To calculate work in progress, take your beginning WIP inventory, add the total manufacturing costs incurred during the period, and subtract the cost of goods manufactured. The result is your ending WIP, the value of production that started but did not finish during the period.
Written out:
Ending WIP = Beginning WIP + Total Manufacturing Costs − Cost of Goods Manufactured
Total manufacturing costs is the sum of direct materials, direct labor, and manufacturing overhead. Cost of goods manufactured (COGM) is the total value of units that reached completion and moved to finished goods during the period. Subtracting COGM from the combined production pool isolates the value still stuck on the floor.
A Worked Example
Say your beginning WIP is $50,000. During the month you spend $200,000 on materials, $150,000 on production labor, and $100,000 on overhead. Total manufacturing costs come to $450,000, and the full production pool (with the opening balance) is $500,000. If $400,000 worth of goods finished production and transferred to the finished goods warehouse, ending WIP is $100,000. Every dollar spent during the period lands in one of two places: finished product or unfinished work.
The math is simple. The work is in getting each input clean.
Beginning WIP
Beginning WIP is always the ending WIP from the prior period. Pull it from your general ledger’s inventory accounts at the last close. A brand-new operation with no carryover starts at zero. Everyone else should see this figure tie back to prior-period financial statements and, ideally, to a physical count or reconciliation from that close.
Direct Materials
Direct materials are the raw goods that physically become part of the finished product. Use the purchase price net of vendor discounts, plus freight and delivery to your facility. Track them through material requisition forms or inventory software that records transfers from the raw materials warehouse to the production floor.
Only count materials that have actually entered production during the period. Raw materials still sitting in storage belong in a separate inventory account, not in WIP.
Direct Labor
Direct labor is the gross wages and associated payroll costs of employees who physically work on production. Include employer-paid payroll taxes, workers’ compensation, and health insurance. Pull the figures from payroll journals, filtered for hours coded to production jobs or departments.
Time-tracking software matters here. You want the labor hours spent building products, not time spent on maintenance, supervision, or other support tasks. Those indirect labor costs belong in overhead.
Manufacturing Overhead
Manufacturing overhead captures indirect production costs: factory rent, property taxes on production facilities, equipment depreciation, utilities, maintenance, and supplies that support manufacturing but do not become part of the product. Federal tax regulations require manufacturers to treat rent, property taxes, and depreciation on production assets as inventoriable costs.1eCFR. 26 CFR Part 1 – Inventories
Because overhead cannot be traced to individual products the way materials and labor can, you need an allocation method. The common approach is a predetermined overhead rate set at the start of the period. Pick a cost driver (machine hours and direct labor hours are the two most popular), then divide estimated total overhead by the estimated total driver. Budget $120,000 in overhead against 10,000 expected machine hours and your rate is $12 per machine hour. As production runs, multiply actual driver hours by that rate to assign overhead to WIP.
Cost of Goods Manufactured
COGM is the total production cost of every unit that finished during the period and transferred to finished goods. Build it from your production records by summing each completed unit’s accumulated materials, labor, and overhead. This is the number you subtract in the WIP formula. It represents value leaving the production floor.
Job Costing or Process Costing
The formula is the same either way. How you accumulate the inputs is not.
Job costing tracks costs by individual job, batch, or customer order. A custom furniture shop or a defense contractor building to specification uses this approach. Each job gets its own WIP subsidiary account, and materials, labor, and overhead are charged to that specific job as costs are incurred. Total WIP is the sum of all open job cost sheets.
Process costing tracks costs by production department or process stage. A chemical plant, a food processor, or any manufacturer producing identical units in continuous runs uses this method. Costs flow through departmental WIP accounts, and you calculate the cost per equivalent unit at each stage. Equivalent units is the key concept: 1,000 units that are 60% complete count as 600 equivalent units for cost allocation.
Most WIP errors trace back to using the wrong system for what you actually make. If your products differ meaningfully from one another, use job costing. If they are identical or nearly so, use process costing. Getting this wrong makes your per-unit costs unreliable, and an unreliable per-unit cost feeds directly into an inaccurate ending WIP.
How Scrap and Spoilage Flow Through
Every process generates some waste, and how you handle it changes the WIP number.
Normal spoilage is the expected, unavoidable scrap that occurs during efficient production. It stays in your product costs, absorbed into WIP and eventually into the cost of finished goods. If your process typically yields a 2% defect rate, the cost of those defective units gets spread across the good units.
Abnormal spoilage is loss beyond what your process normally produces, caused by equipment failures, operator errors, or defective materials. Expense it immediately as a period cost. It hits the income statement directly and does not inflate the value of remaining WIP. Burying abnormal waste inside WIP overstates inventory and understates current-period expenses.
Adjusting to the Lower of Cost and Net Realizable Value
The calculated WIP number is not automatically the number that lands on the balance sheet. Under U.S. GAAP, inventory measured using FIFO, average cost, or similar methods is carried at the lower of cost and net realizable value.2Financial Accounting Standards Board. Accounting Standards Update 2015-11 – Inventory (Topic 330) Simplifying the Measurement of Inventory Net realizable value is the estimated selling price minus reasonably predictable costs to complete, dispose of, and transport the goods. If the market has shifted and your WIP would sell for less than what you have invested, write it down to that lower figure.
Companies using LIFO or the retail inventory method still follow the older lower of cost or market test, which compares replacement cost, net realizable value, and net realizable value minus a normal profit margin.2Financial Accounting Standards Board. Accounting Standards Update 2015-11 – Inventory (Topic 330) Simplifying the Measurement of Inventory
Before closing the books, compare the calculated WIP balance against a physical count or an estimate of stage-of-completion on the floor. Discrepancies usually surface from unrecorded scrap, materials used on one job but charged to another, or labor hours misallocated between departments. Catching them now prevents the error from compounding into next period’s beginning balance.
One Boundary: Tax Rules May Push More Costs Into WIP
The number you calculate for your books may not be the number you use on your tax return. Section 263A of the Internal Revenue Code requires manufacturers to capitalize both direct costs and a proper share of indirect costs, including taxes, into inventory.3Office of the Law Revision Counsel. 26 USC 263A – Capitalization and Inclusion in Inventory Costs of Certain Expenses Under these uniform capitalization rules, costs such as officers’ compensation allocable to production, factory insurance, and certain storage costs may need to be folded into WIP rather than deducted currently. Capitalizing more costs into WIP delays the tax deduction until those goods are sold.
Smaller manufacturers get out of this. If your average annual gross receipts over the prior three tax years fall under the Section 448(c) threshold, you are exempt from UNICAP. That threshold is indexed for inflation, and it was $31 million for 2025 tax years.4Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense Businesses meeting the same test can also elect simplified inventory methods under Section 471(c), including treating inventory as non-incidental materials and supplies.5Office of the Law Revision Counsel. 26 USC 471 – General Rule for Inventories If you clear the threshold, plan on running a separate tax calculation that adds capitalizable costs your book WIP does not include.