When are unrealized profits from downstream sales included in equity income?

Unrealized profits from downstream sales are included in equity income when they are sold to a third party. This is because equity income represents the investor’s share of the net income or loss of an investee company, which only reflects profits that have been realized. In the context of downstream sales, which are transactions between a parent company and its subsidiary, any profits that the parent company recognizes are not considered realized until the subsidiary sells the product to an external party.

Until the sale occurs, these profits remain unrealized and therefore are not included in the equity earnings of the parent company. This treatment ensures that the financial statements reflect only actual income that has been earned through sales to external customers, aligning with the accrual basis of accounting where income is recognized when earned, rather than at the point of transaction between related parties.