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Is "NIFO" really the right way to do accounting? If you sell the government one aircraft carrier, the cost of producing a second one will be much lower, so NIFO

by tgb 5y ago

Is "NIFO" really the right way to do accounting? If you sell the government one aircraft carrier, the cost of producing a second one will be much lower, so NIFO doesn't seem to fit there.

philwelch 5y ago
I think NIFO applies only to variable costs. Fixed costs are fundamentally different. Also, low-volume items like aircraft carriers are probably a bad example. Aircraft carriers are ordered and built in small, specific quantities; I think it makes more sense to account for building a single aircraft carrier as a construction project rather than as a unit of mass production. Almost like you were building a small airport, thousands of units of housing, and a nuclear power plant.
- tgb 5y ago
  But my point was that variable but decreasing costs seem to throw NIFO off too. Aircraft are the extreme example but I'm sure the first of Tesla's latest car model costs more to produce than the thousandth. Not even counting capital expenses but just by things running smoother with practice. NIFO seems to fall short here too.
  - philwelch 5y ago
    I’m not sure that’s always or necessarily true. The variable costs will go down over time if there are process improvements, but eventually there are diminishing returns to those. Meanwhile, the cost of materials and labor could rise.
    - tgb 5y ago
      Sure it's not 100% of the time but that's besides the point still. Isn't NIFO a bad fit for the times when per-unit costs are decreasing? And since this happens fairly regularly it seems like a bad choice period, or at least not obviously better than FIFO or LIFO.
notatoad 5y ago
typically when you're selling aircraft carriers, you're selling it before you build it - the customer is paying you to make it, not paying you for the one you've already made. so the neither the economics or the accounting work the same way as acting as middleman for retail goods.
chernevik 5y ago
I suppose it depends on what we're talking about, but probably not. LIFO and FIFO are book accounting concepts, and business decisions aren't (shouldn't be) based on book. For example, almost every successful company is valued at some multiple of book equity, because book equity doesn't (and shouldn't, and can't) incorporate any notion of growth. Tesla's book value per share is something like $27/share, which reflects the cars it has sold and the ones in process. It trades at $1077, which reflects hopes for cars that it will sell. LIFO and FIFO are just book accounting methods for tracking costs of production. They tell financial statement readers how management puts the cost of unit production into inventory values on the balance sheet, and how inventory values are translated into Cost Of Goods Sold on the income statement. They really aren't the right basis for business decisions like pricing or production. I don't know what he means by "companies now use FIFO or LIFO accounting" as if this is some innovation. These have been the _only_ choices under GAAP for . . . a century? Longer? Letting companies use Next In First Out for financial statements would be inviting management to manipulate its balance sheet and earnings through its cost assumptions. Of course a company will use up-to-date cost information for pricing decisions, but they've always done that. Accounting is really a language of its own. It provides a lot of useful information, but you have to know how to use it and what to use it for.

by tgb 5y ago

Is "NIFO" really the right way to do accounting? If you sell the government one aircraft carrier, the cost of producing a second one will be much lower, so NIFO doesn't seem to fit there.

philwelch 5y ago

I think NIFO applies only to variable costs. Fixed costs are fundamentally different. Also, low-volume items like aircraft carriers are probably a bad example. Aircraft carriers are ordered and built in small, specific quantities; I think it makes more sense to account for building a single aircraft carrier as a construction project rather than as a unit of mass production. Almost like you were building a small airport, thousands of units of housing, and a nuclear power plant.

tgb 5y ago
But my point was that variable but decreasing costs seem to throw NIFO off too. Aircraft are the extreme example but I'm sure the first of Tesla's latest car model costs more to produce than the thousandth. Not even counting capital expenses but just by things running smoother with practice. NIFO seems to fall short here too.
- philwelch 5y ago
  I’m not sure that’s always or necessarily true. The variable costs will go down over time if there are process improvements, but eventually there are diminishing returns to those. Meanwhile, the cost of materials and labor could rise.
  - tgb 5y ago
    Sure it's not 100% of the time but that's besides the point still. Isn't NIFO a bad fit for the times when per-unit costs are decreasing? And since this happens fairly regularly it seems like a bad choice period, or at least not obviously better than FIFO or LIFO.

notatoad 5y ago

typically when you're selling aircraft carriers, you're selling it before you build it - the customer is paying you to make it, not paying you for the one you've already made. so the neither the economics or the accounting work the same way as acting as middleman for retail goods.

chernevik 5y ago

I suppose it depends on what we're talking about, but probably not. LIFO and FIFO are book accounting concepts, and business decisions aren't (shouldn't be) based on book. For example, almost every successful company is valued at some multiple of book equity, because book equity doesn't (and shouldn't, and can't) incorporate any notion of growth. Tesla's book value per share is something like $27/share, which reflects the cars it has sold and the ones in process. It trades at $1077, which reflects hopes for cars that it will sell. LIFO and FIFO are just book accounting methods for tracking costs of production. They tell financial statement readers how management puts the cost of unit production into inventory values on the balance sheet, and how inventory values are translated into Cost Of Goods Sold on the income statement. They really aren't the right basis for business decisions like pricing or production. I don't know what he means by "companies now use FIFO or LIFO accounting" as if this is some innovation. These have been the _only_ choices under GAAP for . . . a century? Longer? Letting companies use Next In First Out for financial statements would be inviting management to manipulate its balance sheet and earnings through its cost assumptions. Of course a company will use up-to-date cost information for pricing decisions, but they've always done that. Accounting is really a language of its own. It provides a lot of useful information, but you have to know how to use it and what to use it for.