What Is Next-In, First-Out (NIFO)?
Next-in, first-out, or NIFO, is a method of valuation where the cost of a particular item is based upon the cost to replace the item rather than on its original cost. This form of valuation is not one of the generally accepted accounting principles (GAAP) because it is said to violate the cost principle. The cost principle is an accounting concept that states that goods and services should be recorded at their original cost, not present market value.
Understanding Next-In, First-Out (NIFO)?
Some companies use the next-in, first-out (NIFO) method when inflation is a factor. Companies will set a selling price on a replacement-cost basis and use this method as a way to price the items it sells.
Although NIFO doesn't conform to GAAP or IFRS accounting standards, many economists and business managers prefer the economic rationale behind the value. As a cost flow assumption technique, by stating that the cost assigned to a product is the cost required to replace it — NIFO can offer a more practical valuation method businesses will actually see during normal operations. For instance, the traditional methods, LIFO and FIFO, can become distorted during inflationary periods. Using accounting methods based on these principles during inflationary environments can mislead business managers. Hence, many businesses will use NIFO for internal purposes during these periods and report results using LIFO or FIFO on their audited financial statements.
Example of Next-In, First-Out (NIFO)
As an 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 were to charge $63 for the cost of goods sold under the NIFO concept, the reported profit would decline to $37.