process - Cost Account Perspective? 1 Views


Share It!


Description:

What is Work in Process from a Cost Account Perspective? Work in Process is an accounting strategy that’s used to account for only the amount of work that has been done on products that aren’t completed yet. Labor costs and overhead are calculated directly in proportion to the amount of work that has been done and accounted for that way.

Language:
English Language

Transcript

00:00

And finance Allah Shmoop What is work in process from

00:05

a cost accounting perspective Aren't people you make a little

00:11

side money selling homemade tea cozies shaped like Nobel Prize

00:15

winning economist Milton Friedman This guy also used to be

00:19

a runway model is your best seller But you also

00:22

do some brisk business in Friedrich Hayek as well To

00:25

make them you need some fabric some insulating foam some

00:29

thread some buttons for the eyes some yarn for the

00:31

air though you don't need much yarn there for Friedman

00:34

Those items represent your raw materials In accounting terms They

00:38

are called your direct materials When you're done you've got

00:42

your completed cozies You post them on your website and

00:45

you wait for orders to come in in accounting Speak

00:48

Those are your finished goods But what about when they

00:51

are You know in between what they called when you're

00:54

just doing the cutting or the working or the sewing

00:57

and they're not done yet Well the cozies Yeah they're

01:00

partially good or partially finished They're not fully finished goods

01:04

but you've done some work on them They're too far

01:05

along to reuse the raw materials somewhere else You kind

01:08

of committed that raw material to that finished product You

01:11

can't just list these products either as direct materials anymore

01:15

They're just kind of like used up raw materials in

01:18

the process of being done right And that's why they're

01:20

called a work in process magic Well you take a

01:23

bunch of fabric cut it in the shape of Robert

01:25

Shiller so on one of the eyes and then you

01:28

get a call from your mother You know she just

01:29

got an email from your Uncle Harry begging her to

01:32

send in money again Trouble is well your uncle Harry

01:35

died in two thousand twelve so you rush over to

01:38

your mom's before she can Long into her PayPal account

01:41

And well meanwhile you've got half of Robert Shiller just

01:43

sitting there on your kitchen table It's not direct materials

01:46

anymore It's been cut in half sewn in semi used

01:49

But it's not finished goods either No one's going to

01:52

buy a half finished Robert Shiller So how do you

01:56

classify that Cozy Yeah it's a work in process or

01:59

work in progress Spork Whip w Well this partly done

02:03

situation is common in business Manufacturing processes can involve a

02:07

large number of steps and can require large amount of

02:09

time tio go from beginning to end In the build

02:13

a lot of dough gets tied up in work in

02:15

process at a large manufacturer If you constrain line the

02:18

waste well then it can save you a ton of

02:20

capital costs and businesses Do periodic inventory counts Toe optimize

02:25

all this They count up their direct materials and record

02:27

how much of them are still waiting to get used

02:30

to just sitting around They're costing rent money for the

02:32

capital that was deployed to build them thereby um the

02:34

value of that material then gets listed in the firm's

02:37

financial statements and those amounts add up like think about

02:40

a major truck maker with a billion two hundred million

02:43

dollars worth of partially made trucks lots of expensive steel

02:47

parts lots of electronics lots of tires and plastic parts

02:51

all waiting to get you know put together So then

02:54

there are finished good and they can be shipped off

02:56

to a you know dealership or car A van near

02:59

you will think about the financing on that amount of

03:01

money The truck payers paying seven percent a year on

03:04

the one point two billion dollars in inventory capital that

03:07

it's holding at any given time Well that's eighty five

03:10

million dollars or about a third of the company's earnings

03:13

Seven percent on a billion to is a lot of

03:15

money for a low profit margin carmaker So then applying

03:19

proper accounting practices the business tallies the amount of finished

03:22

goods it has sitting in its warehouse just like it

03:24

did with direct materials inventory The firm then calculates the

03:27

value of its finished goods or its final product That

03:31

figure then gets listed in the firm's financial statements as

03:34

well as inventory But the inventory isn't done yet There's

03:37

one more step work in process has to be actually

03:41

counted and then added to the inventory value with work

03:44

in process stages a sensitive part of the whole shebang

03:47

Once the products are finished you can then sell the

03:50

inventory You can't sell it until they're done If the

03:52

business hits a rough patch or has to liquidate itself

03:55

like it's going bankrupt And just as the cell for

03:57

parts well the finished products can get sold for cash

04:00

