Highest In, First Out - HIFO

The cost of making a product fluctuates constantly. Raw material prices change, the amount of labor you need varies, labor rates go up over time. The money you spent to make 100 items in May might only produce 98 items in June.

As such, the cost-basis for the items you have in inventory varies. All the products in your warehouse might look exactly the same. But, in fact, there are subtle differences in the amount you spent to make them.

These variations matter for accountants. They're tasked with measuring the value of everything the company has, including its product inventory. Even so, they don't want to bother to keep track of every individual product.

Imagine an accountant at a paper clip factory. Some of the paper clips cost 10 cents to produce 100. Some cost 9.85 cents to produce 100. The accountant can't label and track every individual paper clip. If they did, tracking paper clips is all anyone would spend their time doing.

So instead, accountants use rules of thumb to track the value of inventory. This is where HIFO comes in.

The two most commonly used ways of tracking the value of inventory are called FIFO and LIFO. FIFO stands for "First In, First Out," while LIFO designates "Last In, Last Out." They use the time of production to determine which inventory remains in stock. For FIFO, the earliest items produced get sent out to customers first. LIFO assumes the most recently manufactured items get sold first.

HIFO is an alternative to the other two. As "Highest In, First Out," it tracks cost instead of date of production. Whatever the highest-cost item, whether it was made yesterday or whether it's been collecting dust since the day the factory opened, it gets sent out to customers first.