Highest In, First Out (HIFO)
Highest in, first out (HIFO) Because the inventory that is recorded as used up is always the most expensive inventory the company has (regardless of when the inventory was purchased), the company will always be recording the maximum cost of goods sold. This will impact the company's books such that for any given period of time, the inventory expense will be the highest possible for the cost of goods sold (COGS), and the ending inventory will be the lowest possible. Contrast this with other inventory recognition methods such as last in, first out (LIFO), in which the most recently purchased inventory is recorded as used first, or first in, first out (FIFO), in which the oldest inventory is recorded as used first. HIFO usage is rare to non-existent and is not recognized by GAAP. Highest in, first out (HIFO) is a method of accounting for a firm's inventories wherein the highest cost items are the first to be taken out of stock.
What Is Highest In, First Out (HIFO)?
Highest in, first out (HIFO) is an inventory distribution and accounting method in which the inventory with the highest cost of purchase is the first to be used or taken out of stock. This will impact the company's books such that for any given period of time, the inventory expense will be the highest possible for the cost of goods sold (COGS), and the ending inventory will be the lowest possible.
HIFO usage is rare to non-existent and is not recognized by GAAP.
Understanding Highest In, First Out
Accounting for inventories is an important decision that a firm must make, and the way inventories are accounted for will impact financial statements and figures.
Companies would likely choose to use the highest in, first out (HIFO) inventory method if they wanted to decrease their taxable income for a period of time. Because the inventory that is recorded as used up is always the most expensive inventory the company has (regardless of when the inventory was purchased), the company will always be recording the maximum cost of goods sold.
Companies may occasionally change their inventory methods in order to smooth their financial performance.
Contrast this with other inventory recognition methods such as last in, first out (LIFO), in which the most recently purchased inventory is recorded as used first, or first in, first out (FIFO), in which the oldest inventory is recorded as used first. LIFO and FIFO are common and standard inventory accounting methods, but it is LIFO that is part of generally accepted accounting principles (GAAP). Meanwhile, HIFO is not often used and is furthermore not recognized by GAAP as standard practice.
Some Highest In, First Out Implications
A company could decide to use the HIFO method to reduce taxable income, but there are some implications to be made aware of, including:
- First, because it is not recognized by GAAP the company's books may come under greater scrutiny by auditors and result in an opinion other than an unqualified one.
- Second, in an inflationary environment, inventory that was taken in first may be subject to obsolescence.
- Third, net working capital would be reduced with lower value inventory. Last but not least, if the company relies on asset-based loans, lower inventory value will decrease the amount it is eligible to borrow.
Related terms:
Asset-Based Lending
Asset-based lending is the business of loaning money with an agreement that is secured by collateral that can be seized if the loan is unpaid. read more
Average Cost Flow Assumption
Average cost flow assumption is a calculation companies use to assign costs to inventory goods, cost of goods sold (COGS) and ending inventory. read more
Average Cost Method
The average cost method assigns a cost to inventory items based on the total cost of goods purchased in a period divided by the total number of items purchased. read more
Cost of Goods Sold – COGS
Cost of goods sold (COGS) is defined as the direct costs attributable to the production of the goods sold in a company. read more
First In, First Out (FIFO)
First-in, first-out (FIFO) is a valuation method in which the assets produced or acquired first are sold, used, or disposed of first. read more
Last In, First Out (LIFO)
Last in, first out (LIFO) is a method used to account for inventory that records the most recently produced items as sold first. read more
Mergers and Acquisitions (M&A)
Mergers and acquisitions (M&A) refers to the consolidation of companies or assets through various types of financial transactions. read more
Next In, First Out (NIFO)
Next In, First Out (NIFO) is a valuation method where the cost of an item is based on the cost to replace the item rather than on its original cost. read more