What is Next-In, First-Out (NIFO)?
Next-in, first-out, or NIFO, is a valuation method where the cost of a particular item is based on the cost of replacing the item rather than its original cost. This form of valuation is not part of generally accepted accounting principles (GAAP), as it would violate the cost principle. The cost principle is an accounting concept which stipulates that goods and services must be recorded at their original cost and not at their current market value.
Understanding Next-In, First-Out (NIFO)?
Some companies use the first in, first out (NIFO) method when inflation is a factor. Companies will set a sale price based on replacement cost and use this method to assess the items they sell.
Although NIFO does not comply with GAAP or IFRS accounting standards, many economists and business leaders prefer the economic justification for value. As a cost flow assumption technique, stating that the cost attributed to a product is the cost required to replace it – NIFO may offer a more practical assessment method that companies will actually see during normal operations. For example, the traditional methods, LIFO and FIFO, can be distorted during periods of inflation. Using accounting principles based on these principles in inflationary environments can mislead business owners. As a result, many companies will use NIFO for internal purposes during these periods and will report the results using LIFO or FIFO in their audited financial statements.
Example of Next-In, First-Out (NIFO)
For example, a company sells a toy widget for $ 100. The original cost of the widget was $ 47, which would result in a reported profit of $ 53. At the time of the sale, the replacement cost of the widget was $ 63. If the company billed $ 63 for the cost of goods sold under the NIFO concept, the reported profit would drop to $ 37.