Problem

Equity Method Investment, Intercompany Sales

Harcker Corporation acquires 40 percent of Jackson Corporations voting stock on January 3, 2017, for $40 million in cash. Jackson's net assets were fairly reported at $100 million at the date of acquisition. During 2017, Harcker sells $130 million in merchandise to Jackson at a markup of 30 percent on cost. Jackson still holds $26 million of this merchandise in its ending inventory. Also during 2017, Jackson sells $54 million in merchandise to Harcker at a markup of 20 percent on cost. Harcker still holds $12 million of this merchandise in its ending inventory. Jackson reports 2017 net income of $10 million.

REQUIRED

A. Calculate Harcker's equity in Jackson's net income for 2017.

B. Assume Harcker repots total 2017 sales revenue and cost of sales of $310 million and $262 million, respectively, while Jackson reports total 2017 sales revenue and cost of sales of $254 million and $235 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.