Could I please have some help with question 1, particularly in determining the contract price and allocating the contract price? Also when to recognise the revenue would be much appreciated.

In determining the contract price we use the figures in the example on page 4.

refundable licensing fee. Some clients negotiated a Termination for Convenience (TFC) clause. Since the underlying product was not updated and clients had the option of hosting the software on their systems or on HBP systems (incurring a separate hosting fee), HBP recorded the full value of the licensing fees as revenue at the beginning of the contract period. In contrast, hosting fees were recorded as deferred revenues and recognized as revenue ratably over the life of the contract (terms were 1, 2, or 3 years). The new business model for HMM12 eliminated the option for clients to host HMM software and introduced an ongoing obligation for HBP. Clients would continue to pay an upfront licensing fee, but since only HBP could host the software there was no separate hosting fee. The license fee gave the client access to the software, the hosting, and any future improvement releases over the contract period. Accordingly, the contract was analogous to a subscription, rather than an outright sale. For accounting purposes, HBP was required to record the upfront license fee as deferred revenue on its balance sheet. At the end of each accounting period, it would recognize a portion of the deferred revenue as earned revenue in the income statement. For example, if a client paid $360,000 for a 3-year (i.e., 36-month) license period, at the time of the contract HBP would record the $360,000 as deferred revenue (a liability) and cash (an asset) on the balance sheet. At the end of the first quarter (i.e., 3- months), HBP would recognize $30,000 (i.e., $360,000 divided by 36 months times 3 months) as earned revenue with a corresponding $30,000 subtracted from the deferred revenue liability. Budget Implications David Wan and Paul Bills were both convinced the change in HMM12's business model was necessary. The new model allowed HBP to have more control over content and technology, and to react more quickly to client needs and competitive pressures. However, the revenue recognition change would result in a short-term decline in revenues and surplus. Bills explained one problem that would create, "HBP has long-range contribution targets with HBS, which they rely on for planning future research funding. Our performance consolidates into the HBS financials, and the resulting surplus into [Harvard) university figures." HBP's contribution to HBS and subsequently Harvard University was significant. Any accounting changes, especially if they reduced reported revenues and surplus, could have significant economic consequences for the business school and for the university. For example, Harvard University's financial statements were shared publicly and positive surplus played a role in maintaining the highest credit ratings from Moody's Investors Service (Aaa) and Standard & Poor's (AAA). From time to time, Harvard issued debt to fund eligible activities. High credit ratings helped keep borrowing costs low. (See Exhibits 3 and 4 for summary Statements of Activity for HBS and Harvard University, respectively for the years ended June 30, 2008-2013.) Bills and Wan decided that the first action required was to forecast the likely impact on HBP's financial budgets; they would then have to sit down with Dean Nitin Nohria and Rick Melnick (HBS's CFO) to explain the change and discuss potential financial implications for the School. With that meeting in mind, in early 2014, Bills sat down to estimate the impact of the change in revenue recognition for HMM12 and to construct next year's budget. Under the planned roll-out of HMM12, existing clients could convert to the new version and receive a time-bound inducement discount from the 20% price increase. Specifically, there was an 18% price increase in 2015 for switching from HMM11 to HMM12 and a 20% increase in the subsequent years. Client acquisition efforts centered on selling HMM12, though new HMM11 deals would be approved if circumstances warranted. Existing HMM11 clients were not forced to convert and could continue renewing HMM11 until its retirement date. Bills explained the logic of continuing to offer HMM11: "It takes a while to convert clients. Shifting to a completely hosted model requires increased IT and security involvement, HR has Exhibit 3 Harvard Business School Summary Statement of Activity for Years Ended June 30, 2008- 2013 (in $ millions) 2008 2009 2010 2011 2012 2013 Total Revenues Total Expenses Surplus 451 423 472 438 34 467 415 52 509 456 53 546 504 42 587 542 45 28 Source: Harvard Business School annual reports, 2008-2013. Exhibit 4 Harvard University School Summary Statement of Activity for Years Ended June 30, 2008-2013 (in $ millions) 2008 2009 2010 2011 2012 2013 Total Revenues Total Expenses Surplus 3,482 3,465 17 3,807 3,762 45 3,739 3,740 (1) 3,778 3,908 (130) 4,018 4,026 (8) 4,215 4,248 (33) Source: Harvard University annual reports, 2008-2013. 