I have to say that I find this topic quite boring. Coming from an accounting nerd, you know it must be dull! However, it is something you should understand to run your cannabusiness properly and to understand your financial statements. So let’s push forward and get this one out of the way.
You may have heard the term depreciation, and perhaps some of you are familiar with what it means to capitalize something, but let’s discuss the details, because it affects your net income in a way many of you may not realize.
To get started, let’s assume that you have purchased a video surveillance system that cost you $2,000. It includes a computer, software and 8 cameras. The system was paid for and installed in the month of May and you expect it to last you for three to five years before it will need to be replaced. Your first inclination would be to expense this item on your income statement just as you do other expenses in the month, like rent and utilities. If done this way, your income statement for May will show an expense of $2,000. But this purchase will have a benefit well beyond the month you paid for it, so instead of putting it on the income statement, we will put it on the balance sheet as a fixed asset.
Fixed assets are those items that have a long term life, meaning they don’t get “used up” quickly but deliver benefit for more than a year. Equipment, computers, software, furniture and improvements to your facility fit into this category of asset. When we put an expenditure on the balance sheet as a fixed asset, rather than the income statement, we care capitalizing it.
As a practical matter, small dollar items are generally not capitalized, even though they may have a long term life. For example, a printer that cost you $200 will have a life longer than a year (hopefully) but it is such a small cost that we go ahead and expense this. The threshold I like to use, depending on the size of your business, is $500 to $1,000 per item, meaning that if the cost of your item is more than that threshold, you would need to capitalize it.
We have to have some way of eventually expensing these items, after all, they are costs that in an indirect way, help to generate income. The way we expense them is through depreciation. Depreciation is the process of expensing a capitalized asset over its expected life. For example, if the expected life of an asset is 5 years, we would divide the cost of that asset by 60 (5 years times 12 months each year) and record an expense 1/60th of the cost each month. Depreciation is a non-cash item, and is done through a journal entry on your books.
For most of you, your outside accountant will calculate depreciation and let you know how much you should expense for it each month. It is usually a standardized amount, which is adjusted at year end to match the depreciation schedule your accountant keeps for you. The main take away here is to get the expenditure categorized correctly by capitalizing it if its cost is more than $500 to $1,000. You can set your own threshold, within certain IRS limitations. Choose that threshold and stick with it though, you want your accounting policies to be consistent from year to year.
I promised a non-riveting discussion and I think I delivered. Hopefully you found some useful information to use in managing the accounting for your cannabis business. If not, stay tuned, more interesting topics will follow.