What’s the highest, first out (HIFO)?
The highest, first out (HIFO) is an inventory allocation and accounting method in which the inventory with the highest purchase cost is the first to be used or removed from the stock. This will have an impact on the company’s books so that for a given period of time, inventory expenses will be the highest possible for the cost of goods sold (COGS), and the final inventory will be the most low possible.
The use of HIFO is rare or nonexistent and is not recognized by GAAP.
Key points to remember
- The Highest First Out Price (HIFO) is a method of accounting for the inventory of a business in which the most expensive items are the first to be removed from stock.
- The HIFO inventory helps a business to decrease its taxable income because it will realize the highest cost of goods sold.
- The use of HIFO is quite rare and is not recognized by general accounting practices and guidelines such as GAAP or IFRS.
Understanding the highest, the first out
Accounting for inventory is an important decision a business must make, and how inventory is accounted for will affect the financial statements and figures.
Businesses would likely choose to use the highest first out (HIFO) inventory method if they wanted to reduce their taxable income for a period of time. Since inventory recorded as exhausted is always the most expensive inventory of the business (regardless of when the inventory was purchased), the business will always record the maximum cost of goods sold.
Companies can sometimes modify their inventory methods in order to smooth their financial performance.
Compare this with other inventory recognition methods such as last in, first out (LIFO), in which the last 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). During this time, HIFO is not used often and is also not recognized by GAAP as standard practice.
Some highest implications, first out
A business may decide to use the HIFO method to reduce taxable income, but there are some implications to consider, including:
- First, because it is not recognized by GAAP, the books of the company may be subject to further examination by the auditors and may give rise to an opinion other than an unqualified opinion.
- Second, in an inflationary environment, the stocks that were drawn first may be subject to obsolescence.
- Third, net working capital would be reduced with lower value stocks. Last but not least, if the company uses asset-based loans, a lower inventory value will decrease the amount it is allowed to borrow.