ACCOUNTANCY FORM SIX TOPIC 5: ACCOUNTING FOR ROYALTIES

 

TOPIC 5: ACCOUNTING FOR ROYALTIES

. Concept of Royalty

. Minimum rate and short workings.

. Accounting entries in the books of lesser / landlord.

. Accounting entries in the books of lessee / tenant.

This is the remuneration payable to a person in respect of the use of an asset, calculated with reference to the quality produced/sold as result of use of such asset.

The loyalty is a periodic payment to the owner of an asset for the use of his ownership right that is royalty is a compensation made to the owner of an asset in exchange for the right to use that asset.

Royalty may arise in respect of the following;

1. a) For the extraction of minerals / materials from the ground.
2. b) For the publishing and books from the permission of the author.
3. c) For the use of the artistic work like movies e.t.c

Any lump sum amount paid for the use of any asset in never called royalty because it is capital payment.

TERMS USED IN THIS TOPIC:

1. i)   Lesser / Land lord:   This is owner of the asset, the person whom the right to use the land is granted is called tenant / lessee.
2. ii)  Short workings: This is the difference between royalty and minimum rent/excess of minimum rent over royalty.

iii)  Minimum rent / dead rent / rock rent / flat rent
Is the guaranteed amount that is landlord or the owner of the copy right is to receive.

1. iv)   Recoupment of a short working; according to the short workings closed or contract, the tenant is empowered to cover the amount paid in excess of actual royalty out of the excess royalty over minimum rent (surplus). Until the stage of recovery is reached , he can accumulate the short workings and when once the stage of surplus is reached, he can go on recovering the excess of minimum rent, and after full recovery , pay the actual royalty. Usually in contracts where there is provision of minimum rent, there is also a provision of equipment of short workings. Generally, recoupment is the right of getting back from the land lord excess payment made by the tenant in the earlier years. The right to recoupment short workings may be either; a.1 fixed b.1 A floating type.

In case of a Fixed right or recoupment of short workings, the right is available only for a fixed period of time.

In case the tenant is not in a position to recoup the short workings during this period, the balance amount will be a loss to him which will be w/o from the profit and loss (P + L) a/c.

Illustration 1

A limited Co. leases a mine at a loyalty of 20/= each pert tone of coal raised which a dead rent for 400,000 per annum and further to recouped short workings during the first five years of the lease. Output during the first five years is as follows;

YEAR	PRODUCTION(TONNES)
1	2500
2	12,000
3	20,000
4	30,000
5	40,000

Required:

Show journal entries and ledger accounts in the books of lessor and lessee

Note: All workings should be shown

                                                   ROYALTY TABLE      

				SHORT WORKING			AMOUNT
YEAR	PRODUCTION	ROYALTY	M/RENT	RESULTED	RECOUPED	W/OFF	PAID
1	2500	50,000	400,000	350,000	–	–	400,000
2	12,000	240,000	400,000	160,000	–	–	400,000
3	20,000	400,000	400,000	–	–	–	400,000
4	30,000	600,000	400,000	–	200,000	–	400,000
5	40,000	800,000	400,000	–	310,000	–	400,000

The following account made in;

1. A) When there is no provision for dividend or minimum rent.
2. i) Royalty based on actual production.

DR: Royalty payable a/c

CR: Land lord’s a/c

1. ii) Cash paid to the land lord.

DR: Land lord a/c

CR: Cash a/c

1. B) When there is provision for minimum rent
2. i) Royalty based on production

DR: Royalty payable a/c

CR: Land lord a/c

1. ii) Short workings to be recovered in Future

DR: Short workings a/c

CR: Landlord a/c

iii) Cash paid to landlord

DR: Landlord a/c

CR: Cash a/c

1. iv) Short working unrecovered (if any)

DR: Profit & loss a/c (Bad debts)

CR: Short workings a/c

1. c) When royalty exceed minimum rent
2. i) Royalty based on actual production

DR: Royalty payable a/c

CR: landlord a/c

1. ii) Short working recouped, if any

DR: Landlord a/c

CR: Short working a/c

iii) Cash paid to landlord

DR; Land lord a/c

CR; cash a/c

Note: Cash paid to landlord must not be less than minimum rent

1. iv) Short workings irrecoverable

DR; profit & loss a/c

CR; short working a/c

Workings:

