Highest In, First Out (HIFO)

Highest In, First Out (HIFO) — is an accounting methodology in which the items with the highest value of purchase should be taken out of stock first. The highest in, first out methodology allows the companies to decrease the taxable income. However, this methodology is rarely applied because it isn't authorized by Generally Accepted Accounting Principles. 

Key features of the Highest In, First Out methodology

The highest in, first out methodology implies that the material inventory is written off starting with the goods with the highest acquisition amount, regardless of the purchase period. The process passes according to the principle that "the one who enters with the highest value is first".

This means that the reserves first entering production are estimated at the value of the most expensive purchases. The cost of the product includes the cost of materials purchased at the highest price, and the remainder of the materials is located in the warehouse and estimated at the cost of materials acquired by the lowest price at the end of the month.  

As the remainder are estimated by the lowest price, the property tax also decreases. That’s why the highest in, first out method suits the companies with the high profit that aim to decrease the tax profit. 

As per to the IRS recommendations, the accountant should fix the following data for the application of HIFO:

• Time and day of unit’s acquisition;
• Basic and fair market price of each item at the moment of acquisition;
• Time and day, when units were sold out, exchanged, or got rid of; 
• Fair market price of all units when they were sold out, exchanged, or got rid of, and the money received.    

The company can change the methodology of bookkeeping, if necessary. But first, the accountant should ascertain, if it suits the company.

Highest In, First Out in comparison with other methodologies

There are many types of management accounting. Some of them are similar to the highest in, first out methodology, others don’t. Let’s look at them in detail.

Methods of management accounting:

First In, First Out (FIFO). According to this methodology, the preliminarily acquired items are to be written off on a first-priority basis. The remainder will be estimated at the cost of the latest inflows. The product cost includes the cost of earlier purchased materials. The remainder of the materials located in the warehouse at the end of the month is estimated at the last receipt.

Last In, First Out (LIFO). According to this methodology, the acquired goods are entered into records in the order of their actual receipt. Then, they are issued to be used in production according to the cost of the last receipt. With a constant increase in prices, LIFO is aligned with the highest in, first out methodology. 

Lowest In, First Out (LOFO). According to this methodology, the materials that have the lowest assessment are written off on a first-priority basis regardless of the moment they were acquired. The reserves that had entered production first, are estimated at the cost of the cheapest purchases. Compared to the HIFO, the costs of writing off the goods decreased, and, therefore, the company's profit increased.

Next In, First out (NIFO). According to this methodology, the estimation of resources is effectuated at the price that will be paid for replenishment of the currently spent reserve. The main purpose of this method is to define the real value of material expenditures when the retirement of goods is effectuated at the cost of the next or last inflow. That’s why NIFO is called the methodology of replacement cost. 

Weighted Average Cost (WAC). According to this methodology, the accountant evaluates a weighted average by dividing the cost of goods sold by the number of available items. So, they receive the actual number of available goods. This method is simple and suits the retail business, but the accounted products should belong to the one-price category. If the accountant takes the items of different price categories, they lose money by taking the average price as a reference point and erasing the dissimilarity between expensive and cheap goods.

Why GAAP bans Highest In, First Out

The application of the HIFO method is discouraged by GAAP because it provides the possibility to avoid paying taxes especially when it comes to cryptocurrency. When the traders sell the digital money, they choose a certain unit. Usually, they select the most expensive asset and use it to define the tax obligation. The higher the cost basis, the lower the taxes. 

However, it is the trader who tracks the movement of funds. Without proper data entry, it is impossible to follow IRS recommendations. But in reality, few traders record their transactions in detail. This process requires special software, and not everyone knows about it. The traders use the wash-sale rule together with the HIFO accounting and try to look as poor as possible. The only thing that can cease this practice is the attention of regulators and the cracking down on it.