WIP is the value of products and services being produced. WIP valuation errors directly affect the financial result — overstated WIP overstates profit, understated WIP understates it. Auditors verify WIP in detail: cost qualification, fixed overhead allocation method, stage of completion on contracts, and NRV impairment test. The most common errors are: incorrect fixed overhead allocation, missing NRV write-down, and inconsistent percentage-of-completion method.
Does this apply to your company
This article applies if you run manufacturing operations with a production cycle longer than a few days, execute long-term contracts (construction, IT, engineering), or your company has a material WIP balance at year-end.
What is included in WIP cost — the rules
The cost of production of work in progress comprises three elements:
- Direct materials — raw materials and components identifiable with a specific product
- Direct labour — production workers' wages and employer costs
- A reasonable share of production overheads — fixed costs (machinery depreciation, facility maintenance) and variable costs (production energy) allocated to products
General and administrative costs, selling and distribution costs are not included in the cost of production.
4 errors the auditor finds in the first week
Error 1 — Fixed overhead allocation based on actual production
The company allocates fixed costs (e.g. production line depreciation) to products based on the actual number of units produced, not normal capacity. When production is low — WIP is overstated by the cost of inefficiency. Under both IFRS and local GAAP this is an error.
Example: Lighting OEM, production line with normal capacity of 10,000 units/month. In March 2020 (COVID) produces 3,000 units. Allocates 100% of fixed line costs to 3,000 units — unit cost is three times overstated. Correct approach: allocate on 10,000 units (normal capacity); remaining fixed costs — period cost.
Error 2 — Missing NRV test (net realisable value)
WIP is valued at the lower of cost of production and NRV. If the selling price of the finished product has fallen below cost (e.g. pricing pressure, obsolescence), a write-down to NRV is required. Missing this test is a common error.
Error 3 — Inconsistent percentage-of-completion method on contracts
On long-term contracts (IFRS 15, formerly IAS 11) revenue is recognised using the percentage-of-completion method. The method must be: justified by the nature of the contract (input or output method), applied consistently, and documented. Auditors verify whether the same method is used for similar contracts and whether it is supported by evidence.
Error 4 — Unrecognised contract losses
If the estimated total contract cost exceeds the estimated total revenue — the full contract loss must be recognised immediately (loss provision). Companies often defer this recognition until the loss is "certain". This is an error — a foreseeable loss is sufficient grounds.
Long-term contracts — IFRS 15 in brief
On long-term contracts (construction, IT, engineering) the key question is: when does control transfer to the customer — at a point in time or over time?
- If the customer controls the asset as it is created (e.g. building on their land) — revenue recognised over time, percentage-of-completion method
- If the product has no alternative use and the company has a right to payment for work to date — revenue over time
- In all other cases — revenue at the point of control transfer (delivery)
Frequently asked questions
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