In accounting for investments, what is the treatment of profits from intercompany transactions when using the Equity Method?

When using the Equity Method for accounting investments, profits from intercompany transactions must be estimated and eliminated. This is because the Equity Method recognizes the investor's share of the investee's profits and losses; however, it also recognizes that when transactions occur between the investor and the investee, profits that arise from those transactions may not represent realized gains for the investor.

For instance, if the investee sells goods to the investor and those goods remain unsold by the investor at the end of the reporting period, the profits from that sale are not considered realized by the investor. Therefore, to prevent inflated profits on the income statement and provide a more accurate reflection of the economic reality, the recognized profits on intercompany transactions are adjusted. This ensures that only the profits that are actually earned through external transactions with third parties are included in the financial statements.

The other options don't align with the principles of the Equity Method. Immediate recognition of profits would not account for the potential unrealized gains from intercompany activities. Eliminating only losses would be inconsistent with the necessity to also prevent the recognition of unrealized profits. Lastly, stating that no adjustments are necessary disregards the requirement of making adjustments for intercompany transactions to ensure that the financial statements provide a true and fair view