Pi Corporation acquires 65 percent of Rho Corporation’s voting stock on September 1, 2014, for $120 million in cash. Rho’s net assets are fairly reported at $500 million at the date of acquisition. During 2014, Pi sells $550 million in merchandise to Rho at a markup of 15 percent on cost. Rho still holds $110 million of this merchandise in its ending inventory. Also during 2014, Rho sells $140 million in merchandise to Pi at a markup of 25 percent on cost. Pi still holds $45 million of this merchandise in its ending inventory. Rho reports 2014 net income of $55 million.

Required:

Calculate Pi’s equity in Rho’s net income for 2014.

Assume Pi reports total 2014 sales revenue and cost of sales of $750 million and $600 million, respectively, while Rho reports total 2014 sales revenue and cost of sales of $650 million and $520 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.