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Medical Marijuana Accounting – Navigating the Forest Through the Trees

Draft rules issued by Arizona Department of Health Services contain regulatory requirements over the financial accounting operations of all dispensaries. The draft rules require financial accounting submissions to DHS to be in accordance with Generally Accepted Accounting Principles (GAAP), specifically defined in R17-101 – Definitions. DHS rule R9-17-315 requires an inventory control system and monthly internal audit(s) of the dispensary’s inventory in accordance with GAAP. The draft rules also require an annual financial statement audit in accordance with GAAP and generally accepted auditing standards (GAAS) conducted by an independent Certified Public Accountant. The audit requirements are contained in R9-17-307(3) and (4).

Our goal is to provide general guidance to entities that are anticipating submission of an application and receipt of an Arizona medical marijuana dispensary license. Due to the anticipated changes in rules as a result of the public meetings and comment occurring during February, 2011, the likelihood of additional or amended final rules should be anticipated.

What is a Financial Statement Audit?

The objective of a financial statement audit is to determine whether the financial statements are free of material misstatement. An audit includes examining, on a test basis:

  1. evidence supporting the amounts and disclosures in the financial statements,
  2. assessing the accounting principles used and significant estimates made by management,
  3. evaluating the overall financial statement presentation.

Responsibilities and Functions of the Independent Auditor

The objective of an audit of financial statements by an independent auditor is the expression of an opinion on the fairness with which the following are presented in conformity with generally accepted accounting principles, in all material respects:

  1. the financial position (balance sheet),
  2. results of operations (income statement),
  3. cash flows (cash flow statement).

The auditor’s report is the medium through which they express their opinion or, if circumstances require, disclaim an opinion. In either case, the auditor states whether his audit has been made in accordance with generally accepted auditing standards. These standards require the auditor to state whether, in their opinion, the financial statements are presented in conformity with generally accepted accounting principles and to identify those circumstances in which such principles have not been consistently observed in the preparation of the financial statements of the current period in relation to those of the preceding period.

Distinction Between Responsibilities of Auditor and Management

The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. Because of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected. The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance those misstatements, whether caused by error(s) or fraud, that are not material to the financial statements are detected.

The financial statements are management’s responsibility. Management is responsible for:

  1. adopting sound accounting policies,
  2. establishing and maintaining internal control,
  3. initiate, authorize, record, process, and report transactions (as well as events and conditions) consistent with management’s assertions embodied in the financial statements.

The entity’s transactions and the related assets, liabilities, and equity are within the direct knowledge and control of management. The auditor’s knowledge of these matters and internal control is limited to that which is acquired through the audit.

The fair presentation of financial statements in conformity with generally accepted accounting principles is an implicit and integral part of management’s responsibility. The independent auditor may make suggestions about the form or content of the financial statements or draft them, in whole or in part, based on information from management during the performance of the audit. However, the auditor’s responsibility for the financial statements he or she has audited is confined to the expression of his or her opinion on them.

About the Author

Lance Meilech is a Certified Public Accountant practicing with the firm of AddingMachine.com in Phoenix. He has earned a Masters in Taxation. As a licensed professional, he provides a full range of accounting and tax services, including accounting and tax services for Arizona medical marijuana dispensaries. He has more than twenty years experience in all aspects of taxation, accounting and audit, including income tax planning for closely-held businesses and high and middle net worth individuals.  Lance has extensive experience with both federal and state tax audits and collection matters including offers in compromise.  Lance’s clients include executives, attorneys, physicians, real estate professionals, small business and high net worth individuals.

However, neither this article nor the author purport hereby to offer legal, tax or accounting advice in any form. This article is not a comprehensive assessment of issues that might be experienced in a particular business operation. Each reader’s situation is dependent on his/her facts and circumstances. As a result, each reader should consult his or her own advisor for information concerning his or her specific situation or may contact the author at info@addingmachine.com.  Call Lance at 602-943-2060 to schedule a free initial consultation or if you have questions about this article.

