Pi Corporation acquires 15 percent of Rho Corporation’s voting stock on September 1, 2002, for $240 million in cash. Rho’s net assets are fairly reported at $1,100 million at the date of acquisition. During 2002, Pi sells $1,150 million in merchandise to Rho at a markup of 25 percent on cost. Rho still holds $230 million of this merchandise in its ending inventory. Also during 2002, Rho sells $260 million in merchandise to Pi at a markup of 20 percent on cost. Pi still holds $105 million of this merchandise in its ending inventory. Rho reports 2002 net income of $115 million.

Required:

Calculate Pi’s equity in Rho’s net income for 2002.

Assume Pi reports total 2002 sales revenue and cost of sales of $1,350 million and $1,080 million, respectively, while Rho reports total 2002 sales revenue and cost of sales of $1,250 million and $1,000 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.