Royalty and Related Terminologies

Royalty is the sum payable by the lessee to the lessor for the use of rights vested in the lessor. It is a periodic payment. Royalty is generally paid on the basis of output or sale. It is paid for extraction of mines, for use of the patent, for use of technical know-how, to an author for sale of his books, etc.

Royalty and Related Terminologies

Lease

It is an agreement where a person acquires a right to use an asset for a certain period of time from another person or the owner of the asset in return for a payment. The owner is known as the Lessor. The user is the Lessee. The amount paid is Royalties

For Example, A has developed a machine that uses less material for production. He also got it patented. Now, B wants to use it. B will have to pay a royalty to A for using the machine. Here, A is the lessor and B is the Lessor.

Browse more Topics under Royalty Accounts

• Accounting Treatment in Books of Lessee
• Accounting Treatment in Books of Lessor

Accounting Treatment of Royalties

For the lessee, royalties are an ordinary business expenditure. Royalty paid on the basis of output is debited to Trading or Manufacturing A/c. Whereas, the royalty paid on the basis of sales is debited to Profit & Loss A/c.

Minimum Rent or Fixed Rent

It is the amount that has to be paid by the lessee to the lessor whether or not he has derived benefit from the asset. Hence, it is also called Dead Rent or Rock Rent. Minimum rent can be a fixed sum for every year or may change every year as per the terms of the agreement.

• When the actual royalty for a year is less than the minimum rent, the lessee will pay the minimum rent to the lessor.
• When the actual royalty for a year is more than the minimum rent, the lessee will pay the actual royalty to the lessor.

Short-workings

It is the excess of Minimum Rent over the Actual Royalty payable. It is calculated only when it is allowed to be adjusted against the future royalties by the lessor. Short-workings = Minimum Rent – Actual Royalty

Recoupment of Short-workings

The right of Recoupment means the right given to the lessee by the lessor to carry-forward and set-off the short-workings from the surplus of royalties over the Minimum Rent. It can be of two types:

1. Fixed Right of Recoupment: When the lessor allows the lessee to adjust the short-workings only for a fixed period of time, it is known as Fixed Right of Recoupment.
2. Floating Right of Recoupment: When the lessor allows the lessee to adjust the short-working of any year in the next two or three years, it is known as the Floating Right of Recoupment.

Solved Example for You

Q: Bee Ltd. took a right to publish and sell books from Smith for 5 years. The minimum rent was fixed at ₹20000. Royalty was fixed at ₹4 per book. Bee Ltd. has a right to recoup the short-workings in the first 4 years. The sales in the 5 years are given. Calculate the Royalty payable and short-workings.

Ans: Calculation of Royalty, Minimum Rent and Short-workings

Computation of Recoupment, Short-workings carried forward and transferred to profit and loss A/c