ROYALTY ACCOUNT

Royalty is a consideration received by business entities or individuals who sell their creations to a
third party for use. Typically, royalty is considered to be synonymous with rent, however, its
concept and application vary completely.

Although, the user of asset pays consideration to the owner for using the owner’s asset both in the
case of acquiring a property on rent or a book for publishing. However, royalty is different from
the rent paid by the user.

Where rent is paid for using tangible assets like building, machinery etc, royalty is paid for using
intangible assets or availing special rights such as patents, copyright, mines etc.

Furthermore, the amount of rent paid by the user is fixed. Whereas royalty paid by the user to the
owner varies based on the number of goods produced or sold.

Royalty Meaning in Accounting

Royalty is nothing but a periodical payment made by the user of the asset to the owner or the
creator of such an asset for its use. In other words, the owner/author of the asset such as mine,
patent, book, artistic work etc. may allow the third party like a licensee, publisher etc to use its
creation in exchange of consideration.

Thus, such a payment made by the user to the owner is known as Royalty. Furthermore, the
consideration paid instead of using the asset of the owner is determined in terms of the number of
items produced or sold.

Parties in Royalties Accounting

• Lessor
The person who creates or owns the asset and provides the right to use such an asset to the third
party is known as the lessor or the landlord. Furthermore, lessor receives consideration from the
third party for using the rights to use his asset. Examples of lessors include the owner of the mine
or quarry, author of a book, artist in case of a music composition etc.

• Lessee
Lessee is the person who uses the asset of the creator or the owner in lieu of consideration for
using such an asset. Examples of Lessees include publishers, miners etc.

Types of Royalties in Accounts

 There are following types of royalties in accounting. These include:

• Copyrights
Copyright provides the right to the author or owner of assets like book, artwork, music composition
etc. to claim royalty from the publisher. Therefore, publishers pay copyright royalty to the author
based on sales made by the publishers.

• Patent Royalty
Patent Royalty is paid by the user to the owner based on the number of items produced.

• Mining Royalty
In the case of Mining Royalty, the user or the lessee pays a royalty to the owner or the lessor based
on the output produced.

Therefore, in the case of a patent or a copyright, the publisher pays a royalty to the author based
on the number of book copies sold. In other words, the holder of the patent or copyright receives
a royalty based on the number of items sold by the user. Whereas, in the case of mining, the royalty
is received by the owner of the mine based on the number of items produced by the user.

Important Terms in Royalties Accounting

• Minimum Rent
As mentioned above, the lessor enters into contact or an agreement with the lessee for the payment
of royalty. This royalty is determined based on the number of goods produced or the quantum of
goods sold.

Now, there can be cases when the number of goods produced or sold is nill or relatively low. In
such a case, the lessor would receive no or little royalty directly impacting lessor’s royalty income.

In other words, when there is no or little production or sale, the lessor would be at a loss since no
or less amount of royalty would be received from the lessee. This is despite lessee using the asset.

To get rid of such a situation, the lessor requires a minimum amount of payment to be paid by the
lessee irrespective of the number of goods produced or sold by the lessee.

That is, the lessee is required to pay a minimum amount to the lessor. This is even though the
actual royalty amount, which is calculated based on the items produced or sold, is less than the
minimum rent to be paid.

Such a guaranteed minimum amount so received by the lessor is called the minimum rent.
Minimum rent is fixed at the time when the lessor enters into an agreement with the lessee.
 It is a term included in the contract in the interest of the landlord as it assures minimum rent even
in cases of lower sales or output. Therefore, the lessee pays minimum rent or the actual royalty
amount, whichever is higher.

Since the amount of minimum rent to be paid is fixed, it is also known as Fixed Rent or Dead Rent.
This can, however, vary depending upon the terms of the agreement.
For example, say the output produced by Mine A is 4,000 tons. The royalty to be paid by the lessee
is Rs 100 per ton and the minimum rent in the agreement is Rs 5 Lakhs.

As per production, the actual royalty amount to be paid comes at Rs 4 Lakhs. Since the actual
royalty amount is less than the minimum rent, the lessee is required to pay a minimum rent of Rs
5 Lakhs to the Lessor.

• Short Workings or Redeemable Dead Rent

Short Workings is nothing but the amount by which the minimum rent is more than the actual
royalty. In other words, short workings are the difference between minimum rent and actual
royalty.

In the example above, the Short Workings amount to Rs 1 Lakh (5 Lakh – 4 Lakh). It must be
noted that Short Workings comes into picture only when the clause of minimum rent is included
in the agreement.

• Excess Working
Excess Working is nothing but the amount by which Actual Royalty is more than the minimum
rent.

Say for instance, in the example above, the output produced is 6000 tons. Accordingly, excess
working comes out to be Rs 2 Lakhs (6 Lakh – 4 Lakh).

• Recoupment of Short Workings

Typically, the agreement entered by the lessor and the lessee under Royalty Accounting provides
for a provision. This provision allows carrying forward of short workings in order to adjust the
same in future.

Therefore, in the following years, Short Workings is adjusted against the excess royalty amount.
Such a process of adjusting Short Working capital is known as recoupment of Short Workings.

In other words, the clause of recoupment in Royalty Agreement provides the right to the lessee to
recover the excess payment made by him to the lessor for complying with the clause of minimum
rent in the previous years.
 Furthermore, a time period is stipulated in the agreement. Such a period lays down the number of
years during which Short Workings can be recouped or recovered by the lessee. This time period
can be fixed or fluctuating.

In cases where the lessee fails to recover the Short Workings within the stipulated time, the Short
Working's lapse and is debited to the P&L Account for the period in which the recoupment lapses.

