In this month's QuickBooks & Tricks we will finish the series on why many clients get frustrated about how their Profit and Loss each month moves up and down like a roller coaster, but the business by all indications is doing the same.
This last cause often has the greatest effect on the Financial Reports if not accounted for properly, but not all business types will need to consider it, Work in Process (WIP).
What is WIP ?
In accounting to get an accurate financial picture, the sales and costs associated with each job need to aligned in the same month, otherwise it causes an artifically higher or lower gross profit in a given month. Sales (Revenue) is normally booked when the job has been completed, and the customer accepts it as completed. WIP is simply the jobs that are not completed at the end of the accounting period (month), and typically have costs that have been incurred. In some businesses this can be very minimal since the turn rate on their jobs do not span longer than a day.
However, in a collision shop, construction company, and really any business that completion of the typical jobs take more than a day, there are jobs in which labor (payroll), parts, supplies & materials, and even subcontracted services have been paid out, but the sale will not be taken until a later month. This requires WIP adjustments made to properly align the costs and sales of each job.
In some cases if the jobs are spread across many months there may be additional considereations, but for the sake of this month's issue, we will be focusing on making standard WIP adjustments.
Before we begin, if you have not already read the last two month's QuickBooks & Tips listing the other causes to this issue, you can do so by clicking the links below:
At the end of each accounting period (typically month end) there needs to be a method of determining the costs already incurred for jobs that will not be taken as a "sale" that month. In some situations this can be thousands of dollars of already paid out costs. This can include employee direct labor payroll, parts, supplies, materials, and outside contracted services (towing, subcontractors, permits, licenses, etc). These will vary dramatically by business type and can also vary widely each month. These adjustments should be your actual costs for each, and include items purchased "on account" but not actually paid for yet.
If your business has a 3rd party management system, they generally have reports available for Work in Process. You will only utilize the costs listed on the report, but this report will not be accurate if all jobs have not been closed and sent into QuickBooks that will be included in the month's sales. The WIP report on most systems is a very fluid report, so this report should be one of the last items performed during the month closing process. Again, your goal is to align the sales and costs for each job into the same month, so not having all the sales for the month in QuickBooks before running the WIP Report will be very inaccurate.
Attempting to determine the WIP manually can be very challenging unless detailed records of costs associated to each job are kept and can be combined for monthly totals. This is an area 3rd party management systems provide a great benefit.
WIP adjustments are made using either the reports from 3rd party management systems, or by having a method of tracking all the costs manually.
At the end of the accounting period/month a memorized Journal Entry or Zero Dollar Check is created that will reduce the COGS expenses for the amount determined that were paid for jobs that are not going to be taken as a sale until a later period. For the offsetting entry at the same time, the WIP Accounts will increase that same amount.
WIP Accounts are Current Asset Accounts on the Balance Sheet, and will vary based on the business type. For this article, we will be providing examples based on a collision repair shop, but there will be many similarities to many other business types.
Figure 1 - Typical WIP General Ledger Accounts (Collision Repair Industry)
You may have noticed that even though industries such as Collision Repair have several COGS sub labor, parts, materials, and sublet accounts that are often tracked, the WIP Accounts only have main category accounts. This is because it is not necessary to have every COGS Account listed in the WIP section. The actual adjustments will include each COGS and Sub Account.
Figure 2 - Typical General Ledger Memorized WIP Adjustment Journal Entry (Collision Repair Industry)
You may also notice that there are no Supplies and/or Materials entries. This is because if a 3rd party management system is being used, the costs for these items are a calculated costs, not necessarily actual costs. During the setup of the management system, it is inputted what calculated costs of these items will be used for Job Costing purposes within the system.
If there are actual invoices that have been paid for supplies and/or materials for any job that will be part of WIP, they can be used as well. Another way is to utilize an agreed percentage for these costs each month. For example if the calculated costs of the supplies/materials on the WIP Report are $2030.00, you may elect to include 25% - 50% which would add an entry for 1330.00 WIP - Materials Total of $507.50 - $1015.00 and decrease the COGS for Materials and Supplies the same.
