Understanding the Misunderstood Work in Process (WIP)

Understanding the Misunderstood Work in Process (WIP)

My thoughts on work in process are quite simple. The way we account for this asset is unwieldy, clumsy and awkward, but we handle it this way because it is the way we have always done it. When it comes to managing WIP, there is a much easier and simplified accounting process that I want to share with you, but first there is a need to completely understand how this asset is created and, in turn, how the current system works.

Work in process is an asset that deals solely with flat rate labor paid to technicians and it is this payment to the technicians that creates this asset. The cost reflected on the repair order for these paid hours relieves this asset when the repair orders are closed in accounting. So, what we pay technicians we recover when the repair order is closed and we are back to a zero balance. Consequently, work in process is the amount we have paid technicians for repair orders that are still open. The balance of WIP should theoretically equal the number of hours on these open repair orders multiplied by the associated labor cost. Simple enough.

Understanding how WIP is created, we can now review its balance at the month end and see whether the amount is reasonable by using a simple calculation.

In the service department, a comfortable guide is two open repair orders per tech, translating into approximately two to three hours of work in process per service tech. Due to the longer repair cycle in the body shop, we look for between eight to 10 hours of work in process per body shop tech. So, if you have, say, 10 service techs, the amount of work in process is 20 hours. In dollars, it translates into 20 multiplied by the average hourly rate paid to these techs. For the body shop, I use eight to 10 hours per tech.

Using the example shown at left, the dealership should have $2,700 tied up in WIP at the month end. If the amount is substantially higher, this means (hopefully) that you have a bunch of bona fide open repair orders that need to be closed. If these repair orders are closed this asset balance will be reduced, but will it be enough to fall into line with the guide? (A question I would ask is, “Why are there so many open repair orders?”)

Why do so many dealers show way in excess of their work in process guideline? There are a number of reasons – other than a significant amount of open repair orders – that could be to blame.

• Pay rate does not equal cost. A dealer may be paying one of his techs $21 an hour, but the accounting office has the cost set up at, say, $19 an hour. So, every repair order when closed will be $2 short in cost and $2 over in work in process. Multiply this out by, say, 180 hours of monthly tech production and by the number of techs that fall into a similar situation, and this asset quickly becomes overstated.

• Charges are made to this account that are not flagged hours and don’t belong here. I often see the total pay of a shop foreman who does some service work applied to work in process instead of only those items flagged by him. The difference between his pay and the flagged hours is an expense, not an asset. The same sometimes happens with payments made to apprentices who do not flag and bonuses and/or guarantees paid to technicians. They should not be imbedded in the asset, but rather expensed as they are paid.

Here is a word of warning. Assuming your dealership is pretty much in line with the above guide or even showing a credit, is there a need to worry? Yes, because there is yet another step that must be addressed in order to make sure that the proper accounting protocols are being followed. You need to ascertain whether your technician payroll cycle coincides with the end of the month. Many dealerships have either a weekly or bi-weekly payment cycle that quite often does not coincide with the month end. If this occurs, then the dealership must accrue the amount that the company owes its technicians for that carryover period. I would conservatively estimate that less than half of the dealers whose payroll cycles do not fall in line with the month end are not making this entry, thus leaving a work in process balance that is incorrect and understated. Please be sure to make this entry, so the amount residing in WIP at the month end is accurate.

Next month I will address how to overcome this complex accounting conundrum as it pertains to work in process. There is a better way, I promise. But, before next month start asking questions and as always, feel free to e-mail me if you need some guidance…or sympathy as it pertains to work in process.

This article by Jeff Sacks originally appeared in Dealer Magazine.

Jeff Sacks, president of Jeff Sacks & Associates, is an auto industry speaker, consultant and trainer and is actively involved with dealership and OEM consulting and training.
His website is www.jeffsacksauto.com and his phone number is 800-867-2160.