Royalty Accounts

In business, it's normal for people or firms to use other people's intellectual property or resources. These deals generally entail a royalty, which is a periodical payment made by one party (the user) to another (the owner) for utilizing their asset. For example, using land for mining, publishing a blockbuster novel, or making a patented design. Accountants utilize a separate ledger called the Royalty Account to keep track of these kinds of transactions. This blog talks about what royalty accounts are, the many varieties, how to make diary entries, and why they are important in real life.

What is Royalty?

A royalty is a payment made by one party (the lessee or licensee) to another (the lessor or licensor) for the right to use an asset, which is usually intellectual property, natural resources, trademarks, or patents. These payments are usually made on a regular basis and are based on output, sales, or use.

Here are some examples of royalty agreements:

• A publisher pays an author dependent on how many books they sell.
• A business paying to be able to take minerals from land it rents.
• A company that uses patented technologies in its production process.

What does it Mean to Have a Royalty Account?

A Royalty Account is a book that keeps track of all transactions that have to do with royalty revenue or expenses. It helps keep track of the amount owed, any minimum guaranteed amounts (if any), shortworkings, and actual payments.

Three main stakeholders are frequently involved in royalty transactions:

• Landlord or licensor, who owns the rights.
• Tenant or licensee: who uses the rights.
• The receiver (the owner most of the time) is the one who gets the royalty.

Royalty accounting has two parts:

• Royalty Receivable Account: for the person who gets royalties.
• Royalty Payable Account: for the person who pays the royalties.

Accounting Treatment for Royalty Account

The royalty transactions are usually recorded in the following manner:

For the Licensee (User/Lessee)

• When the royalty is due:

 

Royalty Account                                 Dr.  To landlord’s account

 

• When shortworkings arise:

 

Shortworkings Account                        Dr. To Landlord's account

• When royalty is paid: 

 

Landlord’s account                            Dr. To Bank/Cash account

• When shortworkings are recouped: 

 

Landlord’s Account                           Dr. To Shortworkings Account

For the Landlord (Owner)

• When the royalty is earned:

 

Bank/Cash Account                          Dr.  To Lessee’s Account

 

Key Concepts in Royalty Accounting

If you work in an industry where intellectual property, natural resources, or usage rights are involved, the Royalty Account is an important aspect of your accounting. Royalty agreements for publishing, mining, software, or licensing a brand name need thorough accounting to make sure that everything is clear, fair, and in line with the terms of the deal. Students and professionals who understand this topic will be able to handle complicated contracts and journal entries with ease.

Minimum Rent or Dead Rent

This is the least amount of money that is guaranteed, even if the real royalty (based on sales or output) is smaller. The user has to pay this minimum amount so that the owner will always have money coming in.

Shortworking

Shortworkings are the difference between the actual royalty and the minimum rent. If output or sales go over the minimum level in the future, this money may be paid back.

Getting back shortworkings

Shortworkings can be changed in the future if the royalty is more than the minimum rent in some agreements. This benefit normally only lasts for a certain amount of time (2–3 years).

Shortworkings that have ended

If the licensee doesn't get the shortworking back within the time limit, it becomes a permanent loss.

For example: Royalty on Mining Coal

If a mining business rents land from the government, it commits to: Pay ₹50 per ton of coal mined,

• With a rent of at least ₹1,00,000 per year,
• And shortworking recoupment was allowed for two years.

Output during the first year: 1,500 tons x ₹50 = ₹75,000

Since the actual royalty is less than the required rent (₹1,00,000), Shortworking is ₹25,000.

Royalty transactions In books:

• Debit Royalty A/c ₹75,000
• Debit Shortworkings A/c ₹25,000
• Credit Landlord A/c ₹1,00,000

If the royalty goes over ₹1,00,000 in the next two years, the corporation can get back the ₹25,000 it didn't earn, as long as the agreement allows it.

 

Did you know? The idea of royalty goes back a long way. The name "royalty" comes from the money that was paid to kings and queens for giving people the right to exploit valuable minerals or use specified regions. Governments still get royalties from mining companies that take resources from the country.

 

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Frequently Asked Questions (FAQs)

Is royalty a cost or an income?

It depends on the party:

• The licensee or user has to pay royalties.
• For the owner or licensor, there is money coming in.

What will happen if there is no production?

The licensee must still pay the required amount of rent, even if there is no production, if the agreement has a minimum rent clause. However, there may be exceptions listed in the contract.

Do royalties have to pay taxes?

Yes. In most places, the person who gets the royalty money has to pay taxes on it. Under some tax laws, the payer may be able to deduct the royalty they paid as a business expense.