What is Accounting for Royalties?

Accounting for Royalties

Concept of Royalty

Royalty is an amount payable by one party/person in return for some special right or privilege conceded to him by another party/person, such as the right to publish a book or to manufacture and sell a patented article, or to work in a mine. It is the compensation payable to a party/person in respect of the use of an asset whether hired from such party/person, calculated with reference to and varying with quantities produced or sold as a result of the use of such assets.

In simple words, the term "Royalty" means a payment in the nature of rent, made by one person to another person for using certain assets which belong to the latter. Another words, it is a payment mace for having the privilege of using some right. This may be any of the following types:

1. Right to extract some mineral such as oil. Coal or stone, etc. from land:
2. Right to use certain patents for the manufacture of articles for sale; and
3. Right to publish and sell books under a copyright.

Importance words used in Accounting for Royalty

The following terms are used in accounting for royalties:

1. Lessee: a person or corporation who takes out the special rights of the assets from it owner on lease for a consideration of royalty, is called lessee. A lessee is also known as tenant, license, user or publisher.
2. Landlord or lesser: a person or an organization who gives out some special right of own assets on lease for a consideration, is called landlord or lesser.
3. Minimum rent; it is also termed as "Dead Rent" or "Rock Rent" or "Certain Rent" or "Flat Rent" or "Contract Rent". As the term suggests, minimum rent means the rent payable by the tenant to the landlord irrespective of the fact whether a person has derived any benefit or not, out of the property let out to him by the landlord. In other words, it is a guaranteed amount which the tenant has to pay irrespective of the output or sales on which the royalty is based. The amount is fixed up to avoid financial hardship to the landlord in the waiting period which must necessarily lapse before the production or sales cab begins on a commercial scale.

The following are the main purposes of fixing a minimum rent:

• The landlord receives periodically at least a minimum rational amount.
• The lessee is indirectly inspired for the sake of his/her own interest to reach a minimum level of performance.
• In the absence of minimum rent, the lessee may acquire rights from different landlords to prevent compensation and deliberately may under utilize such rites.

4. Short workings: it is the excess of minimum rent over the actual royalties earned by the landlord. Short working can be determined by using the formula:

   Short working = Minimum rent – Royalty

5. Surplus: the excess of amount of royalty over minimum rent is called surplus or excess workings. It is just opposite of short working. It can be calculated as under:

6. Renouncement of short workings: usually in contracts where there is provision for minimum rent, there is also a provision for renouncement of short-workings. It means that short workings allowed by the tenant to the landlord will be recoverable by him/her from the landlord, during such periods when the actual royalty is more that the minimum rent. In other words, recoupment of short workings is the right of getting back from the landlord, excess payment made by the tenant in the earlier years.

The right of recoupment of short working may be either of: (a) fixed or (b) a floating type:

• Fixed right: in case of a fixed right of recoupment of short workings, the right is available only during a fixed period of lease commencement. In case the tenant is not a position to recoup the short working during this period, the balance amount will be a loss to him/ her which will be written off from the profit & loss account.
• Fluctuation right: in case of a fluctuation right of recoupment of shoert workings, the right is available only during a fixed period of showering. If the landlord promises to compensate the short workings with following year or two subsequent year or three subsequent right. In case the tenet is not a position to recoup the show working during this period, the balance amount will be a loss to him/her which will be written off from the profit & loss account.

1.      Short working not recouped: if the to recoup shoe working time expires in respect of any portion of the short workings, it should be written off to profit and loss account.

(Note: if the recoupable shorthorns should be carried forward any they are shown in the balance sheet as current assets, in the books of lessee.)

2.      Amount paid to landlords: if the amount of royalty is less than minimum rent, the lessee must be paid minimum rent. In the case of the calculated amount of royalty is equal to minimum rent, the lessee paid to landlord that amount? If the amount of royalty is higher than minimum rent, the amount paid to landlord is calculate by deducting short working recouped from royalty.

3.      Strike and Lock out: in the event of strike or lockout volume of production or sales decrease, so minimum rent can be reduced if there is an agreement to the effect between landlord and lessee. The minimum rent is reduced on the following way:

• A certain percentage of minimum rent is reduced.
• The minimum rent is reduced proportionately having regard to the length of the stoppage due to strike or lockout.
• The actual royalty discharge the entire rental obligation.

The following formula must be used for recording royalty transactions.

The following analytical table is prepared to record the transactions of royalties:

Accounting Treatment in the Books of Lessee

When the Royalty is less than Minimum Rent:

Alternative 1:

Without Minimum Rent Account:

       Key point to Remember for Recording Royalty Transactions

•      If the agreement of royalty does not contain a clause for minimum rent, the question of surplus, short-working and its recoupment doe not arise.
•     Minimum rent account can be prepared when the royalty is less than minimum rent (I.e. in the case of short-workings arises.
•            The landlord is always entitled to get either the minimum rent of the actual royalty whichever is more, subject to any adjustment of short-workings recouped.
•      In the event of strike or lockout, the minimum rent can be reduced on the basis of agreement between the lessees and landlord.
•       Recoverable short-working should be carried forward and shown in the balance sheet as a current asset of lessee.
•      In any particular year, if a part or whole of the short-working lapse the landlord can get minimum rent only.
•     Lapsed short-working or unrecorded short-working should be charged to profit and loss account.
•       If the royalty is payable on the basis of sales, it should be charged to profit and loss account if the royalty is payable on the basis of production, it should be charged to manufacturing account.

  Review of Theoretical Concept:

   Write the meaning of royalty.

      Royalty is an amount payable by one part/person in return for some special right or privilege conceded to him by another party/person, such as the right to publish a book or to manufacture and sell a patented article, or tow ok in a mine. It is the compensation payable to a party/person in respect of the use of a assets whether hired from such party/person, calculated with reference to and varying with quantities produced or sold as a result of the use of such assets.

I  similarly words, the term' Royalty" means a payment in the nature of rent, made by one person to another person for using certain assets which belong to the latter. In other words, it is a payments mace for having the privilege of using some right.

    Write the meaning of minimum rent.

I   It is also termed as "Dead rent", "Fixed Rent" or "Rock Rent" or "Certain Rent" or "Flat Rent" or "Contract Rent". As the term suggests, Minimum rent means the rent payable by the tenant to the landlord irrespective of the fact whether a person has derived any benefit or not, out of the property let out to him by the landlord. in other words, it is a guaranteed amount which the tenant has to pay irrespective of the output or sales on which the royalty is based. The amount is fixed up to avoid financial hardship to the landlord in the waiting period which must necessarily laps before  the production or sales can begins on a commercial scale.

   Describe the purposed of fixing a minimum rent.

   The following are the main purposes of fixing a minimum rent:

1.           The landlord receives periodically at least a minimum rational amount.
2.     The lease is indirectly inspired for the sake of his/her own interest to reach a minimum level of performance.
3.    In the absence of minimum rent, the lessee may acquire rights from different landlords to prevent compensation and deliberately may under utilize such rites.

   Describe about short workings.

     It is the excess of minimum rent over the actual royalties earned by the landlord. For example, if the minimum rent is Rs. 10,000 p.a. and royally is @ 50 p. per tones, thee 20,000 tones must be produced before the minimum rent is covered. Is case the production happens to be only 15,000 tones the short workings would amount to Rs.2, 500 (i.e., excess of Rs 10,000 over Rs 7.500). Short working can be determined by using the following formula:

   Short working = Minimum rent – Royalty

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