Managing long-term projects requires specialized accounting to track financial performance before completion. The Work In Progress (WIP) report is the accounting tool designed to maintain accurate financial visibility for these extended contracts. It provides project managers and executives with a structured view of ongoing contracts, particularly relevant in service-based fields.
Defining Work In Progress (WIP)
WIP represents the accumulated cost of partially completed services or projects that have not yet reached final delivery and billing. Unlike traditional inventory, WIP tracks the costs associated with labor, materials, and overhead expended on a contract. This concept is found in project-based sectors where contracts span months or years, such as construction, engineering, and consulting practices. The money spent on these unfinished projects is considered an asset on the balance sheet because it represents future revenue that will be earned upon completion.
What Is a WIP Report?
The WIP report is a formal, periodic accounting document, often generated monthly, that systematically tracks and reconciles the financial status of all active projects. Its function is to calculate how much revenue a company is entitled to recognize based on the progress made. This report acts as the bridge connecting project management data, like hours worked and materials used, with the company’s financial statements. It is instrumental in applying the percentage of completion accounting method for long-term contracts, determining the corresponding percentage of the total contract value that can be recorded as earned revenue.
Why WIP Reports Are Essential for Business Health
Adherence to standardized accounting principles, such as Generally Accepted Accounting Principles (GAAP), requires companies to accurately match revenue recognition with the effort expended. The WIP report provides the necessary calculation to comply with this standard, ensuring financial statements present a true view of performance. It also serves to manage cash flow by comparing recognized revenue with amounts actually billed, helping prevent situations where costs are incurred without corresponding client invoicing.
The WIP report is a primary tool for identifying project risks before they result in financial losses. Projects showing an unfavorable trend, such as costs accelerating faster than the percentage of completion, are flagged immediately. This early warning system allows managers to intervene, reallocate resources, or negotiate changes with clients to mitigate the financial damage of an over-budget contract.
Key Components of a Comprehensive WIP Report
The WIP report relies on several key figures to accurately assess project status:
Contract Value or Total Budget: This figure represents the total monetary amount agreed upon with the client for the entire scope of work. Any authorized change orders must be formally incorporated into this figure, as it establishes the baseline for all revenue calculations.
Total Costs Incurred to Date: This aggregates all direct costs expended on the project up to the reporting date, including labor hours, material purchases, and subcontractor fees. This figure serves as the numerator in the calculation of the project’s physical progress.
Estimated Costs to Complete: This is a forward-looking projection of all remaining costs required to bring the project to its final, contracted state. Project managers must continuously update this estimate, and combining it with costs incurred yields the total estimated cost of the entire project.
Percentage of Completion: This ratio is the primary metric indicating physical progress, calculated by dividing the Costs Incurred by the Total Estimated Project Costs. This percentage dictates the amount of contract value that can be recorded as earned revenue.
Revenue Recognized: This is the calculated portion of the total contract value that the business is permitted to record as earned income in the current period. It is determined by multiplying the total contract value by the percentage of completion.
Over-Billed or Under-Billed Status: This reveals the difference between the cumulative amounts invoiced to the client and the cumulative revenue recognized. Under-billed status means the company has earned more revenue than it has invoiced, creating an asset. Over-billed status means the company has invoiced more than it has earned, resulting in a liability.
How WIP Is Calculated (Simplified Methodology)
The most common method for calculating WIP is the cost-to-cost approach, which mathematically links the effort expended to the total effort required. The simplified formula is: Total Costs Incurred to Date divided by the Total Estimated Project Costs equals the Percentage of Completion. This method operates on the assumption that project costs correlate directly with physical progress. For example, if a project is budgeted for $200,000 in costs and $100,000 has been spent, the project is 50% complete, allowing the company to recognize 50% of the total contract value as revenue.
Using the WIP Report for Strategic Decision-Making
Management utilizes the WIP report for making timely operational adjustments. The over-billed or under-billed status informs the finance department on whether to accelerate invoicing or adjust billing schedules to align cash flow with earned revenue. Projects flagged with high cost overruns or low completion percentages prompt immediate reviews for resource reallocation. Historical data gathered from WIP reports also informs future business strategy by refining cost estimation models and ensuring more accurate pricing for similar contracts.