Zeta Corporation acquires 40 percent of Eta Corporation’s voting stock on April 1, 2007, for $190 million in cash. Eta’s net assets are fairly reported at $850 million at the date of acquisition. During 2007, Zeta sells $900 million in merchandise to Eta at a markup of 25 percent on cost. Eta still holds $180 million of this merchandise in its ending inventory. Also during 2007, Eta sells $210 million in merchandise to Zeta at a markup of 20 percent on cost. Zeta still holds $80 million of this merchandise in its ending inventory. Eta reports 2007 net income of $90 million.

Required:

Calculate Zeta’s equity in Eta’s net income for 2007.

Assume Zeta reports total 2007 sales revenue and cost of sales of $1,100 million and $880 million, respectively, while Eta reports total 2007 sales revenue and cost of sales of $1,000 million and $800 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.