As cannabis companies continue to move to the public markets in Canada, high quality inventory records become much more important. Not only is there greater disclosure and scrutiny of financial information, but International Accounting Standard 41: Agriculture (IAS 41) requires additional computations on biological assets (plants and all inventory derived from those plants) to bring them to their fair market value less costs to sell. For the typical operator in the United States, this means you may need to start tracking additional inventory metrics in addition to what can be extracted from the seed-to-sale software required by the State. At Bridge West, it has been our observation that too many new operators rely solely on the seed-to-sale systems for the reporting inventory information. Seed-to-sale software should be viewed as a compliance requirement running in the background more than as an accounting or operational data tracker.
Seed-to-Sale Tracing Software – Challenges and Tips
State-mandated seed-to-sale software was designed to track inventory with unique barcodes so a single item can be tracked back to its originating batch. State departments routinely perform audits on license holders by tracing inventory IDs from the facility’s production floor into the live seed-to-sale software, and vice versa, to ensure all inventory is being tracked appropriately. Compliance auditors may also perform spot check inventory counts to ensure quantities are accurate at that exact point-in-time against the live system. Seed-to-sale software programs work just fine for these purposes, but they were not designed to generate reports for accountants. The ability to run reports is often extremely limited and each system has quirks, which may pose issues when valuing inventory. The two primary issues with seed-to-sale software are the ability to run historical reports and the ability to track conversions throughout the cannabis lifecycle.
- Retention of Point-in-Time Inventory Reports: METRC and Leaf Logix are two seed-to-sale systems that do not allow operators to run a report as of a historical date. To value inventory from a historical year-end, you would have needed to run a “Current Inventory” report at the end of the business day on December 31st and have retained it in your files. This causes trouble when companies go public and didn’t run these reports at prior periods, which need to be revalued or valued for the first time. If a cannabis company is on METRC (California, Nevada, Oregon, Colorado, Michigan, Ohio, Maryland, Massachusetts, and Alaska require it) or Leaf Logix (often used as a point of sale on top of another seed-to-sale system), the best practice is to run current inventory reports for each license/location of the business at each month end. The reports need to be saved in a safe place, even if you’re currently not using these reports to value inventory.
- Tracking the Flow of Inventory Conversions: Another common issue with seed-to-sale systems is the ability to export conversion detail and summaries. For example, in 2018 how much flower was used to produce distillate and how much distillate was created. This is important information when determining the cost of a gram of distillate, but most seed-to-sale systems fall short in reporting this information for a given period. Even those that do (BioTrack and MJ Freeway) don’t make it easy for a report user to produce a roll forward of activity, which is the ultimate goal. For this reason, it will be beneficial to consult with a cannabis CPA to implement good tracking of your inputs and outputs so you can provide a roll forward of activity for any given period. (Beginning balance + purchases + production – used in production – sold – waste = ending balance)
Key Data Points for the Biological Asset Computation
High quality inventory records are important from both a Generally Accepted Accounting Principles (GAAP) inventory perspective, as well as, the International Financial Reporting Standards (IFRS) because IFRS calculations typically build off the true cost/GAAP inventory calculations. Reviewing a few of the common significant assumptions to the IFRS biological asset computation will shed light on specific data points that are needed.
- Selling Price – represents the selling price of a gram of flower, typically expressed as the weighted average sale price per gram of flower in the various finished goods. For example, if you are vertically integrated and sell a vape pen for $50 and it takes five grams of flower to produce the oil in the pen, the selling price per gram of flower is $10. But this is only one product of a potentially large list of edibles, tinctures, wholesale flower, packaged flower, vapes, etc. To determine the selling price per gram of flower, there should be an in-depth understanding of the conversion rates between various extracts and the amount of flower in each finished good SKU.
- Costs of Completion – represents how much cost will be incurred per gram of flower to convert it into the finished goods being sold. Again, typically expressed at the weighted average of all product lines, this requires an in-depth understanding of the conversion rates between various extracts and an understanding the production levels against costs.
- Yield per Plant – is typically one of the easiest inputs to determine as all seed-to-sale systems report yields for a given time period. The key is to differentiate wet vs. dry vs. fresh frozen yields and the timing of when a plant is no longer considered a plant in the system, which is typically when it is cured and a dry weight is determined. Making sure there is not inventory in limbo (a curing plant that is not in the plant count and has not been assigned a dry weight yet) is the biggest concern. This requires an understanding of how each seed-to-sale system reports this data.
The computation for biological assets is a complex accounting estimate that requires an in depth understanding of the license holders production cycle and seed-to-sale software reports. Often times, there is a need for externally tracked data from management; therefore, it is important to ensure all required information is available for your accounting team. The best practice is to run seed-to-sale system reports monthly for retention and to ensure that data is available to develop inventory roll forwards. We recommend that you contact your external accountants early to ensure that you are set-up for success.
If you have any questions or would like to learn more about biological assets under IFRS in the cannabis industry, contact Brandon Van Asten, CPA, and Manager at Bridge West LLP, CPAs and Advisors to the Cannabis and Hemp Industries, at firstname.lastname@example.org.
If you would like to read more about IFRS Biological Assets in the Cannabis Industry in Brandon’s original CannaBlog, Click Here.