By |2011-02-18T07:19:41-07:00February 18th, 2011|Dispenary Accounting|Comments Off on Medical Marijuana Accounting – Navigating the Forest Through the Trees

Medical Marijuana – Fact or Fiction: What “Good” is an Accounting System?

Background

Voters in State of Arizona passed proposition 203, enacting legislation defined as Arizona’s Medical Marijuana Act. The Medical Marijuana Act authorizes the establishment of nonprofit medical marijuana dispensaries (“dispensaries”). These dispensaries are to be licensed, tightly regulated, and inspected and are intended to provide medical marijuana to qualified patients, with their doctor’s approval, or their designated caregivers.

Arizona’s Medical Marijuana Act is governed under Title 36, Public Health and Safety, Chapter 28.1 – Arizona Medical Marijuana Act. Arizona’s Department of Health Services (“DHS”) has enacted “draft” rules governing the program which are contained in Title 9, Health Services, Chapter 17, Department of Health Services – Medical Marijuana Program.

Draft rules issued by DHS contain regulatory requirements over the financial accounting operations of all dispensaries. The draft rules require financial accounting submissions to DHS to be in accordance with Generally Accepted Accounting Principles (GAAP), specifically defined in R17-101 – Definitions. DHS rule R9-17-315 requires an inventory control system and monthly internal audit(s) of the dispensary’s inventory in accordance with GAAP. The draft rules also require annual financial statement audit conducted by an independent Certified Public Accountant. The requirements are contained in R9-17-307(3) and (4).

Our goal is to provide general guidance to entities that are anticipating submission of an application and receipt of an Arizona medical marijuana dispensary license. Due to the anticipated changes in the draft rules as a result of the public meetings and comment occurring during February, 2011, the likelihood of additional or amended final rules should be anticipated.

Small Business Accounting System

Many new small business owners and entrepreneurs consider accounting and bookkeeping, a necessary evil; forced upon them by various federal, state and local governments. In this case, an Arizona Medical Marijuana dispensary’s perpetual existence will be closely related to how well the accounting system provides Arizona’s Department of Health Services the financial accounting information they require.

Accounting is an essential component of business, and evil or not, it is a critical business function that cannot be avoided. Remember, noncompliance with statute and regulation will eventually collapse an entity, with an entity’s officers possibly being subjected to civil fine(s), penalties and forfeitures. The accounting system is how a business tracks assets, liabilities, equity, revenues and expenses as a mechanism to evaluate if the company is financially successful. A well designed accounting system is:

Organized set of computerized and manual accounting methods, procedures, and controls established to gather, record, classify, analyze, summarize, interpret, and present accurate and timely financial data for management decisions.

It is an information system that should be embraced by small business owners and entrepreneurs as a means of providing a “snapshot of the business”, through the production and analysis of periodic and timely prepared financial statements. It’s also one of the most important management decision making tools used in any business.

Accounting System – Practical Considerations (more…)

By |2011-02-18T16:24:02-07:00February 17th, 2011|Dispenary Accounting, Stories & Articles|Comments Off on Medical Marijuana – Fact or Fiction: What “Good” is an Accounting System?

Medical Marijuana Dispensaries; the Federal Income Tax Deductibility Nightmare

Given the recent enactment of the Arizona Medical Marijuana Act, we anticipate a number of new business enterprises in the Arizona market attempting to comply with its “dispensary” provisions. Thoughtful entrepreneurs engaged in this fledgling industry will be wondering whether they will be permitted to deduct the expenses incurred in their business operations. This article will consider relevant tax provisions and attempt to provide a meaningful “rule of thumb” that these businesspersons, or their tax preparers, may find useful.

