Year-End Adjustments: How Transfer Price Policies Shape Financial Statements

When people hear “transfer pricing”, they usually think of tax audits, documentation, and benchmarking. But the story doesn’t end with the tax computation.

Transfer pricing adjustments directly affect your financial statements your profit and loss account, balance sheet, tax expense, EPS, and even key ratios that lenders and investors look at.

If your group has cross-border or domestic related-party transactions and you’ve ever had a TP adjustment (or expect one), it’s important to understand:

• What exactly a transfer pricing adjustment is
• How it hits your P&L and balance sheet
• What it means for deferred tax, disclosures, and future years

Let’s break it down in simple, practical terms.

What Is a Transfer Pricing Adjustment in Practice?

Transfer pricing is all about pricing transactions between related parties (associated enterprises) at arm’s length as if they were dealing with each other like independent parties.

A transfer pricing adjustment usually arises when:

• The tax authorities (or your own internal review) conclude that the profit declared in India is too low compared to what an independent party would earn, or
• The pricing or margin applied to intercompany transactions doesn’t match the benchmarked range.

The adjustment is typically:

An increase (or sometimes decrease) in your taxable income in India, without an actual change in invoicing after the fact.

So, you’re not necessarily raising invoices to the parent or subsidiary you’re just increasing profits for tax purposes. That’s where accounting questions start.

Read More: Transfer Pricing Methods And Best Practices In India

Impact on Profit and Loss Account

The first and most visible impact of TP adjustments is on the Statement of Profit and Loss.

a) Additional Expense or Income Recognition

There are two broad scenarios:

• Voluntary / Self-Adjustment at Year-End
• Management decides that actual margins are below arm’s length and passes an adjustment entry.
• For example, recording additional revenue from AE or reducing a cost recharge.
• This affects both accounting profit and taxable profit.
• Adjustment Only for Tax Purposes (Post-Assessment)
• The tax officer adds a TP adjustment during assessment.
• Books are not restated, but tax expense and effective tax rate are affected.

b) Impact on Profit Before Tax and Tax Expense

If you recognise the TP adjustment in books (e.g., year-end true-up):

• Revenue goes up or expenses go down → Profit Before Tax (PBT) increases.
• Consequently, current tax expense also increases.

If you don’t adjust books and TP adjustment is only for tax purposes:

• Accounting PBT stays the same, but
• You recognise additional tax expense or tax provision in the year of assessment.

Either way, your net profit after tax and EPS can be impacted.

Recommended: Transfer Pricing (TP) Study Report Applicability In India

Impact on Balance Sheet

Transfer pricing adjustments also flow into the balance sheet, sometimes in ways that are easy to miss.

a) Tax Provision / Income Tax Payable

When a TP adjustment increases taxable income, you:

• Create an additional provision for income tax in liabilities
• Or increase the current tax payable if payment is due

This may also affect:

• Cash and bank balances, when the differential tax is actually paid
• Retained earnings, once the impact hits the P&L

b) Deferred Tax Assets / Liabilities

TP adjustments can create temporary differences between accounting profit and taxable profit.

Examples:

• If books are not adjusted, but tax is paid on higher income, there is a difference between carrying profit in books and taxable income.
• Depending on the situation and accounting standards, this may lead to deferred tax assets (DTA) or deferred tax liabilities (DTL).

Your auditors will usually evaluate:

• Whether the TP adjustment is one-time or likely to recur
• Whether it creates a reversing temporary difference in future years

c) Intercompany Balances

If your TP policy involves true-up entries (for example, additional service fee or margin top-up):

• You may raise intercompany invoices to align to arm’s length.
• This increases trade receivables or payables with the associated enterprise.

So, a TP adjustment isn’t just a tax concept it can move real balances between entities in your group.

