What is Royalty?
Royalty can be defined as a proper and periodic payment that is made by one person to another in order to use the right to some resources. There are two different sides to royalty. The person who is responsible for providing the right for using the resource is known as the lessor. The person who is responsible for the use of the resource by making the payment is known as the lessee. In these notes about royalty accounts, students will be able to learn what these are and what the significance of royalty is.
Royalty in Terms of Accounting
When it comes to deciding royalty meaning in accounting, it can be said that royalty is basically what the lessee is supposed to pay to the lessor in order to use the rights or resources which are provided by them. These resources might include some rights, franchises, copyrights, or some of the other assets of a similar kind. Royalty meaning in accounts is a really important topic for students to understand so that they can get the basics correct in order to score good marks in the examination.
Most students have the question that a royalty account is which type of account. Well, it is technically a nominal account. The system of having to share certain revenues that occurs between the lessor and the lessee can be formally defined as royalty. Hence, this can answer the question that students have about royalty is which type of account.
Some Basic Terminologies Related to Royalty Accounts
After understanding the meaning of a royalty account it is important to understand some basic terminologies related to them. Here are some terminologies of royalty accounting treatment.
What is a Lease?
A lease is basically an agreement that is made between two people. Here one person will acquire the particular rights to use certain assets for a particular time period from someone else. This person is basically the asset’s owner and will require some sort of payment. The owner is called the Lessor and the person who takes the right to the asset is called the lessee. In the royalty account notes, there is often a mention of the lease which is made between two people. The amount which is to be paid to the lessor on behalf of the lessee is known as Royalties.
Different Treatments of The Royalties in Accounting
Now we are proceeding towards the discussion of the treatment of royalty in final accounts. When it comes to that, there are certain aspects that students need to know about. We can say that in the case of the lessee, royalty in final accounts is basically just an expenditure made normally. The royalties which are paid on a proper basis of the output will be provided to the Manufacturing or Trading Account. However, when it comes to paying the royalties on a sales basis, the amount would be debited to the Profit & Loss Account. In the notes, students will also get to know about different types of royalty accounts, so you need to read all of this very carefully.
Fixed Rent or Dead Rent
This can be defined as a minimum amount that the lessee has to pay to the lessor inevitably whether or not they have been able to make proper use of the asset. It is also known as the Minimum Rent or Rock Rent. Dead rent is almost fixed every single year and there can be a few different changes when it comes to the agreement made between the lessor and the lessee. There can be two different scenarios when it comes to the Minimum Rent.
In case the value of Actual Royalty that is set for a year comes out less than what the minimum rent is supposed to be, then the lessor will be paid the minimum rent from the lessee
In case the value of Actual Royalty that is set for a year comes out more than what the minimum rent is supposed to be, then the lessor will be paid the actual royalty from the lessee.
What is Short working in a Royalty Account?
Well, Short working in Royalty accounts can be defined as the particular amount by which the Dead Rent or the Minimum Rent becomes more than the Actual Royalty which is to be paid. It can be calculated by finding out the difference between the actual Royalty and the Minimum Rent.
What Are the Other Important Terms in Royalty Accounting?
Excess Workings: It is the amount by which the actual royalty is more than the minimum rent.
Fixed Right: This means that the lessee can recover short workings from the lessor only within a stipulated time period from the date of lease of the asset. If a lessee fails to recover short workings, within the stipulated time period, the recoupment lapses or ends.
Fluctuating Right: Under fluctuating right, the lessee can recover Short Workings for a certain period of time during the subsequent period or periods. For example, Short Workings of the previous year can be recovered in the following year.
Performance Royalty: The owner of copyrighted music will get an amount whenever the music or song is played by a radio station, used in a film, or used by any other third party.
Book Royalty: These are paid by publishers to authors. Generally, the author will receive a fixed amount decided via an agreement, for every book that is sold.
Patent Royalty: If a creator or innovator has patented their products they are compensated for their intellectual property. When a third party wants to use the same product, they have to have a license agreement that will require them to pay royalties to the patent owner.
Franchise Royalty: The business owner who is a franchisee, has to pay a royalty to the franchisor for the rights that he will get to open a branch under the company name.