7 Exhibit 5 Assumptions and Projections for HMM Forecasted Revenues for years ended June 30, 2014-2017 (in $ thousands) 2014F 2015F 2016F 2017F Renewals by HMM11 customers Revenue from renewals continuing with HMM11 Revenue from renewals switching to HMM12 28,220 15,989 18,751 8,411 29,913 4,518 22,111 New customer revenues HMM11 HMM12 5,980 3,900 3,800 6,868 3,400 9,541 3,050 11,140 Renewals by HMM12 customers Revenue from renewals continuing with HMM12 3,315 23,134 10% 50% Additional information Percent HMM12 revenue recognized in year of sale 2014 2015 2016 2017 25% 40% 50% 25% 25% 50% 25% Source: Note: Harvard Business Publishing. The percentage of revenue recognized was lower in 2014 because HBP introduced HMM12 late in 2014. Sales amounts adjusted to simplify analyses. Exhibit 6 HBP Forecasted Revenues, Expenses, and Contribution for Years Ended June 30, 2014 to 2017 Using Pro Forma Reporting Standard for HMM12 (in $ thousands) 2014F 2015F 2016F 2017F Pro forma reporting: Revenues (a) Expenses (b) Contribution Contribution margin 202,849 174,732 28,117 13.9% 216,119 184,756 31,363 14.5% 231,304 200,318 30,986 13.4% 246,808 213,362 33,446 13.6% Source: Harvard Business Publishing, Note: (a) Total revenues for all of HBP's market groups. (b) Total expenses for all of HBP's market groups. Expenses included ongoing development costs, as well as marketing and sales costs. 8 Case Study Assignment Questions The case is on revenue recognition at Harvard Business Publishing. Although this is a US company, the revenue recognition model is generally the same under the US GAAP and Australia accounting standards (AASB). Please apply AASB in the case analysis. QUESTIONS (1) Use the five-step model to compare revenue recognition between the two versions. (30%) HMM11 HMM12 Steps 1. Contract 2. Performance obligation 3. Contract price 4. Allocate price 5. Recognize revenue (2) Consider the example on p.4 of the case, the last paragraph under the Section Revenue Recognition for HMM, how would you account for the revenue from a contract for HMM11 products? How would you account for the revenue from a contract for HMM12 products? (20%) (3) Does the accounting change in revenue recognition from HMM11 to HMM12 matter to managers of HBP? Please discuss the implications to managers. (20%) Students should try to access at least two articles (either commentary from professional accountants, or academic research articles) to support your answers to Question (3). (Hint: Concentrate on the general results of the articles. You do not have to completely understand the statistical/econometric models). (10%) COMMUNICATIONS Grammar, spelling, and paragraph structures. Please refer to the following marking rubric for more detailed criteria. (20%) refundable licensing fee. Some clients negotiated a Termination for Convenience (TFC) clause. Since the underlying product was not updated and clients had the option of hosting the software on their systems or on HBP systems (incurring a separate hosting fee), HBP recorded the full value of the licensing fees as revenue at the beginning of the contract period. In contrast, hosting fees were recorded as deferred revenues and recognized as revenue ratably over the life of the contract (terms were 1, 2, or 3 years). The new business model for HMM12 eliminated the option for clients to host HMM software and introduced an ongoing obligation for HBP. Clients would continue to pay an upfront licensing fee, but since only HBP could host the software there was no separate hosting fee. The license fee gave the client access to the software, the hosting, and any future improvement releases over the contract period. Accordingly, the contract was analogous to a subscription, rather than an outright sale. For accounting purposes, HBP was required to record the upfront license fee as deferred revenue on its balance sheet. At the end of each accounting period, it would recognize a portion of the deferred revenue as earned revenue in the income statement. For example, if a client paid $360,000 for a 3-year (i.e., 36-month) license period, at the time of the contract HBP would record the $360,000 as deferred revenue (a liability) and cash (an asset) on the balance sheet. At the end of the first quarter (i.e., 3- months), HBP would recognize $30,000 (i.e., $360,000 divided by 36 months times 3 months) as earned revenue with a corresponding $30,000 subtracted from the deferred revenue liability. Budget Implications David Wan and Paul Bills were both convinced the change in HMM12's business model was necessary. The new model allowed HBP to have more control over content and technology, and to react more quickly to client needs and competitive pressures. However, the revenue recognition change would result in a short-term decline in revenues and surplus. Bills explained one problem that would create, "HBP has long-range contribution targets with HBS, which they rely on for planning future research funding. Our performance consolidates into the HBS financials, and the resulting surplus into [Harvard) university figures." HBP's contribution to HBS and subsequently Harvard University was significant. Any accounting changes, especially if