Friday, April 13, 2012

Royalty accounts

Introduction:
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 out put 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:
S.N.
Royalty
Rent
1.                    
Royalty is the consideration payable for the use of special right for both tangible and intangible assets.
But rent is the consideration payable for the use of only tangible assets.
2.                    
Royalty is paid either on the basis of output or sale.
Rent is paid on the basis of period.
3.                    
Royalty varies on the basis of output or sales.
Rent is fixed.
4.                    
Royalty agreement normally contains a clause to pay a minimum rent.
But in rent, there is no concept of minimum rent.
5.                    
Parties are known as lessor and lessee.
Parties are known as tenant and landlord.

Minimum 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
Sl. No.
Circumstances
Royalties are less then the minimum rent
Royalties are more then the minimum rent
01
For Royalty payable  
Royalties a/c                    Dr
Short working a/c            Dr
                  To Land lord a/c
Royalties a/c                     Dr
             To Short working a/c
             To Land lord a/c
02
For payment of royalty
Land lord a/c     Dr
To Bank a/c
03
For transfer of royalty
Profit and loss a/c      Dr
To Royalty a/c
In case short working is not completely recovered (non-recovery of short working)
04
For transfer of short-working
Profit and loss a/c                Dr
               To Short working a/c  

b)      With minimum rent account is opened
Sl. No.
Circumstances
Royalties are less then the minimum rent
Royalties are more then the minimum rent
01
For minimum rent payable
Minimum rent a/c        Dr
               To land lord a/c
No entry
02
For Royalty payable 
Royalties a/c                     Dr
Short working a/c              Dr
To minimum rent  a/c
03
For payment of royalty
Land lord a/c       Dr
To Bank a/c
04
For transfer of royalty
Profit and loss a/c   Dr
To Royalty a/c
In case short working is not completely recovered (non-recovery of short working)
05
For transfer of short-working
Profit and loss a/c            Dr
            To Short working a/c  

Accounting entries in the books of lessor
 Sl. No.
Circumstances
Royalties are less then the minimum rent
Royalties are more then the minimum rent
01
For Royalty receivable  
 Lessee’s a/c Dr
    To Short working suspense a/c
    To Royalties receivable a/c 
 Lessee’s a/c Dr
 Short working suspense a/c Dr
       To Royalties receivable a/c  
02
For receipt of royalty
Bank a/c             Dr
To Lessee’s a/c
03
For transfer of royalty
Royalty receivable a/c    Dr
To Profit and loss a/c
In case short working is not completely recovered (non-recovery of short working)
04
For transfer of short-working
Short working suspense a/c      Dr
To Profit and loss a/c

Table analysis
Year
Output
Minimum rent
Royalty
Short working
Short working recovered
Short working not-recovered
Amount paid to landlord
01
02
03
04
05
06
07
08




(3-4=5)
(4-3=6)
(5-6=7)
(4+5=8)
or
(4-6=8)

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.