LIFO

What it means

LIFO, last in, first out, is an inventory costing method in which the most recently purchased items are treated as used first. The oldest prices therefore remain in stock in the books, while the newest prices, which in times of rising prices are the highest, go to expenses.

The Slovak Accounting Act does not permit LIFO. For the outflow of identical inventory items, only FIFO, first in, first out, or weighted average cost may be used. LIFO is also prohibited under international IFRS standards.

In Slovakia the term is encountered mainly through foreign parent companies reporting under US accounting standards, where LIFO is still allowed. It became popular there mainly because, when prices rise, it reduces reported profit and therefore income tax.

How it works in practice

If a group uses LIFO in reporting to its parent, the Slovak subsidiary must still keep its own books under domestic rules using FIFO or weighted average. The difference between the two valuations is dealt with only in the consolidation package, not in the Slovak financial statements.

The costing method does not have to match the physical flow of goods. Even if the warehouse actually issues the last goods received first, as with bulk materials in a pile, the outflow is valued in the books using a permitted method. It is valuation that counts, not the order on the shelf.

The chosen method must be set out in the accounting policy and applied consistently. A change of method is possible only from the start of an accounting period and must be explained in the notes. Under both method A and method B of inventory accounting, the same permitted costing method applies.

What to watch out for

Using LIFO in Slovak accounts would breach the Accounting Act and could lead to a fine, and the tax authority could recalculate costs and the tax base. When adopting accounting software from abroad, the inventory valuation settings should therefore be checked.

When prices rise quickly, FIFO produces higher profit than LIFO would, because older and cheaper purchases go to expenses. Weighted average smooths results. When choosing between the permitted methods, consider the effect on profit, tax and the workload of record-keeping.