cmabdtheblogger: Financial Accounting

Financial Accounting

Royalty Accounts

Part A: Discussion of basic theories including (1) Defining “Lessor”, “Lessee” and other important terms related to Royalty Accounts, (2) Formats of Statements Showing Royalties Payable and Receivable, and (3) Journal entries to be made both in the books Lessee and Lessor.

Part B: Three Illustrations with Solutions.

Part A

Introduction

Royalty is paid or payable by a lessee (User of an asset owned by another party) to the lessor (owner of the asset used by the lessee) in return for the right to use the asset owned by the lessor. Here, the assets may be mines, quarries, patent, copyright, etc.

Important terms

Minimum rent

The lessor and the lessee may agree upon a minimum periodical amount that the lessor will receive from the lessee, even if the actual royalty as calculated on the basis of actual production or sale is less than such minimum amount. This assured and mutually agreed periodical minimum amount is known as minimum rent.

Short workings

Short workings are the amount by which the minimum rent exceeds the actual royalty. In other words, it refers to the amount by which the actual royalty falls short of the minimum rent.

Excess workings (or Surplus royalty)

It refers to the amount by which the actual royalty exceeds the minimum rent.

Recoupment of short workings

Generally the royalty agreement contains a provision for carrying forward of short workings with a view to adjust it in the future. In the subsequent years, such short workings are adjusted against the surplus royalty. This process of adjustment is called recoupment of short workings. A time limit is usually set upon the number of years within which such short workings can be recouped. This time limit for recoupment of short workings may be fixed or fluctuating. When such time limit is fixed, short workings can be recouped within a certain period (in number of years) from the date of the lease, as per agreement. On the other hand, when such time limit is fluctuating, short workings of any year can be recouped during the next following year(s), as per agreement. If the short workings (partly or wholly) cannot be recouped within the specified time limit, they lapse and are charged to Profit and Loss Account in the year when that specified time limit for recoupment ends. Therefore, short workings are the losses of the lessee, not in the year of their occurrence, but in the year they lapse.

Note:

The recoupable short workings should be carried forward until the time limit for recoupment of such short workings is expired and they are shown in the Balance Sheet as a current asset.

Journal entries in the books of lessee

(A) WHERE THE ACTUAL ROYALTY < THE MINIMUM RENT

Alternative: I

(Without Minimum Rent A/c)

DT	Particulars		Debit (Rs)	Credit (Rs)
1	Royalties (Payable) A/c	Dr
	Short workings A/c	Dr
	To Lessor A/c
	(Minimum rent – which is greater than actual royalty – payable to the lessor)

2	Lessor A/c	Dr
	To Bank A/c
	To Inc. Tax Payable A/c
	(Minimum rent paid to the lessor after deducting TDS)

3	Profit and Loss A/c	Dr
	To Royalties (Payable) A/c
	(Actual royalties for the current period transferred to P/L A/c)

Alternative: II

(With Minimum Rent A/c)

DT	Particulars		Debit (Rs)	Credit (Rs)
1	Minimum rent A/c	Dr
	To Lessor A/c
	(Minimum rent – which is greater than actual royalty – payable to the lessor)

2	Royalties (Payable) A/c	Dr
	Short workings A/c	Dr
	To Minimum rent A/c
	(Actual royalties and short workings credited to Minimum Rent A/c)

3	Lessor A/c	Dr
	To Bank A/c
	To Inc. Tax Payable A/c
	(Minimum rent paid to the lessor after deducting TDS)

4	Profit and Loss A/c	Dr
	To Royalties (Payable) A/c
	(Actual royalties for the current period transferred to P/L A/c)

Note:

Minimum rent account is opened generally in the year when actual royalty is less than the minimum rent. Minimum rent can be reduced proportionately in the event of a strike or lockout, if there is an agreement between the parties.

(B) WHERE THE ACTUAL ROYALTY > THE MINIMUM RENT

DT	Particulars		Debit (Rs)	Credit (Rs)
1	Royalties (Payable) A/c	Dr
	To Lessor A/c
	(Actual royalties for the period payable to lessor)

2	Lessor A/c	Dr
	To Short workings A/c
	(Short workings, if any, recouped)

3	Lessor A/c	Dr
	To Bank A/c
	To Inc. Tax Payable A/c
	[Higher of Minimum rent and (Actual royalties – S/W recouped) paid to the lessor after deducting TDS]

4	Profit and loss A/c	Dr
	To Short workings A/c
	(Short workings lapsed transferred to P/L A/c)

5	Profit and Loss A/c	Dr
	To Royalties (Payable) A/c
	(Actual royalties for the current period transferred to P/L A/c)

Journal entries in the books of lessor

(A) WHERE THE ACTUAL ROYALTY < THE MINIMUM RENT

DT	Particulars		Debit (Rs)	Credit (Rs)
1	Lessee A/c	Dr
	To Royalties (Receivable) A/c
	To Royalty suspense A/c
	(Minimum rent – which is greater than actual royalty – receivable from lessee)

2	Bank A/c	Dr
	TDS A/c	Dr
	To Lessee A/c
	(Minimum rent received from lessee after deducting TDS)

3	Royalties (Receivable) A/c	Dr
	To Profit and Loss A/c
	(Actual royalties for the current period transferred to P/L A/c)

(B) WHERE THE ACTUAL ROYALTY > THE MINIMUM RENT

DT	Particulars		Debit (Rs)	Credit (Rs)
1	Lessee A/c	Dr
	To Royalties (Receivable) A/c
	(Actual royalties for the period receivable from lessee)

2	Royalty suspense A/c	Dr
	To Lessee A/c
	(Short workings, if any, recouped)

3	Bank A/c	Dr
	TDS A/c	Dr
	To Lessee A/c
	[Higher of Minimum rent and (Actual royalties – S/W recouped) received from lessee after deducting TDS]

4	Royalty suspense A/c	Dr
	To Profit and Loss A/c
	(Short workings lapsed transferred to P/L A/c)

5	Royalties (Receivable) A/c	Dr
	To Profit and Loss A/c
	(Actual royalties for the current period transferred to P/L A/c)

Click here for "Format of Statement Showing Royalties Payable".

Click here for "Format of Statement Showing Royalties Receivable"

Part B

Financial Accounting

Royalty Accounts

Selected Problems

Illustration: 1

The Bihar Coal Co. Ltd. holds a lease of coal mines for a period of twelve years, commencing from 1^st April, 2006. According to the lease, the company is to pay Rs 7.50 as royalty per ton with a minimum rent of Rs 1, 50,000 per year. Short workings can however, be recovered out of the royalty in excess of the minimum rent of the next two years only. For the year of a strike the minimum rent is to be reduced to 60%. The output in tons for the 6 years ending 31^st March, 2012 is as under:

Year	Output (Tons)
2006-07	10,000
2007-08	12,000
2008-09	25,000
2009-10	20,000
2010-11	50,000
2011-12 (strike)	15,000

Required:

a) Prepare the Statement Showing Royalties Payable; and

b) Write up the necessary Ledger Accounts in the books of Bihar Coal Co. Ltd.

Click here for Solution: 1(a) in PDF

Click here for Solution: 1(b) in PDF

Illustration: 2

A Ltd. Obtained from B.S. Ltd. a lease of some coal-bearing land, the terms being a royalty of Rs 15 per ton of coal raised subject to a minimum rent of Rs 75,000 p.a. with a right of recoupment of short-working over the first four years of the lease. From the following details,

a) Prepare the Statement Showing Royalties Payable; and

b) Show (i) Short-working Account, (ii) Royalty Account and (iii) B.S. Ltd. Account in the books of A Ltd.