Corporate Learning was in the process of revamping its flagship product, Harvard Manage-Mentor (HMM) from version 11.0
Question:
Corporate Learning was in the process of revamping its flagship product, Harvard Manage-Mentor (HMM) from version 11.0 (HMM11) to version 12.0 (HMM12).
HMM11, was approaching three million licensed users (see Exhibit 2 for a sample page from the HMM11 learning tool). Client companies acquired a license to use the materials and could choose to either let HBP host the software or install it on their own system, in which case they were responsible for service. Users accessed the software on their desktop.
HMM12 would aim to satisfy the curriculum driven and course-like approach that many clients were seeking while also providing flexibility to enable on- demand usage. In addition, the product would incorporate a variety of media formats beyond text to improve user engagement. "the folks on the team that architected the new version of HMM actually designed it in a way that all of the learning assets can be unbundled so that you can pull them out, mix them, and create a micro learning product of shorter bursts of learning.”
Revenue Recognition for HMM
Early in the redesign of HMM12, Bills recognized that the decision for HBP to host the software would affect how revenues were recognized from sales of the new product. For HMM11, the client hosted the software on its servers and was responsible for all maintenance and operating costs. Although HBP offered to fix any software bugs, there was no contractual obligation to provide updates/point releases. As a result, the full value of any multi-year licensing contracts was recognized as revenue when the software was delivered.
If the client chose to have HMM11 software hosted on HBP’s server, the contract specified that the client would pay HBP an upfront licensing fee and a separate hosting fee (equivalent to about 10% of the licensing fee) at the time the contract was signed. In the majority of contracts, the client paid a non-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
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.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.)
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. After some discussion, Bills’ team came up with projections for the revenues expected to be generated from customers renewing HMM11, those switching to HMM12, and HMM11 and HMM12 sales to new customers in the years ended June 30, 2014 to 2017 (see Exhibit 5 for revenue projections). To judge how these forecasts affected the full HBP budget, Bills set out to develop the budget under the required new reporting method to compare with the old method. He labeled the old method as pro forma reporting (see Exhibit 6 for a summary of the HBP pro forma budget).
Determining how to treat the sales force commissions associated with HMM12 was also challenging. Corporate Learning employed a small number of sales representatives responsible for selling HMM. They received a 6% commission on the total contract values for HMM11 sales, identical to the revenues recognized each year.
QUESTION: Use the five-step model to compare revenue recognition between the two versions.
Steps | HMM11 | HMM12 |
1. Contract | ||
2. Performance obligation | ||
3. Contract price | ||
4. Allocate price | ||
5. Recognize revenue |
Expert Answer:
Revenue Recognition Comparison HMM11 vs HMM12 using the FiveStep Model Heres a breakdown of revenue ... View the full answer