Mining Royalty: Mineral royalties are paid by mineral extractors to property owners. If a party wants to extract minerals from a certain land, they will pay the property owner an amount based on units such as barrels of oil or tons of coal.
FAQs on Royalty Accounts: Explained
1. What is a royalties account?
A royalties account is an accounting record that tracks payments made for the use of someone else’s property, such as intellectual property, minerals, or resources. These payments, called royalties, are typically agreed upon in a contract and are paid by the licensee to the owner, often as a percentage of revenue or a fixed amount. Royalties accounts are important in managing and reporting both income and expenses related to licensing agreements. By accurately maintaining a royalties account, businesses can ensure they are meeting their contractual obligations and that all payments are documented. This helps both parties maintain transparency and simplifies financial reporting related to royalty agreements.
2. What are examples of royalties in accounting?
Royalties in accounting refer to payments made for the use of assets belonging to another entity. Common examples include payments for intellectual property such as copyrighted music, patents, and trademarks. Other instances involve mineral rights, where companies pay owners for extracting oil, gas, or minerals from their land. Additionally, publishing royalties are paid by book publishers to authors based on book sales. These examples all involve tracking royalty payments through dedicated royalty accounts to ensure accuracy and accountability. Recording such transactions is essential for compliance with agreements and for accurate financial reporting.
3. What does 12% royalty mean?
A 12% royalty means the licensee pays 12 percent of the gross or net revenue generated from using the licensed property or resource to the owner. This percentage is usually defined in a contract between both parties. For example, if a company sells products using a patented process, and generates $100,000 in sales, a 12% royalty would require a payment of $12,000 to the property owner. Such royalty rates ensure that the property owner receives ongoing compensation based on the success or usage of their asset, resulting in fair revenue sharing.
4. What is the minimum rent in a royalty account?
Minimum rent in a royalty account refers to the lowest fixed amount the licensee must pay, regardless of whether the actual royalties calculated based on sales or production are lower. This ensures the property owner receives a guaranteed payment even if the asset is underused. When royalty payments, according to agreed percentages, fall short of the minimum rent, the licensee still pays the minimum amount specified. Minimum rent terms protect the licensor’s interests and provide financial predictability within royalty agreements, making them standard in many royalty contracts.
5. How are royalty accounts maintained in accounting?
Royalty accounts are maintained by recording all royalty transactions—both receivable and payable—in accounting books. The process involves tracking each payment according to contract terms, calculating amounts owed based on sales, production, or agreed minimums. Accountants use dedicated ledger accounts for royalties to separate these transactions from regular income and expenses. Accurate maintenance of royalty accounts ensures transparency, proper reporting, and easy auditing. This system helps both licensors and licensees monitor compliance with royalty agreements and resolve disputes over payment calculations.
6. What is the difference between royalty receivable and royalty payable?
Royalty receivable and royalty payable refer to two sides of royalty accounting. Royalty receivable is recorded by the property owner, representing the amount they are due for others using their asset. In contrast, royalty payable is recorded by the licensee, the party using the property, and shows the amount they owe. This distinction helps each side manage their respective obligations under the licensing agreement. By maintaining separate accounts for receivable and payable royalties, businesses ensure detailed tracking and proper reconciliation of royalty income and expenses.
7. Why are royalty accounts important for businesses?
Royalty accounts play a key role in ensuring financial clarity and contractual compliance in business arrangements involving licenses or intellectual property. Accurate royalty accounting helps businesses:
- Track income or expenses related to royalty agreements
- Maintain transparency with partners
- Meet audit and reporting requirements
By keeping proper royalty accounts, companies can avoid disputes, ensure timely payments, and support healthy long-term business relationships with licensors or licensees.
8. How are royalty payments calculated?
Royalty payments are typically calculated using terms specified in a licensing agreement, such as a percentage of gross or net sales, a fixed amount per unit, or a minimum rent. The licensee tracks usage or sales data, applies the agreed royalty rate, and calculates the total due. If a minimum rent applies and the calculated royalty is less, the higher minimum rent amount is paid. Clear calculation methods help prevent errors and disputes, ensuring both parties receive or pay the correct royalty amount under the contract.