Read This: The Importance of Transfer Pricing Audits You Should Know

Impact on Cash Flows

Transfer pricing adjustments can affect cash flows in two ways:

• Direct Tax Cash Outflow
• Additional tax (and sometimes interest) paid due to TP adjustments reduces your net cash from operating activities.
• Intercompany Cash Movements (If True-Ups Are Invoiced)
• If you adjust by invoicing extra revenue or cost recharges:
• Cash may flow in or out between Indian and overseas entities.
• This may also require attention under foreign exchange laws and contractual agreements.

Though the Statement of Cash Flows doesn’t show “transfer pricing adjustment” as a separate line, the overall tax paid and working capital movements will reflect its impact.

Impact on Ratios, Covenants, and Investor Perception

TP adjustments can subtly influence key financial metrics like:

• EBITDA and PBT margins
• Return on capital employed (ROCE)
• Debt service coverage ratios (DSCR)
• Effective tax rate

For example:

• A large TP adjustment increasing profit might improve profitability ratios, but
• If it arises only because tax authorities believe your earlier margins were too low, lenders or investors might start asking if your pricing policy is sustainable.

If TP issues repeat over years, it can:

• Raise questions about governance and compliance
• Trigger covenant checks if there are clauses around tax disputes and contingent liabilities

That’s why it’s important to not just “fix it this year”, but also review and refine your TP model going forward.

Disclosures and Notes to Accounts

Significant transfer pricing adjustments often require disclosure in the financial statements, especially when they:

• Involve material tax demands or contingencies
• Are under litigation or appeal
• Can affect future periods

Typical areas of disclosure:

• Contingent liabilities for disputed TP additions
• Management’s view on likelihood of success in appeal
• Significant judgements in recognising deferred tax on TP-related differences

Transparent disclosure helps:

• Auditors sign off comfortably
• Stakeholders understand the nature of risk
• Avoid surprises when scrutiny or appellate orders come through

Voluntary TP Adjustments vs. Litigation-Driven Adjustments

There’s a big difference between:

• Proactive TP Adjustments
• Management reviews margins, compares with benchmarks, and passes true-up entries in the same financial year.
• Books, tax return, and TP documentation are aligned.
• Financial statements reflect a clean, defendable position.
• Litigation-Driven TP Adjustments
• Adjustment arises years later from a TP audit or assessment.
• Impacts current year’s tax expense, often via prior-period tax adjustments.
• May lead to provisions, contingencies, and interest, affecting cash flows and profitability.

From a financial statements perspective, proactive alignment is almost always better than dealing with surprises in later years.

Must Read: Transfer Pricing Litigation: Meaning, Process, and Dispute ...

Practical Steps to Manage TP Impact on Financials

To reduce the negative impact of TP adjustments on your financial statements, consider:

• Aligning TP policy with business reality
• Ensure the margins your TP study recommends can actually be achieved in day-to-day operations.
• Periodic margin reviews during the year
• Don’t wait till year end. Track intra-year profitability on related-party transactions and adjust if needed.
• Year-end true-up where appropriate
• If your group policy allows, pass adjustments (with proper documentation) to stay within arm’s length.
• Close coordination between finance, tax, and accounting teams
• TP cannot be managed in isolation by the tax team alone. It needs finance and business inputs.
• Robust documentation and clear rationale
• If you do make or don’t make adjustments, keep a clear paper trail explaining why. This helps both auditors and tax officers.

Conclusion: TP Is Not Just a Tax Issue – It’s a Financial Reporting Issue

Many businesses treat transfer pricing as a “tax department topic”. In reality, TP adjustments reshape how your financial performance is seen on paper by management, lenders, investors, and regulators.

A thoughtful approach to transfer pricing means:

• Fewer shocks in assessments
• More predictable tax expense
• Cleaner financial statements
• Better comfort for auditors and stakeholders

If your group is dealing with complex intercompany pricing, recurring TP assessments, or large adjustments, it’s worth stepping back and asking:

“Are we managing transfer pricing just for tax, or are we also thinking about the impact on our financials?”

At DSRV India, we help businesses integrate transfer pricing strategy with financial reporting from TP study and documentation to assessing the impact on financial statements, tax provisioning, and disclosures.