Setting Up & Maintaining a Compliant Accounting System
A compliant accounting system requires much more than tracking receipts and entering transactions into a box software or spreadsheet. With good intentions, new businesses generally implement basic accounting processes as their activity develops and the need arises. Too often however, the accounting processes quickly get pushed aside in favor of other activities as the business becomes busier and busier. While basic accounting may include keeping receipts and sales journals, a compliant accounting system requires much more.
Setting Up a Compliant Accounting System
Keeping receipts, invoices, journals, detailed transaction logs, and other source documents are a necessary foundation for a compliant accounting system. Complete record keeping should be done throughout the business’s life and from day one. Even if all records are “thrown in box”, generally a CPA can help decipher the records into useful information. Many small businesses follow this practice. Providing records to a CPA on a predetermined schedule, with the goal of receiving reports or tax returns back in return is common.
For some start ups, categorizing revenues and expenses into a few basic types and tracking in spreadsheets works well. However as activity increases, transactions may need to be categorized in greater volume and detail. An out of the box accounting software may provide general account categories or a basic chart of accounts. Simply using these basic tools alone however is not enough to ensure a compliant accounting system.
A business operating in a regulated or highly specific industry like the cannabis industry has unique laws and processes that must be followed. These laws and processes trickle down to the business’s accounting system foundational needs as well. Basic tools, accounting software and keeping receipts may be a start, but are certainly not enough to be compliant.
Compliant Accounting System for a Cannabis Business
A compliant accounting system for a cannabis business requires as part of its foundation a detailed, often highly customized chart of accounts. A chart of accounts contains detailed accounts based on specific products, expenses and inventory types. A cannabis cultivator requires a different chart of accounts from a cannabis processor, just as one cultivator’s accounts are often different than another cultivator’s, based on their individual processes. A compliant chart of accounts should be designed from the beginning of the business’s life cycle. This ensures transactions are recorded to the proper detail accounts and the correct methodology is in place from the start.
For a cannabis business, a compliant accounting system also requires considering the effects of federal and state laws and regulations. Foremost, this includes cost accounting and details required for compliance with Internal Revenue Code Section 280E, enacted by congress in 1982. IRC §280E states that businesses operating in controlled substances, which currently includes marijuana, may not deduct business expenses. This was later amended to allow for “cost of goods sold” to be deducted from revenues received in effectively determining federal taxable income.
In order for a marijuana business to have an IRC §280E compliant accounting system, the chart of accounts should specifically include for all costs that are accounted into inventory, and then ultimately into cost of goods sold.
As part of the set up process, the business owner should also discuss with their CPA appropriate cost allocation methods. Cost allocation is necessary for shared expenses. For example, a cultivator may have various rooms throughout their facility for different plant batches, drying or curing activities, office space, and storage. Or, a processing facility may have kitchen, oil making, packaging and cold storage areas that each need to be accounted for independently. Shared expenses need to be allocated properly to each of these areas (think rent or electricity), as part of 280E cost accounting. A compliant accounting system should contain allocation procedures, support and a thorough documentation process that is consistently maintained.
State regulations may also require specific accounting and financial oversight processes. For example, licensed medical cannabis businesses operating in Michigan are required to have a financial review each year. A financial review includes having an independent CPA analyze the business’s financial records, accounting compliance, and overall financial presentation. A compliant accounting system should have a record keeping process that allows for a complete audit trail for every transaction recorded. This audit trail should be easy to trace and review.
If your business has a basic accounting system in place, a CPA can help implement a fully compliant accounting system. This includes incorporating your current record keeping to set up beginning balances, chart of account structure, and customized record keeping processes.
Compliant Accounting System Maintenance & Management
Once set up, a complaint account system needs to be consistently maintained and its processes followed. When a business owner can not confidently commit to maintaining the accounting process on their own, they should ensure proper alternatives are in place. This often involves hiring a bookkeeping service, or regularly engaging your CPA to maintain your business’s accounting process instead.
Proper accounting processes should be followed for every transaction as each is recorded into the accounting system. In order for a cannabis business to show consistent compliance with IRS and state financial regulations, record keeping, cost allocations, detailed journal entries, 280E considerations, and audit trail management are all part of their day to day process. Cash businesses require additional reporting, manual filings, and other accounting peculiarities as well.
Businesses should ensure that proper expertise, knowledge and professionalism are in place for anyone working within their accounting system.
Employees should be trained to follow processes, and proper oversight by management is a requirement. Working with an accounting firm to assist the business with its accounting process is often a wise move.
Source documentation like receipts should continue to be maintained on a daily basis. Documents should be organized, and made easily traceable to the related transaction recorded. Using a cloud based record management system can help keep information neatly organized and easily accessible. Many accounting softwares also allow for records to be uploaded and attached to individual transactions. Maintaining duplicate records can help prevent data loss and errors, and offer a more robust and compliant accounting system. A prudent CPA or accounting service can work with your staff to help ensure records are properly kept.
Regular and timely entries into the accounting system are also required to maintain compliance. These entries should contain all cost allocations in real time as they are made. Inventory, sales, expenses, equipment purchases and payroll transactions all require consistent bookkeeping, allocations related to §280e accounting, and record management for a cannabis business.
We can help!
At LC Solutions Michigan PLLC we provide our clients with unparalleled accounting support, professionalism, and industry specific knowledge that is crucial to their business operations. Our team of CPAs, bookkeepers and accounting professionals can help your cannabis business with industry compliant accounting system set up and processes. We understand our client’s needs and the special purpose bookkeeping, reporting, record keeping, and industry specific standards they require.
Proper set up and maintenance of your business’s accounting system ensures compliance. It also helps with cash flow and expense management, business decision making, and overall financial strength. A business’s financial activities, strengths, weaknesses and opportunities can all be better analyzed, budgeted and forecasted for with a compliant accounting system in place.
To learn more about LC Solutions Michigan PLLC and how we can help your business, please visit our site here. For regular tips, insights, and industry accounting know-how, check out our Facebook page here.
April 29, 2019
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