even if prices have to get cut dramatically Those finished

04:04

product still have value the work in process not so

04:07

much like you can think about a ninety eight percent

04:10

finished car that just needs a waxing Yeah you could

04:12

probably auction that for a modest discount But a half

04:15

built car you know Good luck with that Well a

04:18

similar story happens with just raw materials like Think about

04:21

it in practice here a truck maker with a warehouse

04:23

full of tires can extract some value by liquidating the

04:26

unused tires But once they're on a truck and they've

04:29

been driven around for eighteen miles testing things well they

04:32

can't really be returned to the tire maker or sold

04:35

us anything close to newly priced tires So if you

04:38

have a truck that's half made tyres installed but the

04:40

vehicle isn't roadworthy doesn't have bumpers or you know a

04:43

streaming music service already set up in it Well then

04:46

you don't have a truck you Khun Cell and you

04:47

don't have parts that you Khun Cell or return It's

04:50

pretty much the worst of both worlds like un Miley

04:53

Cyrus While tracking work in process figures allow the company

04:56

to give a complete financial picture of its inventory Yeah

05:00

partially done stuff and fully done stuff and you kind

05:02

of add the two values together So what happens Well

05:05

you stop your mom from sending money to the fake

05:08

Uncle Harry turned out the call was a prince of

05:10

Nigeria sort of thing She is so happy you saved

05:13

her from getting scammed She offers to invest in your

05:16

cozy business at a very high valuation to you Then

05:19

you use the money to build the factory and hire

05:21

some employees Now you make ten thousand cozies a month

05:24

You buy one hundred fifty thousand dollars of raw materials

05:26

get started on your expanded cozy business Your workers start

05:29

making little Paul Krugman's and Gary Beckers each cozy cell

05:33

for fifteen bucks After three months it's time to put

05:35

together a financial statements for your first quarter of operation

05:38

Well what happens It was part of the process You

05:40

conduct an inventory taking time It's been three months and

05:44

you've made thirty thousand total cozies Now there's five thousand

05:48

dollars worth of materials in your store rooms just sitting

05:51

there Meanwhile you've sold twenty five thousand cozies over that

05:54

three months The quarter there earning total revenue from sales

05:57

of three hundred seventy five thousand dollars Meanwhile there are

06:00

five thousand finished cozies sitting in the warehouse ready to

06:03

sell the value of those cozy stands at seventy five

06:06

grand That's five thousand cozies times the fifteen dollars sale

06:10

price for each That's net in sales to you and

06:13

you're carrying your inventory at the price that it's expected

06:16

to sell for And that's a controversial that might be

06:19

a high price to carry that But you have so

06:21

many advanced orders coming it's probably fair accounting to hold

06:24

them there because you know there are more or less

06:26

spoken foreign soon out the door Anyway that seventy five

06:29

thousand dollars figure well it goes into the financial statements

06:31

seventy five grand worth of finished inventory Well what else

06:34

is going on here You also find that five hundred

06:37

cozies are in process works in process at the time

06:40

you calculate the value of the inventory you're holding on

06:42

the balance sheet So on average there about a half

06:44

done So at the close of your period this quarter

06:47

you've got net two hundred fifty cozy equivalents in your

06:51

W inventory Their value goes on the books as thirty

06:54

seven hundred fifty bucks in the work in process inventory

06:57

right Because they're half done or half the sale price

07:00

that they would be a tte the goose step seventy

07:02

five hundred bucks price So that's five hundred cozies half

07:05

finished giving you two hundred fifty net finished cozy equivalence

07:09

Each one value fifteen dollars So two hundred fifty times

07:11

fifteen is Yeah three seven five zero for the inventory

07:15

reckoning And that's it That's how you do your books

07:17

You got your finished inventory You're partially finished inventory or

07:20

inventory in process Your total him up And that's the

07:22

total value of your inventory Yes and Milton Friedman would

07:26

be so proud Or at least Uncle Harry Wood Oh

Up Next

GED Social Studies 1.1 Civics and Government
39794 Views

GED Social Studies 1.1 Civics and Government

Related Videos

Fake News
11938 Views

How do you tell fake news from real news?

Finance: What is Bankruptcy?
260 Views

What is bankruptcy? Deadbeats who can't pay their bills declare bankruptcy. Either they borrowed too much money, or the business fell apart. They t...

Finance: What is a Dividend?
1777 Views

What's a dividend? At will, the board of directors can pay a dividend on common stock. Usually, that payout is some percentage less than 100 of ear...

Finance: How Are Risks and Rewards Related?
589 Views

How are risk and reward related? Take more risk, expect more reward. A lottery ticket might be worth a billion dollars, but if the odds are one in...