Cannabis Accounting Cleanup: How to Get Clients Compliant

accounting webinars Oct 18, 2019

Learn how to plan effectively, obtain documentation and get client buy-in for a successful cleanup

With Halloween just around the corner, we decided to speak to a certain kind of horror… specific to the accounting industry. The mention of the word “cleanup” is enough to scare any seasoned accountant. We’ve all heard horror stories from our peers about leftover financials that were too tough to tame. Although most of those stories end with the accounting professional saving the day, the path to a successful cleanup can be a bumpy one, to say the least.

Cleanup is the concept of needing to go ‘back in time’ into a new client’s records to clean them up and “fix” all the errors. And rarely does a cleanup involve a few errors; in most scenarios, there are many, many errors. In order to create a rock-solid set of books, the cleanup will have to go back several months but can also need to go back several years. 

Why are cleanups necessary?

Performing a cleanup is a crucial step before importing amounts into a new “clean” chart of accounts (that is tailored to the way we like it).  If done correctly, a cleanup can add significant value to the client’s business because you have provided them with rock-solid financials that they can use for auditors, lenders, investors, and internal management. Additional, a clean set of books will make your life easier if you choose to provide ongoing services to this client. 

Client financials are not only the documents businesses use to run their company. They are the required records provided to outsiders (such as lenders) to access capital.   When cleaning up client books and records, financial statement assertions need to be considered. Financial statement assertions are “claims made by an organization's management regarding its financial statements.” These claims should be followed to the “T” because they will guide your cleanup journey in ensuring that you do as thorough a job as possible.  

Financial statement assertions include a promise (of sorts) to do the following:

  • Provide accurate information.
  • Complete recordkeeping (all information should be included and organized).
  • Identify and adhere to reporting period cut-offs.
  • Confirming that transactions on financial statements actually occurred.
  • Ensuring that the client has rights to reported assets, and “is reporting all of its obligations as liabilities.”
  • Presenting the information as clear and true.
  • Accurately presenting the value of transactions. 

Before agreeing to a cleanup make sure you can get the following:

  1. Get engagement letter signed and retainer collected.  Bill at a higher hourly rate than usual because it almost always takes longer than you estimated (I suggest $100 or more).
  2. Create a PBC list. A PBC list (“Prepared by Client” set of documents) is a checklist of all the items (corporate documents, legal documents, tax returns, invoices, bank statements, etc) needed on the first day of engagement with the client.  
    • Obtain ALL documents before starting. The number one issue accountants have during a cleanup is NOT getting access or delivery of client supporting documents!
  3. Create an Action Plan with the client. The Action Plan is the timeline of action steps for the cleanup phase, the normal or maintenance phase, specific project phase, etc. Be specific about what the client is expected to deliver, by what date it is expected, and list the “penalty” if not met. Make sure the client agrees or initials each of your documentation requests, necessary action items on their part, and their respective deadlines. 
    •  Accounting always follows legal documents. Make sure to get all the legal documents in your PBCs before starting on other items, such as signed corporate docs, stock option plans, leases, notes and debts, and other contracts first!
    • Obtain ALL tax documentation. If the cleanup starts at the inception of the company (for example Aug 1, 2014) then you want all prior years’ tax returns. Always start off with entry #1 at the date of inception, which will be the capital contribution for the formation of the company (amounts found in legal documents).

A few key points to remember during the cleanup:

    • Assets: the key assertion (and the key risk for an auditor) is accuracy and existence.  We want the balance reported for cash to actually exist and be accurately recorded in the trial balance.
    • Liabilities: completeness is the big one, although other assertions like cut-off and valuation are important as well. The big risk with liabilities is that there might be a debt that is NOT recorded in the trial balance, but that actually exists. For example, Company A owes Company B $10,000 and its not in the general ledger.
    • Trial Balances: as you walk through the trial balance at the cleanup date, it’s extremely important for you to consider the key risks involved, and make sure each item is accurate and tied out to supporting documents. For example, a loan will tie out to a signed legal debt agreement, or rent expenses will tie out to a signed lease. 
    • COAs: if the COAs are a mess, you should download transactions into an excel spreadsheet and start with your own Chart of Accounts (not clients) at day one of inception. Next, make a journal entry in the income and expenses of your COA by year. And based on that excel file, you will need to make sure to get supporting documents for each material transaction.

While a cleanup may seem daunting, with deliberate planning and insistence during the document collection phase of your Action Plan - you can be successful… and make a profit from cleanups. Find out more about cleanups by registering for our hands-on, on-demand Cannabis Accounting Cleanup training  HERE.

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