5 Keys to Properly Managing Cost Accounting & Taxes in Cannabis\Hemp Cultivation Verticals

Proper cost accounting is essential for all Cannabis and hemp verticals, but it gets particularly tricky when you're dealing with cultivation. From the moment a seed is planted in the ground to the harvest of the crop, high-level accounting procedures are mandatory to keep cultivation companies compliant. 

Cannabis growers tend to be uninformed as to the importance of proper accounting. Often focusing more on the science and passion of growing, they have little patience for numbers. Because the growers take such pride in their operations (and need to be educated on the processes and regulations required to keep those operations compliant with the IRS), you may have to work harder to prove the necessity of sound accounting practices. 

Cannabis and hemp both require different approaches to monthly accounting and year-end taxes. Cannabis is federally illegal, although more than 30 states have licensed businesses to sell legal medicinal and/or recreational marijuana. Hemp has been federally legal since the 2018 Farm Bill passed, but is still subject to a variety of regulations. When you understand key tax differences and the challenges experienced in each niche, you can put to work these five solutions to help you keep your cultivation clients compliant.

Understanding Cannabis and Hemp Taxes 

GAAP and cost accounting are necessary in order to correctly do Cannabis accounting and tax. However, the key word here is “correctly.” If you are not doing correct GAAP/cost accounting, then your clients will be paying too much in taxes, as they will miss some allowable deductions under IRC 471-11. If you take too many deductions incorrectly without the proper monthly accounting, you could get your clients in trouble with the IRS, leading to thousands of dollars in penalties and interest.  

In Cannabis, the two main tax codes you want to thoroughly understand and adhere to are IRC 280e and IRC 471. 280e is brief, but limiting. It essentially states that your Cannabis clients cannot deduct business expenses because, federally, they are trafficking Schedule 1 controlled substances. However, Cost of Goods Sold is a return of capital and not a deduction. IRC 471 essentially tells you what you can include in inventoriable costs (and what is prohibited). These these costs will eventually flow to Cost of Goods Sold (meaning lower taxable income).

Hemp isn't subject to 280e, but must comply with 471, as well as 263a, and potentially other tax codes. The other complicated aspect of hemp is synthesizing and interpreting the regulations from other agencies (such as USDA, FDA, OSHA, EPA, and state laws), creating more challenges for the accountant to keep all regulations straight and their clients compliant.

Correctly doing cost accounting and understanding these processes more fully will add exceptional value that you can offer to your Cannabis and hemp clients. To give you an extra boost to properly managing cost accounting, here are 5 keys you will need to do this right.

Five Key Solutions to Help You Navigate Cannabis and Hemp Taxes

Whichever niche you serve, you need these five elemental solutions to help you maintain compliant books and records. 

1. Vertical-Specific Chart of Accounts - The cultivation chart of accounts (COA) must be tailored to the individual niche. To take advantage of the available deductions, you have to account for everything that goes into growing the plant, including both direct and indirect costs, and allocate those expenses into proper categories. 

2. Proper Onboarding Documents and Processes -- If you don’t implement rock solid onboarding documents and procedures from the get-go, it will be very difficult to manage the day-to-day accounting correctly. These documents and processes include an engagement letter, a PBC (Prepared By Client) detailed list, action plan, cleanup plan, internal control documents, accounting policies and procedures, and a perpetual data room.

3. Cannabis and Hemp Grow and Cost Accounting Template -- Utilizing a cost accounting template specific for growers/cultivation businesses will make it easy to collect key information from the client to properly allocate expenses for cost accounting.

The ideal template should include the following:

  • Inventory counts and weights (plants, dry flower, etc.)
  • Seed to sale reports, which reconcile to counts
  • Flower calendar to collect key information for the grow, including the full grow cycle (plant, grow, harvest, dry, cure, trim, lab, ready for sale, etc.), locations and plant dates by strain, estimated yield-per-strain, and % complete at report date
  • System and processes to allocate each trial balance account (ie., rent, labor, electricity, etc.) in the appropriate way, using measures such as square footage, employee hours, and other allocation methods
  • Summary template that will calculate equivalent units for WIP, FG, and COGS
  • Conveniently organized to help you summarize your monthly AJE

4. Month-End System -- You will want to develop a robust month-end system and template. A repeatable, effective month-end system helps you develop a permanent audit trail, since the IRS will likely be auditing many companies in the Cannabis and Hemp/CBD niches. You need to ensure that you include everything in this system. 

You  want to make sure you’ve included the following in your month-end system: 

  • Tabs for every key balance sheet account (with full account reconciliations)
  • Fully tied-out data, tick-marked backwards and forwards
  • All AJEs clearly documented 
  • Cost accounting amounts clearly supported and reconciled to cost accounting files
  • Clear auditable tie-out of trial balance to financials

5. Monthly Report Package -- Any Cannabis or hemp business owner needs to have a robust month-end report package to better manage their business as well as reporting to board, investors, and lenders. 

A proper monthly report package should always include: 

  • Complete monthly financials, including a balance sheet, income statement, and statement of cash flows
  • Reports on all subsidiaries, consolidated financials, and related party information (plus, make sure you have intercompany tie-out and elimination schedules)
  • 6-month rolling cash forecast that is simple, accurate, and usable
  • KPIs, balance scorecard, and budget versus actual reports
  • Financial ratios and deep dives into items, such as P&L analytics, margin by profit, and labor percentages
  • Capital needs template

All Cannabis and hemp accounting professionals need to know that the IRS is watching and winning almost every case when business owners in these niches are non-compliant. Cost accounting is serious and requires exceptional attention to detail.

DOPE CFO has streamlined the process to understanding this complex aspect of Cannabis and hemp accounting, along with all tools, skills, and processes required to provide top notch service to clients in all verticals of both niches. We also have a community of more than 500 accounting professionals that can help you get answers to any and all questions, as well as help you network within the Cannabis and hemp/CBD spaces. 

Ready to dive into Cannabis or hemp? Ask us how to get started today.

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