Kappa Corporation acquires 30 percent of Lambda Corporation’s voting stock on June 1, 2005, for $210 million in cash. Lambda’s net assets are fairly reported at $950 million at the date of acquisition. During 2005, Kappa sells $1,000 million in merchandise to Lambda at a markup of 15 percent on cost. Lambda still holds $200 million of this merchandise in its ending inventory. Also during 2005, Lambda sells $230 million in merchandise to Kappa at a markup of 25 percent on cost. Kappa still holds $90 million of this merchandise in its ending inventory. Lambda reports 2005 net income of $100 million.

Required:

Calculate Kappa’s equity in Lambda’s net income for 2005.

Assume Kappa reports total 2005 sales revenue and cost of sales of $1,200 million and $960 million, respectively, while Lambda reports total 2005 sales revenue and cost of sales of $1,100 million and $880 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.