Chapter 17 Royalty Accounts

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 oilwells.
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.
2.
3.
4.
5.
6.
7.

Name of Landlord and Lessee.

Period of Lease.
Commencement of agreement.
Royalty Rates.
Minimum Rent.
Right of recoupment of shortworkings.
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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