Royalty Accounts Explained: Key Features and Best Practices

 Royalty Account

Royalty is a consideration earned for the right to use certain types of property or assets belonging to another person. It may be earned for the right to extract coal, minerals, or stones from a mine, for the use of a patent, or for publishing books. The owner of such rights is called the lessor (or landlord), and the person who pays the royalty is known as the lessee. Royalty payments are generally based on output or sales.

Royalty represents the remuneration payable to a person for the use of an asset whether hired or purchased calculated with reference to, and varying with, the quantity produced or sold due to the use of that asset. Examples include royalties from a mine, oil well, patent, or copyright.

For example, Mr. A is the owner or lessor, and Mr. B is the lessee who pays royalty to Mr. A for the right to use an asset.

Royalty is a periodical payment based on output or sales, made by the lessee to the lessor for acquiring certain special rights. For instance, the periodic consideration based on the quantity of minerals extracted, books sold, or patented articles produced and sold.

Nature of Royalty Account:

1. Royalty is a nominal account.
2. For the lessee, royalty is an expense.
• If it is based on output, it is treated as a manufacturing expense and transferred to the Production/Trading Account.
• If it is based on sales, it is treated as a selling expense and transferred to the Profit & Loss Account.
3. For the lessor, royalty is an income, and therefore it is credited to the lessor’s account.

Definition (J.R. Batliboi):

“The term royalty expresses an amount payable by one person in return for some special right or privilege conceded to him by another person, such as the right to publish a book, to manufacture and sell a patented article, or to work on a mine.”

Royalty vs Rent

Definition

1. Rent is payable for the use of tangible assets, such as land, buildings, or plant and machinery.
2. Royalty is the consideration payable to the owner for the use of special rights attached to tangible or intangible assets.

Basis of Payment

1. Rent is usually paid according to time per year, per month, per week, or per day.
2. Royalty is generally paid based on production or sales, such as per ton, per unit, or per article.

Types of Royalty

Royalty can be earned on various types of property. Based on the nature of the property or rights involved, royalty may be classified as follows:

1. Mining Royalty Royalty payable for the right to extract coal, minerals, stones, or other natural resources from a mine or quarry.
2. Patent Royalty When the inventor of a patent grants another person the right to use the patent and charges a consideration, it is known as patent royalty.
3. Copyright Royalty When an author grants publishing rights to a publisher and receives payment based on the number of books sold, the amount received is called copyright royalty.
4. Brick-Making Royalty When a brick-making entity leases land specifically for brick production, the payment made for this right is termed brick royalty.
5. Oil Well Royalty Royalty paid by an oil-extracting company to the owner of the oil well for the right to extract crude oil.
6. Technical Royalty Royalty paid for the use of new technology, specialised equipment, or unique technical know-how.
7. Trademark Royalty Royalty paid for the right to use a specific trademark or brand name.

Important Terms in royalty 

1. Landlord or Lessor

The lessor is the owner of the property who grants special rights to another person for using the property and receives royalty in return.

2. Lessee

The lessee is the person who pays royalty to acquire the special right to use the property belonging to the lessor.

3. Minimum Rent / Fixed Rent / Dead Rent / Flat Rent / Contract Rent

Minimum Rent is the minimum guaranteed amount that the lessor agrees to accept from the lessee in any year, regardless of the level of production or sales.

• Royalty is calculated based on output or sales.
• However, the lessor wants protection against low production in the early years.
• Therefore, the lessee must pay whichever is higher:
• Actual Royalty, or
• Minimum Rent

Purpose: To ensure the lessor does not suffer a loss when output is low.

Example:

Minimum Rent = ₹50,000

Actual Royalty (based on production) = ₹40,000

Short working = ₹50,000 – ₹40,000 = ₹10,000

Key Points:

• Minimum Rent is pre-decided and mutually agreed.
• Generally applied in the initial years when production is usually low.
• If actual royalty exceeds minimum rent, only royalty is paid.

4. Short working

Short working is the excess of Minimum Rent over Actual Royalty.

