Theta Corporation acquires 35 percent of Iota Corporation’s voting stock on May 1, 2006, for $200 million in cash. Iota’s net assets are fairly reported at $900 million at the date of acquisition. During 2006, Theta sells $950 million in merchandise to Iota at a markup of 20 percent on cost. Iota still holds $190 million of this merchandise in its ending inventory. Also during 2006, Iota sells $220 million in merchandise to Theta at a markup of 15 percent on cost. Theta still holds $85 million of this merchandise in its ending inventory. Iota reports 2006 net income of $95 million.

Required:

Calculate Theta’s equity in Iota’s net income for 2006.

Assume Theta reports total 2006 sales revenue and cost of sales of $1,150 million and $920 million, respectively, while Iota reports total 2006 sales revenue and cost of sales of $1,050 million and $840 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.