Next In, First Out (NIFO)
Next-In, First-Out (NIFO) is a method of inventory valuation that assumes the goods that are added to the inventory most recently are the ones to be sold or used first. This is opposite to traditional methods like First-In, First-Out (FIFO) or Last-In, First-Out (LIFO), and it’s rarely used in practice due to its impracticality.
NIFO is mostly theoretical and used for economic or financial analysis rather than in actual business operations. This is because it requires predicting future prices, which is inherently uncertain. In a NIFO system, inventory at the end of the period is valued at the predicted cost of replacement or reproduction, which might be different from the actual cost of goods if the predictions were off.
Please note that in most jurisdictions, the use of NIFO for tax and financial reporting purposes is not allowed. Generally accepted accounting principles (GAAP) and the Internal Revenue Service (IRS) in the United States, for example, do not recognize NIFO as a legitimate inventory costing method.
Example of Next In, First Out (NIFO)
Let’s say you own a small business selling a type of electronics.
- On January 1st, you purchase 100 units at $10 each.
- On February 1st, you buy another 100 units, but due to market changes, these cost $15 each.
During February, you sell 150 units.
Under NIFO, you’d assume that the 100 units bought in February (at $15 each) are sold first, along with 50 units from the January batch (at $10 each).
So, the cost of goods sold (COGS) would be:
COGS = (100 units * $15) + (50 units * $10) = $2,000
At the end of February, you’d be left with 50 units from January, but instead of valuing them at their original cost ($10 each), you’d have to estimate the replacement cost.
Let’s say you predict that if you were to restock in March, each unit would cost you $16. Therefore, the value of ending inventory would be:
Ending Inventory = 50 units * $16 = $800
So in a NIFO system, you’d value your remaining inventory based on your prediction of future prices, not what you originally paid for the items.
Remember, while this example serves to explain the concept, NIFO is rarely used in real-world accounting due to its unpredictability and the lack of recognition by many accounting standards.
