everything you wanted to know about dispensary accounting but were afraid to ask

plus why trying to beat 280e isn’t worth it.

by andrew hunzicker

accounting for a dispensary turns out to be quite a challenge for the cannabis accountant.

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there are many issues, both gaap and tax, as well as state-level compliance issues that must be understood as well.

for example, most states have a mandated “seed to sale” software tracking system that must be used and accurate (daily), which must also be reconciled with pos (“point of sale”) systems and accounting systems. additionally, because this is a new industry, many of the tools we use in other niches simply are not available including a cannabis-tailored chart of accounts, qb pos systems, reliable inventory software and common merchant service platforms.
lack of banking, high levels of cash, need for daily inventory, and few reputable merchant service providers mean ceos and accountants have many complex issues to understand, control and account for properly.

challenges include:

• software not syncing and bad pos systems
• incorrect data in software
• using wrong tax codes
• not doing cost accounting or correct non-cannabis accounting
• not doing gaap
• no inventory policies/procedures or controls in place
• no inventory counts and reconciliations
• not understanding the seed to sale process
• not understanding the different verticals

internal revenue code 471-3 is how inventory must be accounted for in a dispensary. for this code, cost means:

“(a) in the case of merchandise on hand at the beginning of the taxable year, the inventory price of such goods.

(b) in the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade or other discounts, except strictly cash discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. to this net invoice price should be added transportation or other necessary charges incurred in acquiring possession of the goods. but see § 1.263a-1(d)(2)(iv)(c) for special rules for certain direct material costs that in certain cases are permitted to be capitalized as additional section 263a costs by taxpayers using a simplified method under § 1.263a-2(b) or (c) or § 1.263a-3(d). for taxpayers acquiring merchandise for resale that are subject to the provisions of section 263a, see §§ 1.263a-1 and 1.263a-3 for additional amounts that must be included in inventory costs.

1. 1. c) in the case of merchandise produced by the taxpayer since the beginning of the taxable year, (1) the cost of raw materials and supplies entering into or consumed in connection with the product, (2) expenditures for direct labor, and (3) indirect production costs incident to and necessary for the production of the particular article, including in such indirect production costs an appropriate portion of management expenses, but not including any cost of selling or return on capital, whether by way of interest or profit.”

note:  

• 263a is specifically not allowed (see harborside opinion for more on this).
• this is basically cost to purchase the inventory (and is a very narrow definition).
  

also, note part “c” allows for the possibility for how irc 471-11 might come into play and allow us to allocate more cost into inventory:

• this requires “an essential change to the character of the merchandise” and must be owned by the retailer (see harborside).
• if you want to utilize 471-11, you must be doing gaap in your recurring financials.

non-cannabis divisions:

there is an opportunity for dispensaries to separate some revenue streams outside of the cannabis division, meaning normal business deductions are allowed for the non-cannabis division. these might include clothing, paraphernalia, coffee, cbd and other goods. also:

• the non-cannabis division doesn’t require a separate entity, but it might be a good idea anyway.
• must be profitable (or clearly heading that way), substantial (relative to cannabis division) and accounted for separately (monthly).
• it helps if other factors show it’s a different “business” such as separate employees, managers, locations and legal entity.
• court will look at “economic substance” of division as opposed to “legal structure.”
• if this is done correctly, the benefits will likely be moderate at best, and there will be additional cost. that said, if it makes sense and meets these criteria, go for it.
• now that cbd is legal, there are opportunities to include this to help the non-cannabis division be more substantial.

irs is aware of many “games” being played to beat 280e:

• complex entity structures with no purpose other than to avoid tax.
• adding everything under the sun into cogs and inventory and doing 471 wrong
• having small “non-canna” divisions with very high allocated losses
• the irs is winning almost all recent court cases! ceos are often given poor advice to play these games and try to “beat 280e.” it’s a bad strategy.
• better for canna ceo to do cannabis accounting correctly, build brand, market share, location, growth and vertically integrate. valuations are based now on these factors, not net income.

so how does this affect you as the cannabis accountant? here are some of the key challenges we face in the niche (note these are also reasons we charge such high fees to the cannabis client!):

• many vendors will not serve cannabis (accounting, pos, merchant services, payroll)
• lack of accounting tools, workpapers, industry guides, gaap guidance, coas
• new software on the market full of bugs, significant periods of downtime, features that don’t work and poor customer service
• state-mandated “seed to sale” tracking software, difficult to use and doesn’t integrate with cannabis or accounting software (metrc/mjfreeway/biotrack)
• software not integrated, doesn’t talk to each other (lot of manual work)
• monthly, quarterly and yearly reporting requirements (specialized accounting, highly regulated)
• consolidations (complex legal entity structures, multiple verticals and canna vs. non-canna divisions)
• workarounds are required and daily reconciliations of cash and inventory

finally here are some of the tools and processes we use to make it all work:

• month-end tie-out files (reconciliations)
• tools and workpapers: cannabis-tailored coas, cost accounting workpapers, pbc lists, internal controls documents, cannabis-tailored cash rolling forecast templates
• inventory counts and controls
• cash counts and controls
• state seed to sale reports and reconciliations
• “flower calendar” and client operation data workpapers (strains, yields, est completion, wip)
• perpetual data room

posted on december 20, 2019