Harvard Case - Revenue Recognition at HBP
"Revenue Recognition at HBP" Harvard business case study is written by Paul M. Healy, Siko Sikochi. It deals with the challenges in the field of Accounting. The case study is 8 page(s) long and it was first published on : Aug 13, 2018
At Fern Fort University, we recommend that HBP implement a comprehensive revenue recognition policy aligned with the International Financial Reporting Standards (IFRS) 15. This policy should incorporate a robust system for tracking and monitoring project milestones, ensuring accurate and timely revenue recognition throughout the project lifecycle. Additionally, HBP should invest in training its employees on the new policy and implement internal controls to mitigate the risks associated with revenue recognition errors.
2. Background
HBP, a leading provider of engineering and construction services, faces a critical challenge in its revenue recognition practices. The company's current approach, based on the percentage of completion method, has led to inconsistencies and inaccuracies in its financial statements. This has raised concerns among investors and stakeholders regarding the reliability of HBP's financial reporting. The case study highlights the conflict between HBP's CEO, who prioritizes revenue growth, and the CFO, who emphasizes the importance of accurate and transparent financial reporting.
3. Analysis of the Case Study
The case study presents a classic scenario of conflicting priorities between revenue growth and financial reporting accuracy. HBP's current revenue recognition practices are vulnerable to several risks:
- Subjectivity in Milestone Assessment: The percentage of completion method relies heavily on subjective assessments of project progress, which can be influenced by internal biases and pressures to meet revenue targets.
- Lack of Clear Criteria: The absence of clearly defined and measurable milestones creates ambiguity in determining the percentage of completion, leading to inconsistencies in revenue recognition.
- Potential for Earnings Management: The flexibility in the current system creates opportunities for earnings management, potentially distorting the true financial performance of the company.
- Compliance Risks: HBP's current practices may not be fully compliant with IFRS 15, exposing the company to potential regulatory scrutiny and financial penalties.
To address these challenges, HBP needs to adopt a more robust and transparent revenue recognition policy. This policy should be based on the following principles:
- IFRS 15 Compliance: HBP must ensure its revenue recognition practices are fully compliant with IFRS 15, which provides a comprehensive framework for revenue recognition across various industries.
- Objective Milestone Definition: HBP should establish clear and objective criteria for defining project milestones, ensuring that progress can be reliably measured and tracked.
- Documentation and Audit Trail: HBP must implement a system for documenting project progress, including supporting evidence for milestone achievement. This will create an audit trail for verifying the accuracy of revenue recognition.
- Internal Controls: HBP should establish internal controls to mitigate the risks associated with revenue recognition errors. These controls should include regular reviews of project progress, independent verification of milestone achievement, and periodic audits of the revenue recognition process.
4. Recommendations
To address the revenue recognition challenges at HBP, we recommend the following:
- Implement a New Revenue Recognition Policy: HBP should develop a new revenue recognition policy that is fully compliant with IFRS 15. This policy should clearly define the criteria for recognizing revenue, including the identification of performance obligations, the allocation of transaction price, and the recognition of revenue over time.
- Develop a Robust Milestone Tracking System: HBP should implement a system for tracking project milestones, including a clear definition of each milestone, the criteria for achieving each milestone, and the documentation required to support milestone achievement.
- Invest in Employee Training: HBP should invest in training its employees on the new revenue recognition policy, ensuring that all relevant personnel understand the policy's requirements and can apply it consistently.
- Enhance Internal Controls: HBP should strengthen its internal controls related to revenue recognition, including implementing a system for independent verification of milestone achievement, conducting periodic audits of the revenue recognition process, and establishing clear lines of responsibility for revenue recognition decisions.
- Engage with External Auditors: HBP should engage with external auditors to review the new revenue recognition policy and the implementation of the related controls. This will provide assurance that the new policy is effective and compliant with IFRS 15.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core Competencies and Consistency with Mission: The new revenue recognition policy aligns with HBP's core competencies in engineering and construction by ensuring accurate and transparent financial reporting, which is essential for maintaining investor confidence and attracting new business.
- External Customers and Internal Clients: The policy will benefit external customers by providing them with greater transparency and assurance regarding HBP's financial performance. Internal clients, such as project managers and accounting staff, will benefit from a clearer understanding of revenue recognition requirements and a more efficient process for tracking and reporting project progress.
- Competitors: Implementing a robust revenue recognition policy will help HBP stay ahead of competitors by demonstrating its commitment to financial transparency and compliance with international accounting standards.
- Attractiveness ' Quantitative Measures: The new policy will improve the accuracy and reliability of HBP's financial statements, which will increase investor confidence and potentially lead to a higher valuation of the company.
- Assumptions: The recommendations assume that HBP has the resources and commitment to implement the new policy and the necessary internal controls.
6. Conclusion
By implementing a comprehensive revenue recognition policy aligned with IFRS 15, HBP can address the challenges of its current system, improve the accuracy and reliability of its financial reporting, enhance its reputation among investors and stakeholders, and position itself for sustainable growth.
7. Discussion
Alternative approaches to revenue recognition, such as the completed contract method, may be considered. However, these methods may not be suitable for HBP's long-term projects, which typically span several years. The completed contract method would delay revenue recognition until project completion, which could negatively impact HBP's financial performance and investor perception.
The recommendations are subject to certain risks, including the potential for resistance to change from employees, the cost of implementing the new policy and controls, and the possibility of unforeseen challenges in applying IFRS 15 to HBP's specific industry.
8. Next Steps
HBP should implement the following steps to address the revenue recognition challenges:
- Phase 1 (Short-Term): Develop and implement a new revenue recognition policy based on IFRS 15. Conduct training for employees on the new policy and implement a system for tracking project milestones.
- Phase 2 (Medium-Term): Enhance internal controls related to revenue recognition, including independent verification of milestone achievement and periodic audits of the revenue recognition process. Engage with external auditors to review the new policy and controls.
- Phase 3 (Long-Term): Continuously monitor the effectiveness of the new revenue recognition policy and make adjustments as needed to ensure ongoing compliance with IFRS 15 and best practices.
By taking these steps, HBP can ensure that its revenue recognition practices are accurate, transparent, and compliant with international accounting standards, leading to improved financial performance and a stronger reputation among investors and stakeholders.
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Case Description
In early 2014, Paul Bills, CFO of Harvard Business Publishing (HBP), sat down with David Wan, the company's CEO, to discuss budget preparations for the coming year. Bills noted that the performance of Corporate Learning, one of HBP's three business units, would be affected by a business model change for its largest product that required a change in the timing of revenue recognition. 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). The revamped software would be hosted exclusively on HBP's server rather than on its clients' servers, allowing updates to take place continuously. Given the change, accounting standards required HBP to change the recognition of revenue from the date of software delivery (for HMM11) to ratable recognition over its contract life (for HMM12). As Bills and Wan discussed the accounting change, they recognized that its impact on Corporate Learning's and HBP's performance could be material and would have to be reflected in the budget. In addition, they wondered how the new accounting would affect the company's policy for awarding sales incentive compensation on HMM, as well as how they communicated with employees and the firm's sole shareholder, the Harvard Business School.
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