What Is Next In, First Out (NIFO)?
Let me explain Next In, First Out (NIFO) directly: it's a way to value your inventory by using the current replacement cost of an item instead of what you originally paid for it.
You should know that this NIFO valuation doesn't align with generally accepted accounting principles (GAAP). The reason is straightforward—it breaks the cost principle, which insists that you record goods and services at their original cost, not at today's market value.
Key Takeaways
- Next In, First Out (NIFO) values items based on replacement cost, not original cost.
- Companies might turn to NIFO internally when inflation drives up replacement costs above original ones, to mirror real business conditions.
- NIFO doesn't comply with generally accepted accounting principles.
Understanding Next In, First Out (NIFO)
If you're dealing with inflation in your business, you might consider using Next In, First Out. Some companies apply it to set selling prices based on replacement costs and to price the items they sell accordingly.
Even though NIFO isn't GAAP-approved, many economists and managers like its logic. As a cost flow method, it assigns the cost to replace a product, which can give you a more realistic view of what you'll actually face in operations.
Think about how traditional approaches like Last In, First Out (LIFO) or First In, First Out (FIFO) can get skewed during inflation. Those methods might mislead you as a manager in such times. That's why businesses often use NIFO for internal tracking during inflation and stick to LIFO or FIFO for their official audited statements.
Example of Next In, First Out (NIFO)
Here's a straightforward example to show you how NIFO works. Say your company sells a toy widget for $100. The original cost was $47, so you'd report a profit of $53 under standard methods.
But at the sale time, the replacement cost is $63. If you apply NIFO and use $63 as the cost of goods sold, your reported profit drops to $37.
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