January 26, 2022

SB-Accounting

Accounting + Finance Blog

Work in Progress (WIP) Conversion Period and Key Explanations

Work in Progress (WIP) Conversion Period and Key Explanations
Shares

One aspect of the gross operating cycle is work in progress conversion period. It tells you how long raw materials remain in the manufacturing process. When raw materials are kept for a long time before they are converted to finished products. It doesn’t tell better things about the entity. This article discusses, WIP conversion period.

Definition of Work In Progress Conversion Period

1. Work in progress conversion period is the period it takes for raw materials, labor, and expenses that are put into production, and the process is yet to be completed as finished goods.
2. Also, it can be defined as the part of a firm’s gross operating cycle that involves the timeframe to process raw material, use labor and machines that are in the various stages of production.

Key Explanations

Operating cycle. The gross operating cycle includes raw material conversion period, WIP timeframe, and account receivable period. I have explained the raw materials timeframe. Read here. Here, I will develop an explanation for the WIP conversion period.

READ ON  Working Capital meaning and key Explanations

The period. Upon buying raw materials for production, labor and machines are applied to convert the raw materials to finished goods. At the various stages of processing raw materials, there is the need to calculate the various works that are still in progress. This helps to keep data of the various stages and avoid stealing unfinished products by employees.

The management must keep the period for WIP short. Failing to do so, implies that the management is keeping too many incomplete inventories idle. The product should have been completed on time and sold to consumers.

Various stages of production. WIP is usually in various stages of production. Some products may require three stages of production. Normally, the processes or stages can’t be completed within a day. This results in WIP. A good example is rice processing. Let’s assume that it requires three stages to make raw rice from the farm fit for eating. Stage 1 is the filtering of the shaft. Stage 2 is refining the rice and stage 3 is the packaging.

READ ON  Inventory Conversion Period of Manufacturing firms and Key Explanations

It may not be possible to shaft out all the raw rice in stage one. Also, the refining may not be completed as well as the packaging on or before inventory count is done. All the unfinished materials constitute work in progress.

Formula to calculate WIP Conversion Period

The formula to calculate is (Average work in progress ÷ cost of production) × 365 days

Average work in progress = (opening + closing WIP) ÷ 2

Example

Given the following information of ABC corporation, calculate the WIP conversion period.

Work in Progress (WIP) Conversion Period and Key Explanations

From the above data, the average WIP is (500,000 + 730,000) ÷ 2. This becomes 1230000 ÷ 2. And the result is 615,000.

Next, the conversion period becomes 615000 ÷ 3570000. This equals 0.17. Multiply this answer by 365 days. You will get 62.89 days. It implies that it takes more than two months for ABC for raw materials to remain as WIP.

READ ON  Account Receivables (Debtors) Collection Period and Key Explanations

Implications of WIP Conversion Period

A shorter period for WIP tells well of the company. It means that the management is efficient. And do not keep unfinished goods idle for a long time. This increases sales reduce the cost of keeping unfinished products, and of course, increases profit. It also boosts shareholders’ and investors’ confidence in the business. It tells them that their investments are in good hands.

Conclusion

WIP conversion period looks at the number of days, weeks, or months it takes for raw materials to remain as an unfinished product. A longer period is dangerous as it does not speak well of the entity. As a result, management should ensure that work in progress is converted as soon as possible to finished goods.

Shares