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LESSON 17

ROYALTY ACCOUNTS

17.1 INTRODUCTION

Royalty is a periodical payment based on output or sale for the use of a

fixed asset or right to its owner. The payment which is made by one

person to another for the use of a certain asset is known as Royalty. The

person who makes the payment to the owner of the asset is known as

lessee and the owner of the asset to whom payment is made is called as

lessor or landlord. Thus, royalty is paid by the publisher to the writer of

the book, by the manufacturer to the patentee or to the owner of oil-

wells.

According to J.R.Batliboi The term royalty expresses an amount payable

by one person in return of some special right or privilege conceded to him

by another person, such as the right to publish a book, or to manufacture

and sell a patented article or to work a mine.

Royalty account is a nominal account in nature and is synonymous with

rent account. Since, it is a nominal account; it is debited in the books of

lessee as ordinary business expenditure and credited in the books of

landlord as income for him. Royalty account is closed at the end of every

accounting year by transferring to Profit and Loss Account.

17.2 DIFFERENCE BETWEEN RENT AND ROYALTY

The major differences between rent and royalty are as follows:

1. Rent is paid for the use of tangible assets such as building, machinery,

whereas royalty is paid for the use of intangible assets or special right

such as mines, patent right.

2. Rent is fixed, but the amount of royalty is not fixed and depends on

number of articles produced or sold.

17.3 IMPORTANT TERMS IN CONNECTION WITH ROYALTY

1. Landlord or lessor:- The person who is the owner of the assets and

surrender the right of its use to some other person and receives the

consideration as royalty is called Lessor.

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2. Lessee:- The person who pays the royalty in consideration for the use

of that asset is called Lessee.

3. Minimum or Dead or Fixed Rent:- It is the minimum amount of rent

which the lessee is required to pay to landlord whether he (lessee) has

desired any benefit or not out of the right or property rented out to him

by the lessor. Thus, such minimum rent is fixed at the time of agreement

between the two parties. The fixation of such a rent is in the interest of

landlord because it guarantees the receipt of the minimum amount in

case of low output or sales. So a lessee has to pay minimum rent or

royalty, whichever is more. Minimum rent is generally fixed that is why it

may be known as Dead or Fixed or Flat Rent but some time it may vary

also according to the terms of the agreement.

4. Shortworking:- The excess of minimum rent over royalty calculated

on the basis of output or sales is termed as short working.

Shortworking = Minimum Rent - Royalty

For example if minimum Rent is fixed Rs. 10,000 and actual royalty for

1st and 2nd year of output is Rs. 4,000 and 9,500/- respectively, so

shortworking will be Rs. 6,000/- and Rs. 500/- for 1st and 2nd year

respectively.

5. Recoupment of shortworking:- Usually in the first few years of the

royalty agreement, the work does not gather the required momentum

because of the time taken in the preparation for starting the production,

so shortworkings may arise in first few years. Keeping this in view,

royalty agreement may contain a clause that shortworking can be

recouped by the lessee in the following manner:-

(i) Without any time limit:- According to this clause in the agreement the

time limit for the recoupment of shortworkings is not mentioned. So, the

shortworkings, then, may be recouped throughout the period of the lease.

In such a case the amount of un-recouped shortworkings will be

transferred to the Profit & Loss Account only in the last year of the period

of lease and not earlier.

(ii) When shortworkings can be recouped in a fixed period:- There may be

a clause in the agreement that the shortworkings can be recouped in the

given first few years of the lease such as first three years, first four years

or first five years.

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For example if a coal mine is leased on 1st Jan. 2000 for a period of 10

years and if shortworkings can be recouped only during the first 4 years

of the lease, the shortworkings will be recouped upto 2003 only and not

afterwards. The balance of shortworkings in 2003 and thereafter will be

transferred to Profit & Loss Account.

(iii) When shortworkings can be recouped in the next few years:- In this

clause of agreement, the period allowed for recoupment of each years

shortworking is calculated from the year during which the shortworkings

arose. For example, if a mine is leased on 1st Jan 1990 for a period of 20

years and if it is given in the agreement that shortworkings can be

recouped in the subsequent 3 years, then shortworkings of 1990 can be

recouped upto 1993 and shortworkings of 1991 can be recouped upto

1994 and of 1992 upto 1995 and so on. If shortworkings which could not

be recouped during the stipulated period of 3 years that shortworkings

will be transferred to Profit & Loss Account in the year in which the right

of recoupment lapses.

17.4 ACCOUNTING PROCEDURE

The following points need to be noted down before preparing the Royalty Accounts:-

1. Name of Landlord and Lessee.

2. Period of Lease. 3. Commencement of agreement.

4. Royalty Rates. 5. Minimum Rent.

6. Right of recoupment of shortworkings.

7. Mode of payment to Landlord.

A calculation table may be prepared before making the Journal entries which makes easy solution, The format of table is as follows:-

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17.4.1 Journal entries in the books of lessee

There may be three types of situations in order to pass Journal entries in

the books of lessee:-

1. When minimum Rent is more than Royalty.

2. When minimum Rent is equal to Royalty.

3. When minimum Rent is less than Royalty.

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17.4.2 Journal Entries in the Books of Landlord

In the books of the lessor or landlord the accounting treatment will be the reverse of what we have done so far. The following entries will be

recorded:

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