It arises when:

• Production or sales are low
• Actual Royalty < Minimum Rent

Formula: Short working = Minimum Rent – Royalty

Consequences:

• Lessee still pays the Minimum Rent
• The difference becomes Short working

5. Recoupment of Short working

Recoupment of Short working refers to recovering past short working from future years’ surplus royalty.

When Minimum Rent > Royalty, the lessee incurs a short working (loss).

To compensate for this, agreements often include a clause allowing the lessee to recoup short working in future years when:

• Actual Royalty exceeds Minimum Rent (called surplus royalty)

Meaning: The extra amount of royalty paid in future years is used to adjust the earlier short working.

Simple Explanation: If you paid extra in the past (minimum rent), you can recover that extra amount from the future year's extra royalty.

Journal Entries Under Different Circumstances in Royalty

Royalty transactions occur in three situations:

1. when royalty < minimum rent 
2. when royalty > minimum rent
3. when royalty = minimum rent

A. When royalty is less than minimum rent, the following entries will be made: 

Suppose the amount of royalty is ₹30,000 while the amount of minimum rent is ₹35,000.

(i)  When royalty is payable:

Royalty A/c                      Dr.     30,000

Short workings A/c                Dr.      5,000

        To Landlord’s A/c                       35,000

(For amount of royalty and short workings due)

(ii) When payment is made:

Landlord’s A/c                   Dr.     35,000

        To Cash/Bank A/c                        35,000

(For minimum rent paid to landlord)

(iii) For closing of royalty account at the end of year:

Profit & Loss A/c / Profit and Loss Statement     Dr.     30,000

        To Royalty A/c                                      30,000

(For royalty A/c closed by transferring it to P & L a/c or P/L statement)

B. When the royalty is equal to minimum rent, the following entries will be made: 

Suppose the amount of royalty is ₹35,000 while the minimum rent is also ₹35,000.

(i) When royalty is payable:

Royalty A/c                           Dr.      35,000

        To Landlord’s A/c                                35,000

(For royalty due to landlord)

(ii) When payment is made:

Landlord’s A/c                        Dr.      35,000

        To Cash or Bank A/c                              35,000

(For royalty paid to landlord)

(iii) For closing of royalty account at the end of year:

Profit & Loss A/c / Profit and Loss Statement    Dr.      35,000

        To Royalty A/c                                         35,000

(For royalty a/c closed by transferring it to P & L A/c / P/L Statement)

C. When the royalty is more than minimum rent, the following entries will be made: 

Suppose the amount of royalty is ₹50,000 while the amount of minimum rent is ₹35,000.

(i) When royalty is payable:

Royalty A/c                                 Dr.      50,000

        To Landlord’s A/c                                     50,000

(For royalty due to landlord)

(ii) When payment made and short working recouped:

Landlord’s A/c                              Dr.      50,000

        To Cash A/c                                         35,000

        To Short workings A/c                                15,000

(For royalty paid to landlord and short working recouped)

(iii) For closing of royalty account at the end of year:

Profit & Loss A/c / Profit and Loss Statement    Dr.      50,000

        To Royalty A/c                                         50,000

(For royalty a/c closed by transferring it to P & L A/c / P/L statement)

(iv) For closing of irrecoverable short workings (if any):

Profit & Loss A/c / Profit and Loss Statement    Dr.

        To Short working’s A/c

(For unrecouped short working’s transferred to P & L A/c / P/L Statement)

Illustration 

Bharat Coal Co took a coal mine on lease from Raghav Coal Co. for 20 years from 1st April, 2004 on a royalty of 80 paisa per ton. The minimum rent was fixed at ₹10,000 per annum with power to recoup short working over the first four years of the lease.

The output was as follows:

Year	2004–05	2005–06	2006–07	2007–08	2008–09
Tonnes	4,000	7,500	15,000	20,000	30,000

Draft journal entries and show the necessary ledger accounts in the books of the lessee. Accounts are closed on 31st March every year.

