Annual Financial Statements (AFS) are critical to complying with state regulations, maintaining investor trust, and supporting long-term growth. Unfortunately, cannabis businesses often struggle with the related compliance requirements and timely submission.
Here are five of the most common mistakes we see in cannabis AFS reports—and how to avoid them:
1. Inaccurate or Incomplete Vendor Information
In cannabis accounting, maintaining precise vendor records is essential, not just for internal clarity but also to satisfy regulators, accountants, and auditors. Inaccurate vendor names, outdated addresses, and missing tax identification numbers can slow down your reporting process and trigger red flags during audits.
How to Avoid It:
Set up internal controls to verify vendor information upon onboarding and update information regularly. Designate a team member to manage the vendor master file and establish a consistent process for data validation. Integrate your accounting software with vendor databases when possible to minimize manual entry errors. It is imperative to use vendor legal names and ensure there are no duplicates.
2. Lack of Supporting Documentation
Missing receipts, purchase orders, or contracts can complicate your cost of goods sold (COGS) allocation—a key element in cannabis accounting due to Section 280E. Regulators expect complete and verifiable audit trails for all financial transactions.
How to Avoid It:
Implement a robust document management system to retain all necessary backup documentation. Encourage staff to upload documents immediately after a transaction occurs, and train your team on what qualifies as sufficient support. Cloud-based solutions with automatic tagging and secure access control can streamline this process.
3. Errors in Vendor Reclassification
Vendor misclassifications, such as labeling a consultant as a contractor instead of a professional service, can distort financial statements and lead to issues in calculating allowable deductions. The AFS requires vendors to be designated as “service vendors” or “other vendors,” and misclassifying vendors can create the need for rework, delayed filings, and additional fees from accountants and auditors.
How to Avoid It:
Develop a clear chart of accounts and set classification standards that align with your accountant’s expectations. During monthly closes, review vendor activity and reclassify items proactively, rather than leaving it for year-end cleanup. Collaborate closely with your accounting team to ensure accuracy throughout the year.
4. Improper Identification of Licenses
The Michigan Cannabis Regulatory Agency informs licensees when and which licenses are subject to the AFS. It is important to identify all licenses involved in their request and to provide all relevant data to your CPA for every license.
How to Avoid It:
Take extra care when discussing the need for an AFS with your CPA. Forward the email received from “noreply@accela.com” to your CPA directly. That email identifies all licenses subject to the AFS. Ensure accounting records accurately report information and can be disaggregated by license.
5. Inconsistent Application or Lack of Accounting Policies
Changing methods mid-year or applying inconsistent logic between periods (e.g., switching between cash and accrual without documentation) undermines the reliability of your financials. In the cannabis industry, consistency is particularly critical due to the scrutiny placed on financial operations. Standard operating procedures should be written and evaluated periodically.
How to Avoid It:
Establish written accounting policies and review them annually. Ensure the same methods are applied uniformly across locations and subsidiaries. When changes are necessary, document the rationale and discuss implications with your CPA before implementation.
Conclusion
Avoiding these common mistakes requires discipline, systems, and a team that understands the unique challenges of cannabis accounting. Whether you’re a cultivator, manufacturer, or retailer, staying ahead of these pitfalls will save you time, money, and headaches down the road. When in doubt, consult with a cannabis-specialized accountant who can help you navigate this complex landscape with confidence.