Cannabis Inventory Accounting, Processes, and Controls

Cannabis businesses face unique challenges when it comes to inventory management. From complying with regulations to optimizing profitability, effective inventory tracking is crucial for success in the industry. In this comprehensive guide, we will explore the various aspects of cannabis inventory accounting, processes, and controls. By understanding the requirements and implementing best practices, cannabis businesses can ensure compliance, minimize losses, and maximize profits.

The Importance of Cannabis Inventory Management

Inventory management is a critical aspect of running a successful cannabis business. It involves tracking and controlling the flow of products from seed to sale. Proper inventory management allows businesses to:

• Comply with regulations: Cannabis businesses must adhere to strict regulations regarding inventory tracking. From seed-to-sale systems to reporting requirements, accurate inventory management is essential for maintaining compliance with state and federal laws.
• Optimize profitability: Effective inventory management helps businesses minimize costs, reduce waste, and improve cash flow. By accurately tracking inventory levels, businesses can avoid overstocking or understocking, ensuring they have the right products available to meet customer demand.
• Prevent fraud and theft: Cannabis businesses are vulnerable to theft and fraud due to the high value of their products. Implementing robust inventory controls and segregation of duties can help deter and detect any unauthorized activities.

Mitigating Theft with Cannabis Inventory Management & Internal Controls

Internal controls are crucial for minimizing the risk of theft and ensuring accurate inventory tracking. Here are some key practices to consider:

Segregation of Duties

Segregation of Duties (SOD) is a fundamental building block of internal controls. It involves splitting responsibilities so that one person performs a task while another reviews and verifies its correct fulfillment. In the context of cannabis inventory management, SOD is particularly important between cash/accounting and product-handling responsibilities. This helps prevent opportunities for fraud and theft.

For example, employees with access to physical custody of assets, such as budtenders, should not have access to the accounting system. By designating different employees to handle cash, POS systems, and products, businesses can reduce the risk of losses and better identify any mishaps.

Cannabis Inventory Controls

Cannabis inventory controls are essential for both cultivation sites and dispensaries. By implementing effective controls, businesses can minimize the opportunity for theft or misappropriation. Some key considerations include:

• Limiting access: Controlling who has access to certain areas of the business, such as cultivation sites or administrative offices, can help prevent unauthorized access to products or supplies.
• Surveillance and security: Implementing robust surveillance and security measures, such as cameras and access controls, can deter theft and provide evidence in case of any incidents.
• Clear procedures: Establishing clear procedures for product deliveries, verification, stocking shelves, inventory counts, and other regular activities helps ensure consistency and accountability.
• Surprise inventory audits: Conducting surprise inventory audits can help uncover any issues or discrepancies that may have gone unnoticed. These audits also serve as a deterrent to potential theft or fraud and demonstrate the business's commitment to transparency and accountability.

Internal Revenue Code 471: The General Rule for Inventories

Internal Revenue Code 471 provides guidelines for valuing and accounting for inventories. This is particularly relevant for cannabis businesses, considering the limitations imposed by Section 280E. Here's an overview of how IRC 471 applies to cannabis cultivators and product manufacturers:

IRC 471 for Cannabis Cultivators & Product Manufacturers

Cannabis cultivators and product manufacturers must comply with IRC 471 when determining the cost of goods sold (COGS). COGS includes the direct and indirect costs associated with producing the products. However, certain indirect costs, such as advertising and marketing expenses, are not permitted under IRC 471.

To maximize the inclusion of costs in COGS, cannabis businesses must follow generally accepted accounting principles (GAAP) and accrual absorption accounting. This involves properly allocating expenses to inventory and ensuring accurate cost accounting practices. By doing so, businesses can determine the total cost spent on developing their products and price them accordingly.

Cannabis Inventory Accounting for Cultivators

For cannabis cultivators, proper inventory accounting is essential for determining the cost of developing their products. Let's consider a hypothetical scenario of a cultivator growing two strains: Blue Dream and Golden Goat. Here's how the inventory balance sheet would include various categories:

• Raw materials: This includes seeds, soil, pesticides, and nutrients added to the plants as they grow.
• Work in process (WIP): WIP includes all plants at different stages, from growing to harvesting and lab testing.
• Finished goods (FG): FG includes all cannabis flower that is post-lab tested and ready to sell but remains unsold.

During the inventory accounting process, the CEO and/or accountant must determine the costs incurred in growing each strain. This involves calculating the direct and indirect costs associated with each strain, such as labor, materials, rent, and utilities. By accurately tracking these costs and dividing them by the total yield, businesses can determine the total cost spent and set appropriate pricing. It's important to note that COGS should equal the sum of all allowable direct and indirect costs under IRC 471-11.

Cannabis Product Manufacturers & Bill of Materials

Inventory accounting for cannabis product manufacturers and processors requires a detailed understanding of the Bill of Materials (BOM) for each product. The BOM includes the costs and resources needed to create a product, such as ingredients, labor, and overhead. By calculating the average cost per unit based on the BOM, businesses can determine the unit cost of their products.

For example, a cannabis edible manufacturer producing gummy bears would consider the cost of THC oil, sugar, packaging materials, assembly costs, and allocated overhead in their BOM. By calculating the weighted average cost per box, businesses can determine the average cost of their products and make informed pricing decisions.

Cannabis Dispensary Inventory Accounting

Effective inventory accounting is crucial for licensed dispensaries to comply with regulations and make informed business decisions. Here are some key considerations for dispensary inventory accounting:

• Track inventory regularly: Conducting regular inventory counts, including cycle counts and reconciling them with seed-to-sale software, helps dispensaries maintain accurate inventory records.
• Optimize inventory levels: Analyzing sales data and consumer trends can help dispensaries make informed decisions about which products to stock and when to reorder. By tracking inventory metrics like gross margin, dispensaries can assess profitability and adjust their inventory levels accordingly.
• Implement inventory management software: Utilizing inventory management software can streamline the inventory management process, provide real-time sales analytics, and improve data accuracy. By automating inventory tracking, businesses can minimize manual errors and ensure efficient inventory management.
• Conduct regular audits: Regular audits, both scheduled and surprise, help identify any discrepancies or potential issues in inventory management. By conducting thorough audits, dispensaries can demonstrate transparency, accountability, and adherence to best practices.

Conclusion

Effective cannabis inventory accounting, processes, and controls are essential for running a successful cannabis business. By implementing robust internal controls, leveraging inventory management software, and adhering to applicable regulations, businesses can minimize losses, optimize profitability, and ensure compliance. Additionally, proper valuation of inventory and cost of goods sold calculations under IRC 471 help businesses accurately determine their financial position and make informed pricing decisions. With a comprehensive approach to inventory management, cannabis businesses can thrive in a highly regulated and competitive industry.

‍