Background

The Arizona Medical Marijuana Act authorizes the establishment of nonprofit medical marijuana dispensaries (“dispensaries”). These dispensaries are to be licensed, tightly regulated, and inspected and are intended to provide medical marijuana to qualified patients, with their doctor’s approval, or their designated caregivers. Although, under Arizona Revised Statutes Section 36-2806, these dispensaries are to be nonprofit entities (but they need not be tax-exempt organizations for IRS purposes), they are clearly authorized by Arizona Revised Statutes Section 36-2801 to receive payment for all expenses incurred in their operations. As a result of receiving such revenue, they will undoubtedly be required to file income tax returns. Before considering these tax returns, however, an important legal issue must be dealt with. Is this business legal or illegal?

Although this may seem like a strange question to be asking, given that we are able to review specific Arizona statutes that authorize the business and provide detailed rules on numerous aspects of the creation and operation of such dispensaries, we would be remiss if we failed to do so. Since, however, the focus of this article is not the legality of a dispensary, we will rely on existing analysis of the issue as it has arisen in connection with California statutes, which have been around for the past decade and a half.

Since the passage of the Compassionate Use Act of 1996 and the California Medical Marijuana Program Act, California businesses have been wrestling with a number of legal issues and have had the opportunity to create a growing base of case law that will undoubtedly provide precedence as these same issues arise under Arizona law. The most important issue is whether the creation of these state statutes that authorize the possession and use of marijuana for medical purposes provides some protection, some defense, from Federal prosecution for the possession or use of illegal drugs.

A number of cases make it clear that the possession and use of marijuana, even for medical purposes, is still illegal under Federal law. See, for example, Footnote 10 of the California Supreme Court case, People v. Kelly (2010). According to the Controlled Substances Act, marijuana remains a Schedule I drug and, state statutes authorizing medical use to the contrary, Federal law does not contain any exception for “medical use”. Furthermore, Federal law still supersedes state law (Gonzalez v. Raich US Sup. Ct (2005)). In short, except perhaps for certain, specific research purposes, no use of marijuana is legal.

Thus, it would appear that any person or business possessing marijuana, even if in compliance with state medical use laws, is involved in an illegal business activity. This fact explains the many legal conundrums arising in advice given in the industry. Should a doctor merely “approve” of a patient’s medical use of marijuana or may she “recommend” it? May the product be “sold” or must it be given away (in exchange for a donation)? What is the difference between distribution by a “dispensary” and a “collective”? It should be noted that these issues arise, not necessarily as a result of any ambiguity in the state statutes, but because of concern over exposure to legal liability at the Federal level.

One may find some comfort (but, perhaps, not much) in statements issued by/on behalf of the Department of Justice (DOJ). In 2009, the Attorney General indicated that even though the DOJ does not condone any possession or use of marijuana, in an effort to use its resources efficiently, it would limit its prosecution efforts and target only dispensaries being used as a front for dealers of illegal drugs. However, in the DOJ guidelines issued in October 2009, I believe it expressed its intention more broadly, that is, it intended to prosecute “for profit” enterprises. Its statements have also indicated that it will not require its agents to prove any violation of specific state (Medical Use) statutes during such prosecutions (that is, such statutes do not matter and, even if followed precisely, offer no defense).

Thus, although AS 36-2811(B) clearly states that those complying with the provisions of the Arizona Medical Marijuana Act are not subject to arrest, prosecution or penalty for their possession or use of marijuana, this statute should not provide much comfort for anyone using or possessing marijuana for medical purposes. It may serve to give guidance to state police on the proper use of their resources but will apparently not affect Federal law enforcement officials. For further analysis of this issue, and others, you may wish to consider the White Paper on Marijuana Dispensaries, issued by the California Police Chief Association’s Task Force in April 2009 (www.counties.org. , under the CSAC Advocacy tab), as a possible starting point.

We will leave the resolution of this issue to the interested lawyers among you. For the remainder of this article, we will assume that a medical marijuana dispensary is an “illegal” business activity for Federal tax purposes.

Tax Guidelines (more…)

By |2011-02-17T07:56:34-07:00February 16th, 2011|Tax Issues|1 Comment