In most instances, the WIP adjustments will increase your Gross Profit and Net Profit.
Reversing Entries vs WIP Change
Once the monthly entry is made typically on the last day of the accounting period, there are two methods how to finish the process:
- Reversing Entry on the first day of the following month
- Entering Only WIP Change Each Month
These entries are made on the first day of the following month, and are the most common and easiest way clients finish the WIP Adjustment Process, but it has some downfalls. The reversing entry on the following month will transfer all the costs again into the COGS and out of the WIP Asset Accounts. This will return the WIP Accounts to zero balances on the first day of the following month, but increase all the COGS accounts as well, even though the jobs probably still have not been completed.
Figure 3 - Typical General Ledger Memorized WIP Adjustment Journal Entry Reversal (Collision Repair Industry)
In QuickBooks once you open the original WIP Journal Entry, there is a "Reverse" Button on the Tool Bar in the Main Tab. Just click it, and change the date of the entry to the first day of the following month.
This will as mentioned earlier zero out the WIP Accounts and transfer the costs back into the COS Accounts.
The key downside to this method is that if you wanted to just check your current month profitability before the next WIP Adjustment is made, it will generally report a much lower Gross Profit and Net Profit than actual, unless you also run the WIP Report and do WIP Adjustments to offset the current WIP costs.
Entering Only WIP Change
The most accurate method, if we are splitting hairs, is to only enter the "Change of WIP" each month. So, after the first month's WIP Adjustment is made, you do not do a Reversing Entry the beginning of the following month.
This method however requires a spreadsheet created to make the math easier at the end of each month. Over the years, I have created these WIP Spreadsheets for many management systems since their reports are different. I have always tried to make the spreadsheet follow the management system's report for easy entry, and provide the Journal Entry to match the memorized transaction in QuickBooks. It is possible to actually create an import file for QuickBooks, but I have never had a client request this feature.
Figure 4 - WIP Change Spreadsheet (Collision Repair Industry CCCone Management System)
The spreadsheet follows the management system report and each month the entries are inputted. In this example materials are being included at 50% of the calculated costs.
The spreadsheet does the calculation of the "Change in WIP" each month and provides the Journal Entry needed each month.
Figure 5 - WIP Change Journal Entry (Collision Repair Industry CCCone Management System)
Whether you use the first or second method is up to you, but if your business type has jobs that carry over from one accounting period to another, you should include WIP Adjustments in your accounting process for closing the month.
The whole purpose of this three month series of QuickBooks Tips & Tricks is designed to improve your QuickBooks accuracy. Otherwise your P&L will move up and down like a roller coaster, and your financial information to run your business is simply inadequate.
Next month, we will look at another very common mistake made by QuickBooks clients ... how to properly track loans, leases, and depreciation.
Well we have just begun our final quarter of the calendar year, and before you know it, it will be year end time. Have you analyzed your year end profitability and tax liability yet ? If not, this is the time to do so, begin to get your QuickBooks in order for the year end closing, and getting ready for the new year to come.
There are many responsibilities you have to get ready for the year end, but there are many Holidays and personal events that will hinder your time as well. Year end closing normally requires a great deal of "Clean Up" to correct accounts and verify them for a good new year beginning, and certainly before you turn them over to your CPA for tax preparation.
You may also consider benchmarking your financials against industry key performance indicators (KPI's), and even consider what your budget should be for capital equipment expenses. Keep in mind, it may be best for your tax liability to get the needed purchases done before the end of the year, but it takes good information and analysis to determine this.
There are several resources you should consider to get assistance in this area... the first being our company AEII, QuickBooks R Us. We are here to assist any small business with these services, and provide the training and support needed to achieve their goals. We have assisted businesses worldwide ... why not yours ?
Again, if you are thinking about upgrading your chart of accounts to reflect a better detail for your financials the best time to make the transition is at year end. However, to schedule this type of project, needs to be done now, and not wait until the end of November or December.
If you have missed our earlier issues of QuickBooks Tips & Tricks, you can catch up on past issues by Clicking Here
Thank You and I look forward in sharing QuickBooks Tips and Tricks with you next month ...