Highest In, First Out (HIFO)
Definition
Key Facts
- Definition: HIFO is a method of accounting for a company’s inventories where the inventory with the highest cost of purchase is the first to be used or taken out of stock.
- Impact on Financial Statements: Using HIFO will result in the highest possible cost of goods sold (COGS) for a given period, which can help decrease taxable income.
- Rare Usage: HIFO is not commonly used and is not recognized by generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS).
- Comparison to Other Methods: HIFO differs from other inventory recognition methods such as last in, first out (LIFO) and first in, first out (FIFO). LIFO is part of GAAP, while HIFO is not recognized by GAAP.
- Implications: There are several implications to consider when using HIFO, including potential scrutiny from auditors, obsolescence of older inventory in an inflationary environment, and reduced net working capital and borrowing eligibility due to lower inventory value.
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 (Investopedia, 2022). This method results in the highest possible cost of goods sold (COGS) for a given period, which can help decrease taxable income (Vanguard, 2023).
Impact on Financial Statements
Using HIFO will result in the highest possible COGS for a given period, as the most expensive inventory is recorded as used up first. This can lead to lower reported profits and, consequently, lower tax liability (Empower, 2017).
Rare Usage
HIFO is not commonly used and is not recognized by generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS) (Investopedia, 2022). This is because HIFO can lead to inventory values that are not reflective of current market prices, which can distort financial statements.
Comparison to Other Methods
HIFO differs from other inventory recognition methods such as last in, first out (LIFO) and first in, first out (FIFO). LIFO is part of GAAP, while HIFO is not recognized by GAAP (Investopedia, 2022). FIFO, on the other hand, is a more common method that assumes that the oldest inventory is used first.
Implications
There are several implications to consider when using HIFO, including:
- Potential scrutiny from auditors due to its non-GAAP status
- Obsolescence of older inventory in an inflationary environment
- Reduced net working capital and borrowing eligibility due to lower inventory value (Investopedia, 2022)
Conclusion
HIFO is an inventory accounting method that can be used to decrease taxable income by recording the highest possible COGS for a given period. However, it is not commonly used and is not recognized by GAAP or IFRS. There are several implications to consider when using HIFO, including potential scrutiny from auditors, obsolescence of older inventory, and reduced net working capital and borrowing eligibility.
References
- Empower. (2017, November 30). Tax reform & capital gains: FIFO vs. HIFO. Empower. https://www.empower.com/the-currency/money/tax-reform-fifo-vs-hifo
- Investopedia. (2022, December 20). Highest In, First Out (HIFO) Definition vs LIFO, FIFO. Investopedia. https://www.investopedia.com/terms/h/hifo.asp
- Vanguard. (2023). Cost basis-Highest in, first out method. Vanguard. https://investor.vanguard.com/investor-resources-education/taxes/cost-basis-highest-in-first-out
FAQs
What is HIFO?
HIFO stands for highest in, first out. It is an inventory accounting method in which the inventory with the highest cost of purchase is the first to be used or taken out of stock.
How does HIFO impact financial statements?
Using HIFO will result in the highest possible cost of goods sold (COGS) for a given period, which can help decrease taxable income.
Is HIFO commonly used?
No, HIFO is not commonly used and is not recognized by generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS).
What are the implications of using HIFO?
There are several implications to consider when using HIFO, including potential scrutiny from auditors, obsolescence of older inventory in an inflationary environment, and reduced net working capital and borrowing eligibility due to lower inventory value.
How does HIFO differ from LIFO and FIFO?
HIFO differs from LIFO (last in, first out) and FIFO (first in, first out) in that HIFO assumes that the inventory with the highest cost is used first, while LIFO assumes that the inventory with the most recent cost is used first and FIFO assumes that the oldest inventory is used first.
What are the advantages of using HIFO?
The main advantage of using HIFO is that it can help decrease taxable income by recording the highest possible COGS for a given period.
What are the disadvantages of using HIFO?
The main disadvantages of using HIFO are that it can lead to inventory values that are not reflective of current market prices, which can distort financial statements, and that it is not recognized by GAAP or IFRS.
When should HIFO be used?
HIFO should only be used in specific circumstances, such as when a company has a large amount of inventory that is not expected to increase in value over time.