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HIFO

HIHO or Highest in, First-out is one method to determine the cost basis of the mutual fund shares you sell. HIFO is also used as an accounting method by corporations for asset management and asset valuation .

Contents

Expanded Definition

Under HIFO, the most expensive shares purchased are considered the first shares sold. Because these are the highest-priced shares, this method usually results in a lower gain. A lower gain means lower taxes. HIFO is less commonly used by investors than LIFO or FIFO

Corporations

The same basic concept applies to corporations, for example in the case of a semiconductor manufacturer the Highest inventory in is considered the the first inventory sold. This is not usually necessarily be reflective of reality and is put into use by a company wising to smooth financial performance and to pay lower taxes. For a company that wants to have the benefits of LIFO in an environment where their repurchase prices prices are falling, HIFO is the preferred method. Using HIFO thus can skew a company's results particularly their cash conversion cycle, inventory turnover and net income.

HIFO is considered by some to be an example of financial engineering and usually results in lower taxes than FIFO making it a preferable choice in The United States.

A corporation that uses HIFO must use it consistently (i.e. it can't use FIFO on it's annual statements but tell the taxman the HIFO number).

An example of how it works

Let's say Herbert TV has 100 LCD TVs in stock that it bought for a 1,000 a piece and has just bought 100 new ones ( same exact sku) for 600 a piece (deflation is great!). Under HIFO The first 100 TVs Herbert TV sells will be valued at the COGS of 1,000 whether Herbert sells from the first batch or the second. The remainder is put on its balance sheet at their cheapest merchandise's purchase price (600). Pretty sneaky eh?

But let's say Herbert sales were actually like this...100 units sold total consisting of 20 old tvs , 80 new tvs. Herbert Tv's real life COGS obviously would not be a 1,000 a piece (as LIFO would say it is) since 80% of its sales were of inventory that cost 600 dollars! Herbert's net income as a result looks much much smaller than it actually is and he pays less taxes as a result. That's good for business but can be deceptive to shareholders especially those who don't do their due diligence. This can lead to negative future earning shocks if managed improperly.

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