The nature of accounting liabilities II

Altran Technologies is a fast-growing French R&D consulting firm. In x1 its revenues soared to A1.3 billion, a 40% increase on the x0 figure, and it maintained its operating profit margin ratio at a healthy 18%. However, its share price fell 65% during the second quarter of x2 as doubts emerged about its accounting policies. Some analysts accuse the company of understating its liabilities, a charge which management vigorously deny.

The main area of controversy surrounds Altran's treatment of acquisitions. The company has grown rapidly by acquiring smaller consultancies in other countries - it bought 28 businesses in x1 alone - in order to increase market share. In most cases it pays for the acquired business with cash: part is paid when the contract is signed and part is deferred and linked to the increase in the acquisi- tion's annual earnings over the following five years. The total price paid is usually twice the initial payment. Altran does not recognise the ‘earn-out payments' as a liability until the acquired company has generated the increase in profits. ‘It's impossible to quantify these earn-out payments in advance, so they shouldn't be held as debts,' argues Michel Friedlander, the company's chief executive.

Altran paid A78 million in earn-out payments in x1. Analysts claim the company's end-x1 indebted- ness including estimated earn-out payments was A956 million rather than the A337 million reported in the x1 balance sheet. This gives a debt-equity ratio of over 240% which puts the company's bonds in the ‘junk' category, according to analysts.

Required

How should Altran account for future estimated earn-out payments at the balance sheet date, in your view? Give the reason(s) for your decision.