Rolling Up the Cannabis Chart of Accounts

If “roll up” is a part of your daily vocabulary you’re either a stoner or an accountant (or both). 


Accounting & taxes for cannabis companies
Accounting & taxes for cannabis companies

Chart of Accounts Defined

Financial statements are produced by recording transactions in various accounts in a company’s general ledger system. The conglomerate of these accounts is referred to as a chart of accounts. The chart of accounts is a listing of all accounts set up in the business to capture and categorize transactions as revenue, expenses, assets, liability, or equity. These categorizes are further broken down into more specific categories. Revenue, for example, could include revenue from dispensary sales and a second revenue stream from apparel or accessory sales. Expenses would be categorized by Cost of Goods Sold (COGS) or operating (or non-COGS):


COGS

  • Direct labor

  • Seedlings/plants

  • Supplies

Operating/non-COGS

  • Indirect labor 

  • Rent

  • Utilities

  • Travel

How the Chart of Accounts Impacts Your Cannabis Business

In the business sense, a roll up refers to the process of one or more sub-accounts being consolidated into a parent account. For example, the Travel account above can be a parent account with sub-accounts like flights, hotel, meals, and taxi. Business owners have more visibility into how funds are spent and identify performance trends. This is also beneficial for lenders and potential investors and your CPA when filing your tax returns. Auditors will appreciate the transparency as they must attest to the accuracy of your financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The easier it is to understand your business transactions makes your audit much smoother and less expensive. 

The chart of accounts detail (or lack thereof) is also important internally. Without a well structured chart of accounts your accounting team may not have enough detail to properly categorize transactions. If for example a purchase is recorded to operating expenses when it’s actually COGS that creates financial misstatements. That means you have understated your COGS and overstated your margin. Suppose the misclassification is several million dollars - now your margins are inaccurate and you’re be making business decisions based on bad data. COGS expenses are the only deductible items for cannabis companies under section 280e - if your margin is inaccurate, in this example overstated, your pay more in taxes. A business not subject to Section 280E could typically deduct operating expenses too but because cannabis is still a Schedule I controlled substance, you lose the benefit of deducting traditional business expenses. 

Your company’s chart of account structure can also make financial reviews more productive. Typically a P&L review involves lots of questions where stakeholders are wanting to identify where something has been recorded. Most disconnects between operations and accounting teams arise because the financial statement view that’s needed for decision-making is not aligned to the structure of the chart of accounts. A simple marrying of the two provides comfort in knowing financial information is accurate and complete and decisions are made that reflect the true health of the business.  


The Chart of Accounts Challenge for Cannabis Companies

When starting a business most companies select an accounting system like Quickbooks or Oracle for general ledger management. These systems include a standard chart of accounts that includes the five categories of accounts (revenue, expense, asset, liability, equity) that most businesses use. Cannabis companies, however, have a unique structure that requires a customized chart of accounts. The importance of having a proper chart of accounts for your cannabis business all comes down to the fact that cannabis is a Schedule I Controlled Substance. Despite society’s overwhelming approval of legalized marijuana, it is illegal to the federal government so many expense deductions and credits are lost. This impacts your taxable income since only costs directly related to producing cannabis products is deductible for federal tax purposes.  Consider the two scenarios below:

Scenario 1: Cannabis Company A has $5,700,000 in revenue with $4,500,000 in COGS with gross income of $1,200,000. The company will pay federal income taxes on the $1,200,000 at a 21% effective tax rate. 


Scenario 2: Cannabis Company has $5,700,000 in revenue with $2,000,000 in COGS with gross income of $3,700,000. The company will pay federal income taxes on the $3,700,000 at a 65% effective tax rate. 

The 44% difference between the 2 is in the recognition and classification of COGS expenses. Without the proper setup in the chart of accounts, a cannabis company could be liable for millions in additional federal taxes

The roll up of the chart of accounts is key because is provides visibility into what’s happening in the business. 

If you operate a dispensary but you also sell apparel, you’d want to know how the dispensary performs vs. apparel sales. To evaluate those separately, the related transactions need to be distinguished from others in the financial statements. The effort is there no matter what - the transactions have to be recorded so why not make sure they’re recorded for maximum benefit?

1 line for COGS when COGS includes supplies, labor + other things. By breaking out those lines in the chart of accounts  you can determine, for example, if you need to hire more labor. If your COGS overtime is growing then it might be time to hire more staff. Evaluate that decision along with a look at revenue to determine if sufficient organic growth exists to warrant labor increases. 


Have questions about your cannabis chart of accounts? Schedule a consultation today.


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