Royalty Accounts (Theory)

ACCOUNTING SOLUTIONS

SCO: 209, First Floor, Sector-36/D. Chandigarh (M): 0172-4670390, 9876149390,9041394669 ROYALTY ACCOUNTS Write short not on following: a)

Royalty

b)

Minimum Rent OR Dead Rent.

c)

Short-working

d)

Recoupment of Short-Working

e)

Sub-Lease.

Ans. (a) Royalty. The term 'Royalty' is used to denote the periodic payment made by one person called lessee to another person called lessor for using the right by the lessee vested in the lessor. For example, if X is the owner of coal mine, and instead of extracting the coal himself, he concedes this right to Y in return for amount calculated on the basis of coal extracted from the mine, such a payment is called 'Royalty'. Royalties are usually payable in the following cases: (a)

For the extraction of oil, coal, and minerals from the ground

(b)

To an author for sale of his books.

(c)

To holder of patent rights for the use of his patent by other manufacturer.

Nature of Royalty Account:- Royalty Account is nominal in the nature. So it is debited in the books of party paying it and credited in the books of the party receiving it. As it is a nominal account, the amount is transferred either to P & L Account or Production Account, depending upon its treatment as direct or indirect expenses as the case may be. (b) Minimum Rent or Dead Rent: Minimum Rent is also called 'Dead Rent' or 'Rock Rent' or Fixed Rent. As the name suggests, this is the minimum amount of rent which the lessee is required to pay to the lessor whether he has derived any benefit or not out of the right vested to him by the lessor. Thus, if in any year the actual royalty is less than the minimum rent, the landlord will claim the minimum rent. But in the years

when actual royalty exceeds Minimum Rent, the landlord will claim the actual royalty.

Moreover, Minimum Rent may be the same for each year or may vary for different years according to the terms of agreement. For example. If X has taken a lease of mine with minimum rent of Rs. 10,000 for a year and with a rate of royalty at Rs. 2 per tonne of coal extracted. if coal extracted in the first year is 4000 tonnes then Royalty comes to Rs. 8000 i.e. 4000 tonnes X Rs. 2 per tonne but (x) has to pay Rs. 10,000 as it is the minimum rent decided under the Royalty agreement. Thus, Minimum Rent will assure a guaranteed income per year to lessor. (c) Short Working:- The excess of Minimum Rent over the Actual Royalty is known as short-working. Therefore short-working will only arise when the Actual royalty is less than the Minimum Rent. In the above example as given in Minimum Rent. Short-working for the year will be Rs. 2000 i.e. [M.R. (10,000)- Royalty (8,000)]. (d) Recoupment of short Working:- When the Royalty agreement contains the clause that lessee can recover the

short working of one year from the excess of Royalty as compared to Minimum Rent in the

coming years, it is known as Recoupment of short working.

SCO:209,F.F. Sector-36/D Chandigarh. 0172-4670390,9876149390, 9041394669

ACCOUNTING SOLUTIONS

SCO: 209, First Floor, Sector-36/D. Chandigarh (M): 0172-4670390, 9876149390,9041394669 However, the right of recoupment can be of two types; 1.

Fixed Right

2.

Floating Right.

(1) Fixed Right of Recoupment:- When the lessor promises the lessee to compensate the loss (short working) only for a fixed time period. The right is said to be fixed. For example. If lessor promises to compensate the loss only during the first 4 years, the right is said to be fixed and any unrecouped balance of short-working will be transferred to P & L A/c Any short working arises in some future years cannot be recouped. (2) Floating Right of Recoupment:- When the lessor promises the lessee to compensate the short working of any year in the next two or three years. Then the right is said to be floating. For example, if lessor promises to compensate the (short-working) of any year in coming 2 years. Then shortworking of 3rd year can be recouped in 4th and 5th year and short-working of 8th year in 9th and 10th year. (e) Sub-lease:- When the actual lessee transfers a part of right of asset acquired by him to another person, it is known as situation of sub-lease. In such a case, actual lessee assumes the double position in the whole scenario. He is lessee for actual owner but landlord for the sub-lessee. So, in sub-lease, actual lessee recovers the royalty from sub-lessee on the rate decided between him and sub-lessee and transfer the amount along with his own payment for Royalty to actual owner as per agreement between him and landlord.

Q.

Give Journal Entries in the books of the lessee and lessor (Landlord) in the following cases. (i)

Where no minimum Rent exists; and

(ii)

Where a minimum Rent exists with right of recoupment.

Ans. (i) Where no minimum rent exists: The following are the journal entries in books of lessee and lessor when no minimum rent exists.

JOURNAL ENTRIES (IN BOOKS OF LESSEE) (1) Fro Royalty becoming Due. Royalty A/c

Dr.

To landlord A/c (2) Fro Payment of Royalty Landlord A/c

Dr.

To Bank/Cash A/c

(3) For Transferring Royalty to profit and Loss /Production A/c P & L A/c Production A/c

Dr.

To Royalty A/c

SCO:209,F.F. Sector-36/D Chandigarh. 0172-4670390,9876149390, 9041394669

ACCOUNTING SOLUTIONS

SCO: 209, First Floor, Sector-36/D. Chandigarh (M): 0172-4670390, 9876149390,9041394669 JOURNAL ENTRIES (In Books of Lessor, i.e., landlord) (1) For Royalty Receivable Lessee A/c

Dr.

To Royalty Receivable A/c (2) For Receipt of Royalty Cash/Bank

Dr.

To Lessee (3) For transferring Royalty Receivable to P & L Royalty Receivable A/c

Dr.

