Victor and Associates

Cannabis accounting firms

Your Internal Controls Suck!

Your Internal Controls Suck! Here’s What You Can Do About It.

The cannabis industry is perceived as the new gold rush. Everyone wants in and many investors are jumping in feet first without any due diligence. As difficult as it is to believe investors are writing checks for millions of dollars without any control requirements. These investors are quickly learning that this is a guaranteed way to lose their investments and stringent internal controls are quintessential to the success of Cannabis businesses.

Cannabis CEOs should follow these principles to attract much-needed financing. The accounting functions of the business should be of prime concern for three reasons:

  • Proper accounting is a requirement to maintain licensing and remain compliant in this industry
  • Proper accounting is the ONLY way to legally circumvent IRC 280e
  • Proper accounting builds value into your business and can increase valuation by up to 5% on exit
  1. Does your company have documented accounting policies, procedures, and controls?

Your organization should have written documents detailing its accounting policies, procedures, and controls. This document should detail all accounting policies, procedures, and controls currently in use within the company and should be reviewed at least once per year. Your policy document should include the division of responsibilities (who does what and when) and internal controls and enterprise governance, such as segregation of duties to protect your assets. Accounting policies, procedures, and controls are vital to your organization. When used correctly, they ensure transactions are documented correctly and consistently and protect your business from IRS audits.

  1. Cash Control Procedures

Cannabis businesses are highly cash-intensive and therefore require even tighter cash controls than other companies. Large amounts of cash on the spot is a temptation for staff and external criminal elements. Additionally, states maintain a public registry of all cannabis businesses, including physical addresses and contact details, making it easier for criminals to locate your businesses. This underscores the importance of written procedural documentation.

Here are some steps you should take:

  • Prepare a comprehensive document on how employees manage money every day in your business. That is especially important for retailers. How are the daily cash receipts, deposits, and petty cash managed?  (Include who does what, how, and when). Document how the daily reconciliation between your POS system and your cash will be managed. How will your company handle large quantities of cash? Is there an established amount that needs to be removed off-site ($10,000/$20,000, etc.)? How will it be transported? Who is in charge of processing transfers? Frequent transfers can decrease the risk of theft internally and externally.
  • Security Systems

As a licensing requirement, all cannabis companies need to have a written security plan that includes a central surveillance system. The central monitoring system must have a digital video surveillance system with a minimum camera resolution of 1280 × 720 pixels, storage device or the cameras using transmission control protocol (TCP) capable of being accessed through the internet, and the video should always be able to effectively record images of the area under surveillance. The surveillance system must also be capable of producing a stationary photograph from any camera image.

This camera must be in an area where the inventory is kept, where the transactions are processed (POS), and where the money is kept. It is in the interest of the CEO, the investor, and management to ensure that there is no doubt as to the amount of cash received and the amount reported. State officials may request up to 90 days of your images if there is any suspicion of inappropriate handling of funds. The images will be used to determine if there was negligence and could result in heavy fines and even the loss of your license.

Cannabis businesses are heavily burdened with banking problems. Most financial institutions do not accept their business because they fear retribution from the federal government. For this reason, the industry is highly liquid and subject to extensive review by the local and federal governments. Protect your company and employees by implementing a cash policy that details cash processing procedures. This will provide peace of mind, save you countless hours of stress, and help you survive both state and IRS audits.

Do you have any idea what it costs to grow a pound of marijuana? Inventory Controls

I don’t mean to belabor the point, but controls, controls, controls. The same control documents necessary for accounting and treasury are equally important for inventory. In fact, the lack of proper inventory control may lead to the rejection of expenses related to the cost of goods sold. Those are the only expenses that cannabis companies are allowed to deduct, so they’re critical to your bottom line. Inventory control is so critical that every state has a seed-to-sale inventory tracking system. You must ensure that monthly inventory counts are performed (physical count and handwritten documentation are best).

Physical counts must be reconciled with the state inventory system (Metrc, etc.), POS, and accounting software every month. This ensures that discrepancies that occur during the month are correct and that the accurate inventory value is recorded. To maximize deductions under IRC 471, generally accepted accounting principles (GAAP) cost and absorption accounting must be used for cultivators, extractors, and manufacturers. Your accountant should do this monthly to properly assign costs to inventory or COGS. If this is not done properly the IRS will disallow all expenses.

Another major advantage of cost accounting is that when done correctly, you know, down to the penny how much it costs to grow or create your product. You must ensure that you have a Cannabis Accountant on your team who is qualified to navigate the many pitfalls of IRC 280e.

Internal Controls Audit

Ever heard the phrase “Who will guard the guards?” This should be one of the most pressing questions in a Cannabis business! Policies and procedures are ineffective if internal controls are not in place. Segregation of duties minimizes the risk of misappropriation of funds. There should be appropriate segregation of duties to ensure that employees with access to key operational assets (cash and inventory) do not have access to accounting records.

Internal controls should have oversight.

Employees who enter data into Seed to Sale and accounting software should never have access to money and inventory and should always be reviewed by someone else. When independent parties are responsible for monitoring the work of others, this minimizes the risk of fraud and embezzlement. The implementation of these measures, protects your company and allows you to discover mistakes before any reporting is made to the state saving you from huge under-reporting penalties and even the loss of your license.

For a marijuana company, an audit is inevitable in the early years of operation. Hiring a cannabis accountant and implementing these measures will dramatically increase your chances of surviving the audit unscathed.