DR                      ROYALTY PAYABLE ACCOUNT                        CR

DATE	DETAILS	AMOUNT	DATE	DETAILS	AMOUNT
1ST YEAR	A.LTD COY	50,000		Manufacturing a/c	50,000
2ND YEAR	A.LTD COY	240,000		Manufacturing a/c	240,000
3RD YEAR	A.LTD COY	400,000		Manufacturing a/c	400,000
4TH YEAR	A.LTD COY	600,000		manufacturing a/c	600,000
5TH YEAR	A.LTD COY	800,000		Manufacturing a/c	800,000

DR                                         A. LTD’s ACCOUNT                                     CR

DATE	DETAILS	AMOUNT	DATE	DETAILS	AMOUNT
1st year	Bank	400,000	1st year	Royalty payable	50,000
				short workings	350,000
		400,000			400,000
2nd year	Bank	400,000	2nd year	Royalty payable	240,000
				short workings	160,000
		400,000			400,000
3rd year	Bank	400,000	3rd year	Royalty payable	400,000
4th year	Bank	600,000	4th year	Royalty payable	600,000
5th year	Bank	800,000	5th year	Royalty payable	800,000

DR                                           LAND LORD ACCOUNT                                     CR

DATE	DETAILS	AMOUNT	DATE	DETAILS	AMOUNT
2000	Bank	200,000	2000	Royalty payable	100,000
			2000	short workings	100,000
		200,000			200,000
2001	Bank	200,000	2001	Royalty payable	150,000
				short workings	50,000
		200,000		short workings	200,000
2002	Bank	200,000	2002	Royalty payable	200,000
2003	Bank	200,000	2003	Royalty payable	225,000
	short workings	25,000
		225,000			225,000
2004	Bank	200,000	2004	Royalty payable	250,000
	short workings	50,000
		250,000			250,000

       DR                               ROYALTY     RECEIVABLE                                     CR

DATE	DETAILS	AMOUNT	DATE	DETAILS	AMOUNT
2000	Manufacturing a/c	100,000	2000	S.G COY LTD	100,000
2001	Manufacturing a/c	150,000	2001	S.G COY LTD	150,000
2002	Manufacturing a/c	200,000	2002	S.G COY LTD	200,000
2003	Manufacturing a/c	225,000	2003	S.G COY LTD	225,000
2004	Manufacturing a/c	250,000	2004	S.G COY LTD	250,000

DR                       TENANT   ACCOUNT (S.G COY LTD)                                        CR

DATE	DETAILS	AMOUNT	DATE	DETAILS	AMOUNT
2000	Royalty receivable	100,000
	short workings	100,000	2000	Bank	200,000
		200,000			200,000
2001	Royalty receivable	150,000
	short workings	50,000	2001	Bank	200,000
		200,000			200,000
2002	Royalty receivable	200,000	2002	Bank	200,000
2003	Royalty receivable	225,000	2003	Bank	200,000
				short workings	25,000
		225,000			225,000
2004	Royalty receivable	250,000	2004	Bank	200,000
				short workings	50,000
		250,000			250,000

              DR                                 ROYALTY SUSPENSE ACCOUNT                                        CR

DATE	DETAILS	AMOUNT	DATE	DETAILS	AMOUNT
31.12.2000	Balance c/d	100,000	2000	S.G COY LTD	100,000
31.12.2001	Balance c/d	150,000	2001	Balance b/d	100,000
			2001	S.G COY LTD	50,000
		150,000			150,000
31,.12.2002	Balance c/d	150,000	2002	Balance b/d	150,000
	S.G COY LTD	25,000	2003	Balance b/d	150,000
31,12,2003	Balance c/d	125,000
		150,000			150,000
	S.G COY LTD	50,000	2004	Balance b/d	125,000
31.12.2004	Balance c/d	75,000
		125,000			125,000
			2005	Balance b/d	75,000

