Chi Corporation acquires 80 percent of Psi Corporation’s voting stock on December 1, 2011, for $150 million in cash. Psi’s net assets are fairly reported at $650 million at the date of acquisition. During 2011, Chi sells $700 million in merchandise to Psi at a markup of 30 percent on cost. Psi still holds $140 million of this merchandise in its ending inventory. Also during 2011, Psi sells $170 million in merchandise to Chi at a markup of 15 percent on cost. Chi still holds $60 million of this merchandise in its ending inventory. Psi reports 2011 net income of $70 million.

Required:

Calculate Chi’s equity in Psi’s net income for 2011.

Assume Chi reports total 2011 sales revenue and cost of sales of $900 million and $720 million, respectively, while Psi reports total 2011 sales revenue and cost of sales of $800 million and $640 million, respectively. Compute each company’s gross margin on sales as reported following U.S. GAAP. Now compute gross margin on sales again, excluding intercompany sales. Comment on the results.