Royalty
accounts
Royalty is an
amount payable for utilizing the benefit of certain rights vested with some
other person. For example a landlord possesses right over the mine in his land,
the author of book possesses right over his book. When the rights are leased
the owner receives a consideration for the same which is called royalty.
Royalty is a
periodical sum based on the output payable by the lessee to the lessor for
having utilized the rights of the lessor. The person who makes the payment to
the owner of asset is known as lessee and the owner of the asset is known as
lessor. Royalty is a business expense and
closed and transferred to profit and loss account.
According to
William Pickles, “Royalty is the remuneration payable to a person in respect of
the use of an asset, whether hired or purchased from such person, calculated by
reference to and varying with quantities produced or sold as a result of such
asset.”
Types of Royalties:
There are many types of royalties but
following types of royalty are very popular.
a)
Mining Royalties,
b)
Brick-making Royalties,
c)
Oils-wells Royalties,
d)
Patent Royalties
e)
Copyright Royalties
Difference
between Royalties and Rent:
In the common usage, the term royalty
is used to mean rent. But there is some difference between royalty and rent.
The following are the major difference between royalty and rent:
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S.N.
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Royalty
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Rent
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1.
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Royalty is the consideration payable for the use of special
right for both tangible and intangible assets.
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But rent is the consideration payable for the use of only
tangible assets.
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2.
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Royalty is paid either on the basis of output or sale.
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Rent is paid on the basis of period.
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3.
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Royalty varies on the basis of output or sales.
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Rent is fixed.
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4.
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Royalty agreement normally contains a clause to pay a minimum
rent.
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But in rent, there is no concept of minimum rent.
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5.
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Parties are known as lessor and lessee.
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Parties are known as tenant and landlord.
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Minimum Rent / Dead Rent / or Fixed Rent:
Minimum Rent is the amount below
which landlord never accepts in any year from the person who has to pay royalty
in case of mines. Minimum Rent is also known as Fixed Rent, Dead Rent, Flat
Rent or Contract Rent. If in any year amount of royalty is less than the amount
of minimum rent, the amount of minimum rent is payable by the person who has to
pay the royalty, but if the amount of royalty is more than the amount of
minimum rent, royalty will be paid.
Importance of Minimum Rent:
Fixation of minimum rent is in the
interest of landlord because it guarantees him the receipt of the minimum rent
even in the case of low output or sales. In the absence of minimum rent clause,
only the actual royalty will be paid to the landlord. Moreover, it also gives
incentive to the lessee to enhance production or sales because he is bound to
pay minimum rent.
Redeemable Minimum Rent:
Generally, when minimum rent is more
than royalty, then minimum rent is payable if no such provision is given in the
agreement, but if it is mentioned in the agreement that when royalty will be
more than minimum rent, the excess of minimum rent over royalty paid in the
earlier years will be written off out of the excess of the royalty over minimum
rent in the coming years such minimum rent is called Redeemable Minimum Rent.
Shortworkings:
The excess of minimum rent over
royalty is called ‘Shortworkings’. Minimum Rent – Royalty = Shortworkings or
M.R. – R = S.W.
Recoupment or Writing off Shortworkings:
Recoupment of short working refers to recovering the
short working of any year, from surplus royalty of the succeeding years. the
Recoupment may be permitted over a
stipulated period of time (fixed Recoupment) or over a specified period
following the year of short working (floating Recoupment) or within the life
time of the lease(Recoupment within life time of the lease).
All the
conditions regarding recoupment or writing off shortworkings are based on the
mutual agreement between the lessee and lessor. Shortworkings may be recouped
in all the future years or it may be recouped throughout the period of lease.
For example, if It recouped during the first four years of the lease, then
recoupment will take place only during the first four years, and not
afterwards, in the fourth year unwritten balance of shortworking will be
transferred to the Profit and Loss Account and future year’s shortworkings will
also be transferred to the Profit and Loss Account of the concerning year.
Accounting entries in the books of lessee
a)
Without
minimum rent account is not opened
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Sl. No.
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Circumstances
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Royalties are less then the minimum rent
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Royalties are more then the minimum rent
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01
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For Royalty
payable
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Royalties
a/c Dr
Short
working a/c Dr
To Land lord a/c
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Royalties
a/c Dr
To Short working a/c
To Land lord a/c
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02
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For payment
of royalty
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Land lord
a/c Dr
To Bank a/c
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03
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For transfer
of royalty
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Profit and
loss a/c Dr
To Royalty
a/c
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In case
short working is not completely recovered (non-recovery of short working)
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04
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For
transfer of short-working
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Profit and
loss a/c Dr
To Short working a/c
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b)
With minimum
rent account is opened
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Sl. No.
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Circumstances
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Royalties are less then the minimum rent
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Royalties are more then the minimum rent
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01
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For minimum
rent payable
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Minimum
rent a/c Dr
To land lord a/c
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No entry
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02
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For Royalty
payable
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Royalties
a/c Dr
Short
working a/c Dr
To minimum
rent a/c
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03
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For payment
of royalty
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Land lord
a/c Dr
To Bank a/c
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04
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For
transfer of royalty
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Profit and
loss a/c Dr
To Royalty
a/c
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In case short
working is not completely recovered (non-recovery of short working)
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05
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For
transfer of short-working
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Profit and
loss a/c Dr
To Short working a/c
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Accounting entries in the books of lessor
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Sl. No.
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Circumstances
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Royalties are less than the minimum rent
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Royalties are more than the minimum rent
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01
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For Royalty
receivable
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Lessee’s a/c Dr
To Short working suspense a/c
To Royalties receivable a/c
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Lessee’s a/c Dr
Short working suspense a/c Dr
To Royalties receivable a/c
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02
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For receipt
of royalty
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Bank
a/c Dr
To Lessee’s
a/c
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03
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For
transfer of royalty
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Royalty
receivable a/c Dr
To Profit
and loss a/c
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In case
short working is not completely recovered (non-recovery of short working)
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04
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For
transfer of short-working
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Short
working suspense a/c Dr
To Profit
and loss a/c
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Table analysis
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Year
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Output
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Minimum
rent
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Royalty
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Short
working
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Short
working recovered
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Short
working not-recovered
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Amount paid
to landlord
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01
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02
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03
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04
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05
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06
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07
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08
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(3-4=5)
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(4-3=6)
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(5-6=7)
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(4+5=8)
or
(4-6=8)
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Sub-Lease:
Sometimes a
lessee grants a sub-lease to another person either for the whole land or for
the portion of it. The person, to whom a sub-lease is granted, is called
sub-lessee. In such a case whatever yield is taken out by the lessee and
sub-lessee is added and on this total yield lessee has to pay royalty to the
landlord.
As lessee he maintained royalty
payable a/c, Short Workings a/c and landlord a/c and as lessor for sub-lessee
he maintains royalty's receivable a/c, shortworking suspense a/c and sub
-lessee a/c .The entries in the book at all the parties will be the same as
above. To the original landlord Royalty should be paid on the basis of the
total output of both the lessee and sub-lease
