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And finance Allah Shmoop What is work in process from

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

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side money selling homemade tea cozies shaped like Nobel Prize

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winning economist Milton Friedman This guy also used to be

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a runway model is your best seller But you also

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do some brisk business in Friedrich Hayek as well To

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make them you need some fabric some insulating foam some

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thread some buttons for the eyes some yarn for the

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

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Those items represent your raw materials In accounting terms They

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

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your completed cozies You post them on your website and

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you wait for orders to come in in accounting Speak

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Those are your finished goods But what about when they

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

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just doing the cutting or the working or the sewing

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

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

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

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along to reuse the raw materials somewhere else You kind

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of committed that raw material to that finished product You

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

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

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

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called a work in process magic Well you take a

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bunch of fabric cut it in the shape of Robert

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Shiller so on one of the eyes and then you

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get a call from your mother You know she just

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got an email from your Uncle Harry begging her to

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send in money again Trouble is well your uncle Harry

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died in two thousand twelve so you rush over to

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

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

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

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

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

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buy a half finished Robert Shiller So how do you

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

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work in progress Spork Whip w Well this partly done

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situation is common in business Manufacturing processes can involve a

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large number of steps and can require large amount of

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time tio go from beginning to end In the build

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a lot of dough gets tied up in work in

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process at a large manufacturer If you constrain line the

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waste well then it can save you a ton of

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capital costs and businesses Do periodic inventory counts Toe optimize

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all this They count up their direct materials and record

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how much of them are still waiting to get used

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

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capital that was deployed to build them thereby um the

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

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financial statements and those amounts add up like think about

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a major truck maker with a billion two hundred million

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dollars worth of partially made trucks lots of expensive steel

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parts lots of electronics lots of tires and plastic parts

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all waiting to get you know put together So then

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there are finished good and they can be shipped off

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to a you know dealership or car A van near

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you will think about the financing on that amount of

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money The truck payers paying seven percent a year on

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the one point two billion dollars in inventory capital that

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

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

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Seven percent on a billion to is a lot of

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money for a low profit margin carmaker So then applying

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proper accounting practices the business tallies the amount of finished

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goods it has sitting in its warehouse just like it

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did with direct materials inventory The firm then calculates the

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value of its finished goods or its final product That

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

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

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one more step work in process has to be actually

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counted and then added to the inventory value with work

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in process stages a sensitive part of the whole shebang

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Once the products are finished you can then sell the

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

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business hits a rough patch or has to liquidate itself

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

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parts well the finished products can get sold for cash

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even if prices have to get cut dramatically Those finished

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product still have value the work in process not so

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much like you can think about a ninety eight percent

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finished car that just needs a waxing Yeah you could

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probably auction that for a modest discount But a half

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built car you know Good luck with that Well a

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similar story happens with just raw materials like Think about

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it in practice here a truck maker with a warehouse

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full of tires can extract some value by liquidating the

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

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been driven around for eighteen miles testing things well they

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

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us anything close to newly priced tires So if you

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

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

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streaming music service already set up in it Well then

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

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

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pretty much the worst of both worlds like un Miley

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Cyrus While tracking work in process figures allow the company

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to give a complete financial picture of its inventory Yeah

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partially done stuff and fully done stuff and you kind

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of add the two values together So what happens Well

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you stop your mom from sending money to the fake

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Uncle Harry turned out the call was a prince of

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Nigeria sort of thing She is so happy you saved

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her from getting scammed She offers to invest in your

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cozy business at a very high valuation to you Then

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you use the money to build the factory and hire

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some employees Now you make ten thousand cozies a month

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You buy one hundred fifty thousand dollars of raw materials

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get started on your expanded cozy business Your workers start

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

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

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together a financial statements for your first quarter of operation

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Well what happens It was part of the process You

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

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

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dollars worth of materials in your store rooms just sitting

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

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three months The quarter there earning total revenue from sales

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of three hundred seventy five thousand dollars Meanwhile there are

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five thousand finished cozies sitting in the warehouse ready to

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sell the value of those cozy stands at seventy five

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

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

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

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

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a high price to carry that But you have so

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

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them there because you know there are more or less

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spoken foreign soon out the door Anyway that seventy five

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thousand dollars figure well it goes into the financial statements

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seventy five grand worth of finished inventory Well what else

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is going on here You also find that five hundred

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cozies are in process works in process at the time

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

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the balance sheet So on average there about a half

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done So at the close of your period this quarter

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

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W inventory Their value goes on the books as thirty

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seven hundred fifty bucks in the work in process inventory

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

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that they would be a tte the goose step seventy

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

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finished giving you two hundred fifty net finished cozy equivalence

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Each one value fifteen dollars So two hundred fifty times

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fifteen is Yeah three seven five zero for the inventory

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

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

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

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total value of your inventory Yes and Milton Friedman would

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be so proud Or at least Uncle Harry Wood Oh

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