Upsilon Corporation acquires 75 percent of Phi Corporation’s voting stock on November 1, 2012, for $140 million in cash. Phi’s net assets are fairly reported at $600 million at the date of acquisition. During 2012, Upsilon sells $650 million in merchandise to Phi at a markup of 25 percent on cost. Phi still holds $130 million of this merchandise in its ending inventory. Also during 2012, Phi sells $160 million in merchandise to Upsilon at a markup of 10 percent on cost. Upsilon still holds $55 million of this merchandise in its ending inventory. Phi reports 2012 net income of $65 million.

Required:

Calculate Upsilon’s equity in Phi’s net income for 2012.

Assume Upsilon reports total 2012 sales revenue and cost of sales of $850 million and $680 million, respectively, while Phi reports total 2012 sales revenue and cost of sales of $750 million and $600 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.