The cannabis public company market is growing fast into a valuable, widespread industry. Audits of these cannabis companies are unique, requiring an understanding of the market and diverse operations.
The industry includes companies with operations that directly handle cannabis, such as the cultivation and harvesting of the plant and retail dispensaries. But a host of other businesses support these operations. These “cannabis-adjacent” activities include manufacturing greenhouse equipment, building and leasing facilities for marijuana operations, and consulting services.
Because of the varying laws surrounding cannabis, their accounting and auditing needs are complicated. Operating in jurisdictions where cannabis is illegal presents challenges.
For example, due to US federal law, banking services for cannabis companies are limited. As a result, cannabis businesses rely on cash transactions for significant portions of revenue and expenses. An increased reliance on cash not only heightens the risk for material misstatements, errors, and fraud, it also complicates the audit process.
Cannabis-adjacent businesses face their own distinct risks because a portion of their revenue is derived from a highly volatile industry. Changes or fluctuations in regulations, laws, and even societal attitudes can dramatically and suddenly impact the value of cannabis companies. That volatility then extends to those providing goods and services to the industry.
As it continues to grow, companies operating in and around this space will continue to face novel accounting and auditing scenarios.
Who Audits Cannabis Companies?
The audit market for public cannabis companies is diverse. At least 40 firms perform audits for SEC-registered cannabis or cannabis-adjacent companies.[1]
Because of the emerging nature of the market, the Big Four don’t dominate as they do in most public company markets. This leaves space for mid-sized and smaller accounting firms.
These companies have higher risks and lower market caps. Many of them trade on the OTC markets. But more involved audits can yield higher-margin engagements. However, to ensure audit quality, these engagements require a level of industry-based knowledge and access to appropriate resources.
As the industry expands outward, the audit market landscape will inevitably evolve.
Highlighting the unique nature of these cannabis engagements, one firm, California-based GreenGrowth CPAs, has operations solely dedicated to serving the cannabis industry. Similarly, other audit firms have specialized cannabis teams and advisory groups.
One of those specializing firms is Marcum, which has a noticeable presence in the cannabis industry. The firm is a big player in the Special Purpose Acquisition Company (SPAC) IPO market, an attractive option for a cannabis company to be taken public.
But Marcum also has a specifically established cannabis services group with subject matter experts. This knowledge base is expanding given their recent acquisition of Friedman, which also had a dedicated cannabis team.
Growing Pains
In Canada, recreational marijuana has been legal since 2018. Looking at their audit processes and audit quality trends in this emerging space provides insights into specific challenges the industry faces as it develops.
In February 2021, the Canadian Public Accountability Board (CPAB) announced the discovery of significant findings in 52% of reviewed cannabis company audits. This indicates widespread deficiencies in the application of generally accepted auditing standards relating to material financial balances or transactions. Prevalent issues included procedures surrounding inventory counts and the estimates used in the valuation of biological assets. Furthermore, CPAB noted inconsistencies in fraud risk assessments and audit procedures performed related to the company’s legal and regulatory compliance.
As evidenced by the audit issues noted by CPAB, the emerging cannabis industry presents nuanced difficulties. And while new industries periodically emerge and flourish in the markets, the constantly evolving legal, regulatory, and social landscape surrounding cannabis is an added layer of complexity. But, especially in new industries, high quality audits are necessary to protect capital markets and stakeholders.
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[1] Based on a sample population of 114 publicly listed companies in the US and Canada that filed an annual report with the SEC after January 1, 2021 containing an audit opinion and disclosure of significant operations involving or supporting the cannabis industry, including CBD products. Auditor engagement data as of April 29, 2022.