Solution

Calculation Table

Year	Output in Tonnes	Royalties @ 80 paisa per ton	Minimum Rent	Short workings	Surplus	Short workings recouped out of Surplus	Unrecouped Short working transferred to P & L A/c	Amount paid to Landlord
2004–05	4,000	3,200	10,000	6,800	–	–	–	10,000
2005–06	7,500	6,000	10,000	4,000	–	–	–	10,000
2006–07	15,000	12,000	10,000	–	2,000	2,000	–	10,000
2007–08	20,000	16,000	10,000	–	6,000	6,000	2,800	10,000
2008–09	30,000	24,000	10,000	–	–	–	–	24,000

In the Books of Bharat Coal Co. (Lessee)

Journal

Date: 2005 – March 31

Royalties A/c ...................................................... Dr. 3,200

Shortworkings A/c ............................................. Dr. 6,800

 To Raghav Coal Co. ..................................................... 10,000

(For royalties & shortworking due)

March 31

Raghav Coal Co. .............................................. Dr. 10,000

 To Cash A/c ................................................................. 10,000

(For minimum rent paid to landlord)

March 31

Profit & Loss Statement ................................... Dr. 3,200

 To Royalties A/c ......................................................... 3,200

(For royalties transferred to P & L statement)

Date: 2006 – March 31

Royalties A/c ...................................................... Dr. 6,000

Shortworkings A/c ............................................. Dr. 4,000

 To Raghav Coal Co. ..................................................... 10,000

(For royalties & shortworking due)

March 31

Raghav Coal Co. ............................................. Dr. 10,000

 To Cash A/c ................................................................. 10,000

(For minimum rent paid to landlord)

March 31

Profit and Loss Statement .............................. Dr. 6,000

 To Royalties A/c ......................................................... 6,000

(For royalties transferred to P & L statement)

2007

March 31

Royalties A/c ...................................................... Dr. 12,000

 To Raghav Coal Co. .................................................... 12,000

(For royalties due)

March 31

Raghav Coal Co. ............................................. Dr. 12,000

 To Cash A/c ................................................................. 10,000

 To Shortworkings A/c .................................................. 2,000

(For minimum rent paid and shortworking recouped)

March 31

Profit & Loss Statement .................................... Dr. 12,000

 To Royalties A/c ......................................................... 12,000

(For royalties transferred to P & L statement)

2008

March 31

Royalties A/c ...................................................... Dr. 16,000

 To Raghav Coal Co. .................................................... 16,000

(For royalties due)

March 31

Raghav Coal Co. ............................................. Dr. 16,000

 To Cash A/c ................................................................ 10,000

 To Shortworkings A/c .................................................. 6,000

(For minimum rent paid and shortworking recouped)

March 31

Profit & Loss Statement .................................... Dr. 18,800

 To Royalties A/c ......................................................... 16,000

 To Shortworkings A/c .................................................. 2,800

(For royalties and unrecovered shortworking transferred to Profit and Loss statement)

2009

March 31

Royalties A/c ...................................................... Dr. 24,000

 To Raghav Coal Co. .................................................... 24,000

(For royalties due)

March 31

Raghav Coal Co. ............................................. Dr. 24,000

 To Cash A/c ................................................................ 24,000

(For royalties paid to landlord)

March 31

Profit & Loss Statement .................................... Dr. 24,000

 To Royalties A/c ......................................................... 24,000

(For royalties transferred to P & L statement)

Royalties Account

Year	Date	Particulars (Dr.)	Amount (₹)	Particulars (Cr.)	Amount (₹)
2005	March 31	To Raghav Coal Co.	3,200	By Profit & Loss A/c	3,200
2006	March 31	To Raghav Coal Co.	6,000	By Profit & Loss A/c	6,000
2007	March 31	To Raghav Coal Co.	12,000	By Profit & Loss A/c	12,000
2008	March 31	To Raghav Coal Co.	16,000	By Profit & Loss A/c	16,000
2009	March 31	To Raghav Coal Co.	24,000	By Profit & Loss A/c	24,000

Related Posts

Previous

Next