ILLUSTRATION III;Mr. R Company leased a Royalty from Mr. A of 1 E per tone’s which a minimum rent of 30,000 E.P.A each years of excess of dead rent over royalty is recoverable out of the royalties of the next five (5) years. In the event of strike and the minimum rent not being reached. The lease provided that the actual royalty and for the year should be paid, the result of workings were as follows;

YEARS	PRODUCTION
2001	–
2002	9750
2003	27750
2004	33750
2005	42000
2006	52500
2007	28500
2008	45,000

SUB- LEASE

• The lease agreed sometimes gives right to the lessee to sub contact the right for the use of asset, this is known as “Sub – lease”.
• And the person who is sub – contracted is known as sub lessee / sub tenant.
• The accounting treatment for the sub lease and the lease and the lessee is similar to that of the land lord and sub lease.
• In the case of sub- lease, the lessee takes the legal stand of the land lord to the sub-lessee.
• It must be noted that there is no agreement between the original landlord and the sub- lessee as per the original agreement terms. But what eventually is paid to the original land lord is calculated based on the total output of the both lessee and sub- lessee.
• The lessee is paid based on the output produced or manufactured by sub – tenant.
• In most cases the lessee chargers higher price to the sub-lessee than be is charged to the original landlord. Profit of the such price are transferred to the P + L A/C

ACCOUNTING TREATMENTS:           

1. i) Royalty payable ( own + sub- lessee)

DR: Royalty payable a/c

CR: Land lord’s a/c

1. ii) Royalty receivable a/c (Based on sub – tenant production)

DR: Sub tenant a/c

CR: Royalty receivable a/c

iii) Short working recoverable in future by sub – Lessee

DR: Sub – tenants

CR: Short workings

1. iv) Royalty payable by tenants on sub-tenants production

DR: Royalty Receivable a/c

AC: Royalty payable a/c

1. v) Profit on sub – lease;

DR; Royalty Receivable a/c

CR: P + L a/c

ILLUSTRATION

Doti limited acquired rights from Note ltd to manufacture and sell a certain brand of perfume on the following terms;

1. i)   Royalty shall be paid on number of bottles manufactured at 20/= per bottle /per unit.
2. ii)  The minimum royalty in any one year shall be 500,000/=

iii)Short working will be recouped within the first two year of short workings.

iv)The agreement to become effective on 1^st July 2000.

1. v)  All settlement were made on 31^st December on each year.

On 1^st January 2000, Doti limited granted right to Mwingine Ltd to manufacture and sell the same perfumes on the following terms;

1. a)   Royalty shall be paid on number of bottles manufactured at 30/= per bottle/ per unit.
2. b)   The minimum royalty in any one year shall be 200,000/=
3. c)   Short working recouped only in the year

Following the year of short workings.

The following information is provided;

YEARS	DOTI LTD	MWINGINE LTD
2000	80,000	–
2001	11,000	6000
2002	14,000	7000
2003	16,000	11,000
2004	12,000	5000

Required;

Show ledger account in the books of Doti LTD.

                          ROYALTY TABLE       (i)       ORIGINAL LEASE

YEARS	PRODCTN	ROYALTY	M.RENT	SHORTWORKINGS			AMOUNT
				RESULTED	RECOUPED	W/OFF	PAID
2000	8000	160,000	500,000	340,000	–	–	500,000
2001	17,000	340,000	500,000	160,000	–	–	500,000
2002	21,000	420,000	500,000
2003	27,000	540,000	500,000		40,000	40,000
2004	17,000	340,000	500,000	160,000	–	160,000	500,000

                                               ROYALTY TABLE       (ii)

YEARS	PRODCTN	ROYALTY	M.RENT	SHORTWORKINGS			AMOUNT
				RESULTED	RECOUPED	W/OFF	PAID
2000	–	–	200,000				200,000
2001	6000	180,000	200,000	20000		20,000	200,000
2002	7000	210,000	200,000		10,000	10,000	200,000
2003	11,000	330,000	200,000		130,000
2004	5000	150,000	200,000

Profit on sub- lease:

Royalty payable       –    20/=

Royalty receivable   –     30/=

10/=

2001 : 6000 x 10 = 60,000

2002: 7000 x 10 = 70,000

2003: 11000 x 10 = 110,000

2004: 5000 x 10 = 50,000

READ TOPIC 6

...