Cost of Goods Sold

This is by far one of the most important accounting terms any business with inventory must know. If you’re in the cannabis industry, this is the financial statement line item that you must take more serious than any other line (expect maybe your sales). So why is cost of goods sold the most important financial line item for a cannabis business owner? Well, for federal purposes it’s the only thing that a cannabis business can deduct. THE ONLY thing.

In this blog post we’ll go over how the IRS looks at Cost of Goods Sold, and some key take aways that you can implement in your business today.

You or your CPA will need to file a form 1125-A to calculate your Cost of Goods Sold. I will go over each of these items in detail. We will discuss inventory valuation in another post.

Inventory at beginning of year (A)

To determine the inventory at the beginning of the year, you will need to be able to evidence the quantity and the value associated with the inventory. This is best documented in terms of an inventory count (quantity) and listing of inventory cost (price).

Purchases (B)

Unless you are a magician, you will be buying things during the year that will either help you make the product you will sell (think manufacturing here) or you will be buying and re-selling to the end consumer (retailer). To evidence your purchases during the period, you will need to have evidence of all invoices.

Cost of labor (C)

Unfortunately the cost of labor isn’t all labor expenses that you pay in a period, it is the labor that is associated directly with inventory. Direct labor costs include the costs of labor that can be identified or associated with particular units or groups of units of specific property produced.

Additional section 263A costs (D)

Section 263A costs are generally those costs, other than interest, that were not capitalized under your method of accounting immediately prior to the effective date of section 263A, but are now required to be capitalized under section 263A. Consult with a CPA regarding section 263A as this can be very complicated. FYI, if you’re selling cannabis, the IRS does not allow you 263A.

Other costs (attach schedule) (E)

On line 5 you can enter any costs paid or incurred during the tax year not entered on lines 2 through 4. The IRS does not define this cost, so consult with a CPA. Suggested costs include storage and shipping and freight (depends on the term of your agreement).

Inventory at end of year (F)

To determine the inventory at the end of the year, you will need to be able to evidence the quantity and the value associated with the inventory. This is best documented in terms of an inventory count (quantity) and listing of inventory cost (price).

To arrive at Cost of Goods sold for the year, you will take add A + B + C + D +E and subtract the ending inventory amount (F).

If you are feeling confused, uncertainty, and a bit overwhelmed, please let me know – I’m here to help!