To P & L A/c Case (ii) When Minimum Rent exists with right of Recoupment The following are the journal entries in the books of lessee and lessor:

Books of Lessee (A) When Royalty is less than Minimum Rent

(i)

Entries without opening of

Entries with opening of

Minimum Rent A/c

Minimum Rent A/c

Royalty becoming due

(i)

Royalty A/c (Actual Royalty) Dr.

Minimum Rent due:

Minimum Rent A/c

Short-working A/c (Shortage) Dr.

To Landlord A/c

To Landlord A/c (Minimum Rent) (ii)

Payment of Royalty

(ii)

Landlord (minimum Rent)

Dr.

For Royalty Royalty A/c (Actual Royalty) Dr.

To Cash/Bank

Short working A/c (Shortage) Dr. To Minimum Rent A/c

(iii)

Transferring Royalty to P & L or Production P & L A/c Production A/c

(iii)

Payment of Royalty Landlord A/c Dr.

Dr.

To Royalty A/c (Actual Royalty)

To Cash/Bank A/c (iv)

Transferring Royalty to P & L Or Production P & L A/c/Production A/c Dr. To Royalty A/c

(B)

When Royalty is more than Minimum Rent:In such a case there is no need to open the minimum rent Account and the entries are as follows: (i)

Royalty becoming Due: Royalty A/c

Dr.

To Landlord A/c

(Actual Royalty) (Diff. between Actual Royalty And short-working recouped)

To short working A/c (with the Amt. Which can be recouped) (ii)

Payment to Landlord Landlord A/c

Dr.

SCO:209,F.F. Sector-36/D Chandigarh. 0172-4670390,9876149390, 9041394669

ACCOUNTING SOLUTIONS

SCO: 209, First Floor, Sector-36/D. Chandigarh (M): 0172-4670390, 9876149390,9041394669 To Cash/Bank (iii)

Transfer to P & L A/c or Production A/c P & L A/c Production A/c

Dr.

To Royalty A/c (iv)

Transfer of unrecouped short working to P & L: P & L A/c Production A/c

Dr.

To short working A/c For Entry (i) and Entry (ii) following entries can be passed: Royalty A/c

Dr.

(Actual Royalty)

To Landlord A/c Landlord A/c

Dr.

To Cash A/c To short working A/c with the Amt. Which can be recouped) BOOKS OF LESSOR (LANDLORD) (i)

When Royalty is less than Minimum Rent (a) Royalty becoming Due Lessee A/c (Minimum Rent)

Dr.

To Royalty Receivable A/c (Actual) To short-working suspense A/c (shortage) (ii)

Receipt of Royalty Cash/Bank

Dr.

To Lessee A/c (Min Rent) (iii)

Transfer of Royalty Receivable to P & L Royalty Receivable A/c (Actual)

Dr.

To P & L A/c

(B)

When Royalty is more than minimum Rent (i)

Royalty becoming due Lessee A/c (Actual Minus Recouped)

Dr.

Short working Suspense A/c {Recouped Amt.

Dr.

To Royalty Receivable A/c (Actual) (ii)

Receipt of Royalty Cash/Bank A/c

Dr.

To Lessee A/c (iii)

Transfer to P & L Royalty receivable A/c

Dr.

To P & L A/c

SCO:209,F.F. Sector-36/D Chandigarh. 0172-4670390,9876149390, 9041394669

ACCOUNTING SOLUTIONS

SCO: 209, First Floor, Sector-36/D. Chandigarh (M): 0172-4670390, 9876149390,9041394669 (iv)

Amt. of short working no long Recoupable Short working suspense A/c To P & L A/c

DICTINCTION BETWEEN RENT AND ROYALTY: The following are the main distinctions between rent and royalty:

Rent 1. Nature of Assets

It

2. Basis of Payment

It is mostly payable on the basis of time as weekly, monthly or yearly. The amount of rent is generally fixed with regard to time.

3. Fixed or Variable

is the consideration payable for the use of only tangible assets as building, machinery etc.

4. Minimum Rent

There is no concept of minimum rent.

5. Parties

The parties are known as tenant and landlord.

Royalty It

is the consideration payable for the ue of special right for both tangible and intangible assets. (i.e., patents, copy-rights etc.) It is paid on the basis of production, yield or sale. The amount of royalty is variable and is calculated in accordance with production or sales. It generally contains a clause in the agreement to pay minimum rent. The parties are known as lessee/patentee/publishe r and lessor/patent holder/author etc.

STOPPAGE OR WORK DUE TO STRIKE/LOCKOUT/ACCIDENT ETC. Generally minimum rent is fixed taking into consideration the minimum expected output under normal conditions. Whenever there is stoppage of work due to abnormal reasons as strike, lockout, accident or for any other reason, the minimum rent is required to the adjusted as provided for in the agreement. Such agreement may have the following arrangements: (a) Non-application of the condition of minimum rent:- In such a case the clause of minimum rent is not applied. Actual royalties will discharge all rent obligations. There will not be any short workings or surplus. (b) Reduction in the Amount of minimum rent:- If thee is any clause in the agreement, regarding reduction in the amount of minimum rent, it can take the following form. 

The minimum rent is reduced proportionately to the length of the stoppage of work during the relevant year.



The minimum rent can be reduced by a fixed percentage or by a fixed amount is the year of stoppage.

INCOME TAX: If the is a provisions in the income tax law that the payer of royalty should deduct tax at source at the prescribed rate and tax so deducted shall be deposited to the credit of the Central Government within a specified time. The landlord will get the amount of royalty or minimum rent after adjustment of tax. The total amount of royalty (including tax) will be charged to profit & Loss or Production A/c.

SCO:209,F.F. Sector-36/D Chandigarh. 0172-4670390,9876149390, 9041394669