A company sold merchandise to a wholesaler for $4 million. In a side agreement, it agreed to reimburse the wholesaler for any lost gross profit if it was unable to resell these goods for at least an 80% markup on cost. In the industry, the usual average markup is about 65% on cost.
In the company's files, the CFO of the company wrote on the side agreement: "Do not show this to auditors!"
a. Why do you think that the CFO did not want the auditors to see this side agreement?
b. By how much was this company's gross profit overstated?
c. What was the proper accounting for this sale?