• Fixed Right
Fixed Right means that the lessee can recover short working from the lessor within a particular
time period from the date of the lease of the asset.

For instance, as per fixed right, say the lessee can recover Short Workings within 2 years from the
date of the lease. In case he fails to do so, the recoupment lapses or ends.

• Fluctuating Right
Under Fluctuating Right, the lessee can recover Short Workings for any period during the
subsequent period or periods. For instance, Short Workings of the previous year can be recovered
in the subsequent year.

• Strike and Lockout

There can be cases where a strike or a lockout takes place during the period of the Royalty Contract.
Thus, the Royalty Agreement can provide for a provision that the minimum rent would be reduced
proportionately in case a strike or a lockout takes place.

Royalties Accounting Treatment

There can be three types of circumstances in which both the lessor and the lessee would be required
to pass journal entries. Let’s understand Royalties Accounting Treatment with the help of an
example.

Royalties Accounting Example

Zen is the owner of Mine A located in Gujarat. He enters into a Royalty Agreement with Kapoor
Ltd. As per the agreement, the Minimum Rent is Rs 5,00,000 and the Royalty amount to be paid
is Rs 100 per ton of production every month. The output in various years is as follows:

• 2017 – 4000 tons

• 2018 – 5000 tons
• 2019 – 6000 tons

1. Royalties Accounting Entries in Books of Lessee

• Case-I: When Minimum Rent Exceeds Actual Royalty Amount (2017)
1. When Royalty is Due

Royalties A/c Dr 4,00,000

Short Workings A/c Dr 1,00,000

To Zen A/c 5,00,000

(Being Royalty and Short Workings due to Zen)

2. Entry for Making Payment

Zen A/c Dr 5,00,000

To Cash/Bank A/c 5,00,000

(Being cash paid to Zen)

3. Closing Entry at the Year-End

P&L A/c Dr 5,00,000

To Royalty A/c 5,00,000

(Being Royalty transferred to P&L A/c)

• Case-II: When Minimum Rent Equals Actual Royalty Amount (2018)
1. When Royalty is Due

Royalties A/c Dr 5,00,000

To Zen A/c 5,00,000

(Being Royalty due to Zen)

2. Entry for Making Payment

Zen A/c Dr 5,00,000

To Cash/Bank A/c 5,00,000

(Being cash paid to Zen)

3. Closing Entry at the Year-End
 P&L A/c Dr 5,00,000

To Royalty A/c 5,00,000

(Being Royalty transferred to P&L A/c)

• Case III: When Actual Royalty Amount is More Than Minimum Rent and Short Working is
Recouped (2019)
1. When Royalty is Due

Royalties A/c Dr 6,00,000

To Zen A/c 6,00,000

(Being Royalty due to Zen)

2. Entry for Making Payment and Recouping Short Working

Zen A/c Dr 6,00,000

To Cash/Bank A/c 5,00,000

To Short Working A/c 1,00,000

(Being cash paid to Zen and Short Working Recouped)

3. Closing Entry at the Year-End and Short Working Unrecouped

P&L A/c Dr 6,00,000

To Royalty A/c 5,00,000

To Short Working A/c 1,00,000

(Being Royalty and Short Working transferred to P&L A/c)

As per the terms of the agreement, Short Workings can be recovered in the year in which actual
royalty exceeds minimum rent. In case, lessee fails to recover Short Working in a specific period,
it becomes irrevocable and is charged to P&L in the year in which the Short Working recoup
lapses.
 On the other hand, Short Working that can be recovered must be carried forward and shown as a
current asset in the balance sheet.

2. Royalties Accounting Entries in Books of Lessor

• Case-I: When Minimum Rent Exceeds Actual Royalty Amount (2017)
1. When Royalty is Due

Kapoor Ltd 5,00,000

To Royalties A/c 4,00,000

To Short Workings A/c 1,00,000

(Being Royalty and Short Workings to be received from Kapoor Ltd)

2. Entry for Making Payment

Cash/Bank A/c Dr 5,00,000

To Kapoor Ltd 5,00,000

(Being cash received from Kapoor Ltd)

3. Closing Entry at the Year-End

Royalty A/c Dr 5,00,000

To P&L A/c 5,00,000

(Being Royalty credited to P&L A/c)

• Case-II: When Minimum Rent Equals Actual Royalty Amount (2018)
1. When Royalty is Due

Kapoor Ltd 5,00,000

To Royalties A/c 5,00,000

(Being Royalty received from Kapoor Ltd)

2. Entry for Making Payment

Cash/Bank A/c Dr 5,00,000

 To Kapoor Ltd 5,00,000

(Being cash received from Kapoor Ltd)

3. Closing Entry at the Year-End

Royalty A/c Dr 5,00,000

To P&L A/c 5,00,000

(Being Royalty credited to P&L A/c)

• Case III: When Actual Royalty Amount is More Than Minimum Rent and Short Working is
Recouped (2019)
1. When Royalty is Due

Kapoor Ltd 6,00,000

To Royalties A/c 6,00,000

(Being Royalty received from Kapoor Ltd)

2. Entry for Making Payment and Recouping Short Working

Cash/Bank A/c Dr 5,00,000

Short Working A/c Dr 1,00,000

To Kapoor Ltd 6,00,000

(Being cash received from Kapoor Ltd and Short Working Recouped)
3. Closing Entry at the Year-End and Short Working Unrecouped

Royalty A/c Dr 5,00,000

Short Working A/c Dr 1,00,000

To P&L A/c 6,00,000

(Being Royalty credited to P&L A/c and Short Working transferred)