The Essentials of Cannabis Inventory Accounting, Procedures, and Controls

Understanding inventory is essential for cannabis operators as it is intrinsically related to regulatory compliance and taxation.

The complexities can be monumental as state reporting requirements are stringent and largely dictate how inventory must be reported. Companies can find some relief by capitalizing some assets under 471(c), but this approach can be risky.

Compliance is the keyword here. Cannabis companies that lack the right processes and procedures may land themselves in hot water or open themselves up to theft and fraud, negating any chance of tax savings.

Best Practices for Cannabis Inventory Accounting

Inventory controls are essential to cannabis businesses in all niches: cultivation facilities, farms, retailers, dispensaries, and distributors alike. Here are a few best practices to implement.

·       Segregation of duties assigns responsibilities so that no one person controls all aspects of inventory. For example, one person does the task, another verifies the data, and a third person signs off on it in a log or tracking document. Additionally, employees with access to products should not have access to cash or accounting systems. While this might be challenging in smaller operations, limiting access to reporting systems should be paramount and will help prevent loss and support tracking theft if it does occur.

·       Inventory controls. Controlling access to inventory is critical for all cannabis businesses. Understand and protect all access points. Install security systems that can be remotely monitored, maintain detailed logs of product additions or removals, and enforce strict adherence to policies around receiving and verifying deliveries. Inconsistencies must be documented when they occur. Restocking should be considered through a security lens to mitigate impropriety and deter opportunism.

·       Random audits. Complete physical counts should be conducted at least monthly and reconciled to POS and seed-to-sale systems. Unscheduled inventory audits can be performed in between inventories and may help you discover issues that would have otherwise gone unnoticed until the next inventory cycle. When employees know you do random audits, it will deter theft and ensure everyone stays aligned with policy. Plus, in doing so, you’ll never be caught unaware if regulators pay you a visit.

IRC 471(c) General Inventory Rules

IRC 471c is a process used to figure out how much it costs to produce your products, aka Cost of Goods Sold (COGS). Add up all costs involved in making the products, including materials, employee time, and packaging, plus indirect costs like electricity, fuel, rent, and utilities. Once you have these numbers, you’ll know how much of your money is tied up in unsold inventory and the cost of what you’ve already sold.

The rule applies to any type of cannabis product and covers many costs ineligible under 280E, effectively maximizing what you can include in COGS. However, before any expense can be assigned to COGS, it must first go to inventory via generally accepted accounting principles (GAAP) cost accounting.

GAAP accounting is exceptionally complex and requires diligence, expertise, and the right resources to ensure they are consistent and done regularly.

Cannabis Inventories: Developing Your Process

Inventory methods for cannabis must be verifiable and effective for tracking the product you have on hand. They need to align with your accounting, POS, and seed-to-sale systems, meaning product descriptions and other data should be precisely the same in all. If any critical information is missing, a factual inventory will be challenging to achieve.

In best practice, audit all systems before implementing any inventory-related processes to verify that the data is correct.

Your inventory informs many processes and activities, including regulatory compliance, financial planning, and COGS determinations for taxation. Keeping these systems current and clean is in your best interests, as investors, lenders, and auditors will want to see them.

Implement a Standardized Purchase Order Process to Optimize Inventory

Optimizing your purchase order process helps ensure you aren’t over or understocking and may save you a ton of time, effort, and money over time.

Avoid the tendency to place recurring orders without first checking stock and considering sales or usage volumes. Blindly issuing POs for products you don’t necessarily need will tie up capital needlessly. If necessary, adjust your par levels.

Internal POs or requests should always be reviewed before submission. When a delivery arrives, it should be handled only by authorized personnel and verified for accuracy. Errors should be noted and escalated before being passed on to the finance department for entry into accounts payable.

Compliance With Seed-to-Sale

All cannabis operations must use state-mandated seed-to-sale software. Though these systems are sometimes complex and often glitchy, they are 100% necessary for compliance and must be reconciled to inventory.

Inventory counts and POS systems must match the seed-to-sale data as these systems inform cost accounting and taxation. Non-compliance can result in fines, over or underpayment of tax bills, and attract undue attention from state or federal auditors.

Though seed-to-sale inventory procedures vary between cannabis business models, they should be consistent, precise, repeatable, and strictly enforced.

In best practice, compare physical counts to POS and seed-to-sale to ensure they match.

Many seed-to-sale systems integrate with popular cannabis POS. However, these integrations can be unreliable, and if systems become uncoupled, your numbers won’t match.

To avoid these issues (as best you can), back up your systems regularly to protect your data and update the software as needed. If there are any connection issues, report them to the appropriate person immediately. Don’t let time pass between error identification and resolution, as the longer you wait, the more difficult it will be to get your inventory back on track.

Seed-to-sale issues tend to arise when states change cannabis laws or policies. Staying on top of the changes will ensure you are primed for possible trouble ahead.

Speak to a Cannabis Accountant About Inventory Compliance

Inventory is nobody’s favorite pastime—but it’s essential to compliance, tax reporting, and ensuring you understand your business assets. Working with a qualified cannabis accountant can help establish a sustainable and compliant inventory system while minimizing loss and liability.

Speak to the experts at Growise today to learn how we can help.