they reduced reported revenues and surplus, could have significant economic consequences for the business school and for the university. For example, Harvard University's financial statements were shared publicly and positive surplus played a role in maintaining the highest credit ratings from Moody's Investors Service (Aaa) and Standard & Poor's (AAA). From time to time, Harvard issued debt to fund eligible activities. High credit ratings helped keep borrowing costs low. (See Exhibits 3 and 4 for summary Statements of Activity for HBS and Harvard University, respectively for the years ended June 30, 2008-2013.) Bills and Wan decided that the first action required was to forecast the likely impact on HBP's financial budgets; they would then have to sit down with Dean Nitin Nohria and Rick Melnick (HBS's CFO) to explain the change and discuss potential financial implications for the School. With that meeting in mind, in early 2014, Bills sat down to estimate the impact of the change in revenue recognition for HMM12 and to construct next year's budget. Under the planned roll-out of HMM12, existing clients could convert to the new version and receive a time-bound inducement discount from the 20% price increase. Specifically, there was an 18% price increase in 2015 for switching from HMM11 to HMM12 and a 20% increase in the subsequent years. Client acquisition efforts centered on selling HMM12, though new HMM11 deals would be approved if circumstances warranted. Existing HMM11 clients were not forced to convert and could continue renewing HMM11 until its retirement date. Bills explained the logic of continuing to offer HMM11: "It takes a while to convert clients. Shifting to a completely hosted model requires increased IT and security involvement, HR has Exhibit 3 Harvard Business School Summary Statement of Activity for Years Ended June 30, 2008- 2013 (in $ millions) 2008 2009 2010 2011 2012 2013 Total Revenues Total Expenses Surplus 451 423 472 438 34 467 415 52 509 456 53 546 504 42 587 542 45 28 Source: Harvard Business School annual reports, 2008-2013. Exhibit 4 Harvard University School Summary Statement of Activity for Years Ended June 30, 2008-2013 (in $ millions) 2008 2009 2010 2011 2012 2013 Total Revenues Total Expenses Surplus 3,482 3,465 17 3,807 3,762 45 3,739 3,740 (1) 3,778 3,908 (130) 4,018 4,026 (8) 4,215 4,248 (33) Source: Harvard University annual reports, 2008-2013. 7 Exhibit 5 Assumptions and Projections for HMM Forecasted Revenues for years ended June 30, 2014-2017 (in $ thousands) 2014F 2015F 2016F 2017F Renewals by HMM11 customers Revenue from renewals continuing with HMM11 Revenue from renewals switching to HMM12 28,220 15,989 18,751 8,411 29,913 4,518 22,111 New customer revenues HMM11 HMM12 5,980 3,900 3,800 6,868 3,400 9,541 3,050 11,140 Renewals by HMM12 customers Revenue from renewals continuing with HMM12 3,315 23,134 10% 50% Additional information Percent HMM12 revenue recognized in year of sale 2014 2015 2016 2017 25% 40% 50% 25% 25% 50% 25% Source: Note: Harvard Business Publishing. The percentage of revenue recognized was lower in 2014 because HBP introduced HMM12 late in 2014. Sales amounts adjusted to simplify analyses. Exhibit 6 HBP Forecasted Revenues, Expenses, and Contribution for Years Ended June 30, 2014 to 2017 Using Pro Forma Reporting Standard for HMM12 (in $ thousands) 2014F 2015F 2016F 2017F Pro forma reporting: Revenues (a) Expenses (b) Contribution Contribution margin 202,849 174,732 28,117 13.9% 216,119 184,756 31,363 14.5% 231,304 200,318 30,986 13.4% 246,808 213,362 33,446 13.6% Source: Harvard Business Publishing, Note: (a) Total revenues for all of HBP's market groups. (b) Total expenses for all of HBP's market groups. Expenses included ongoing development costs, as well as marketing and sales costs. 8 Case Study Assignment Questions The case is on revenue recognition at Harvard Business Publishing. Although this is a US company, the revenue recognition model is generally the same under the US GAAP and Australia accounting standards (AASB). Please apply AASB in the case analysis. QUESTIONS (1) Use the five-step model to compare revenue recognition between the two versions. (30%) HMM11 HMM12 Steps 1. Contract 2. Performance obligation 3. Contract price 4. Allocate price 5. Recognize revenue (2) Consider the example on p.4 of the case, the last paragraph under the Section Revenue Recognition for HMM, how would you account for the revenue from a contract for HMM11 products? How would you account for the revenue from a contract for HMM12 products? (20%) (3) Does the accounting change in revenue recognition from HMM11 to HMM12 matter to managers of HBP? Please discuss the implications to managers. (20%) Students should try to access at least two articles (either commentary from professional accountants, or academic research articles) to support your answers to Question (3). (Hint: Concentrate on the general results of the articles. You do not have to completely understand the statistical/econometric models). (10%) COMMUNICATIONS Grammar, spelling, and paragraph structures. Please refer to the following marking rubric for more detailed criteria. (20%)