When is equity income reduced in relation to unrealized profits from sales?

In the context of equity accounting, equity income is reduced for unrealized profits from sales when the profits are not recognized until the goods are sold to an unrelated third party. This treatment aligns with the principles of conservatism and the realization concept in accounting.

When a company sells goods to an investee and the investee has not yet sold those goods to an external party, those profits are considered unrealized from the investor's perspective. This is because the profits could be seen as not yet definitive until the end customer purchases the goods. Therefore, it's necessary to defer recognizing these profits in the income statement of the investor until the completion of this last transaction with an unrelated third party.

This principle is significant because it prevents the premature recognition of income that could potentially be reversed if the goods are not ultimately sold, thereby providing a more accurate and conservative representation of financial performance.