For all cannabis businesses, understanding cost tracking and allocation is a crucial aspect of maintaining healthy finances. However, the process can be complex, and the unique nature of the cannabis industry presents additional challenges. This guide aims to simplify the concept of Cannabis Cost of Goods Sold (CoGS), shedding light on effectively tracking and allocating costs while staying within the confines of legal and financial regulations.
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Understanding Cannabis CoGS
The Cost of Goods Sold (CoGS) is essential to any cannabis business operator’s arsenal. It pertains to the direct costs associated with producing the goods sold by a company. The correct calculation of CoGS is paramount to accurate tax filings and robust records, especially in the event of an audit.
In the cannabis business, CoGS is affected by IRC 280E, a tax code implemented to prevent illegal drug traffickers from deducting ordinary business expenses. State-legal cannabis businesses dealing with Schedule I controlled substances are limited in the expenses they can deduct. Hence, calculating CoGS correctly is crucial to offset revenue and lower the cannabis business tax burden.
Identifying Inventorial Costs
The first step in cost tracking and allocation is identifying costs that qualify as inventorial. These costs for a cultivator include direct materials, labor, and cultivation overhead. It’s essential to delineate which costs qualify as inventory and which do not.
For instance, costs that qualify as inventorial could include labor linked to product production, raw materials like grow supplies or nutrients, and packaging supplies. Expenses that typically do not qualify as inventorial include office supplies or marketing costs associated with selling products.
Defining Equivalent Units of Measure
After identifying inventorial costs, the next step is defining equivalent units of measure. This process involves tracking the progress of the business’s production and sales in a specific and consistent unit. For cultivators, an equivalent unit of measure could be plants, which are then converted into pounds of flower and trim by calculating an average yield per plant.
Understanding the entire production process is crucial, as not all plants will be at the same stage of maturity. Thus, equivalent units need to be calculated based on completion percentage.
Calculating Total Costs and Sales
With inventorial costs identified and equivalent units defined, the next step in the process is determining the total costs. This process involves evaluating the total costs incurred during a specific period, typically a month or a quarter.
The goal is to understand how much of the total cost will be allocated to inventory and how much will be allocated to CoGS. It’s also essential to calculate sales during this period, which can be used later to calculate business margins.
Allocating Costs to CoGS and Inventory
The final cost-tracking and allocation step involves allocating costs to CoGS and inventory. This process necessitates knowing the quantity of equivalent units at the beginning and end of the month and the number of equivalent units sold during the month.
The allocation process is critical to accurately breaking down the costs into CoGS and inventory. An incorrect allocation can lead to an overestimated or underestimated tax burden.
Cannabis CoGS in Practice: A Case Study
To illustrate the process of cost tracking and allocation in cannabis businesses, consider the following simplified example. In this case, a company produces 160 pounds of cannabis in its first month, selling 40 pounds and leaving 120 pounds in inventory. The total cost for the month is $80,000.
The costs are allocated between CoGS and inventory based on the quantity sold and the quantity in inventory, respectively. In this case, $20,000 is allocated to CoGS (representing the cost of the 40 pounds sold), and the remaining $60,000 is allocated to inventory (representing the cost of the 120 pounds left).
The Importance of Accurate Reporting
Accurate reporting is essential for successful cost tracking and allocation. Cultivation operations, for instance, need harvest schedules showing how many plants are at each stage of the process. They also need to know the expected yield of each plant and the projected sale date.
The data captured for these reports should be digital and easily sharable. It should also be updated regularly, ideally every 30 days, to reflect the most accurate picture of the business’s inventory and production.
Challenges in Cost Tracking and Allocation
One of the significant challenges in cost tracking and allocation is the communication gap between different departments. Cultivation and accounting teams often speak different languages, leading to miscommunication and errors. This is where a third-party CPA experienced in the cannabis industry can bridge the gap and ensure accurate communication and data integrity.
The Role of a CPA in Cost Allocation
A Certified Public Accountant (CPA) can be invaluable in allocating costs. They can help establish a reasonable methodology for allocating costs to inventory and CoGS. They can also aid in creating accurate reports and records that can be used in the event of an audit.
Understanding Cannabis CoGS and effectively tracking and allocating costs is crucial for maintaining a healthy financial state in a cannabis business. It requires a clear understanding of the costs involved, accurate tracking of production, and a systematic approach to allocating costs. With careful planning and the assistance of a knowledgeable CPA, businesses can navigate the complexities of CoGS and set themselves up for financial success.