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Royalty Accounts

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Last updated date: 21st Jul 2024
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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?

  1. Excess Workings: It is the amount by which the actual royalty is more than the minimum rent.

  2. 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.

  3. 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

1. Who is a Lessor in Royalty Accounts?

A Lessor is a person who is responsible for transferring the rights to any particular asset by accepting a payment from the lessee in Royalty Accounts.

2. What does Royalty Mean?

Royalty meaning in accounting is the amount that the lessor is paid by the lessee for providing the right to any resources such as franchises, copyrights, and much more.

3. What is Shortworking?

It is the difference between the minimum rent and the actual royalty to be paid. More information can be found in the Royalty meaning in Accounts notes.

We hope that with the help of these notes, you can understand the royalty in accounting meaning. These notes are definitely going to be useful when students need to revise some answers so that they can score well.

4. What is recoupment of short workings?

Generally, the agreement between a lessor and the lessee under Royalty Accounting comes with a provision. This provision allows the short workings to be carried forward and adjusted in the future.

So, the short workings are adjusted against the excess royalty amount, in the following years. This process where Short Working capital is adjusted is called the recoupment of Short Workings.

The recoupment clause in Royalty Agreement gives the lessee the right to recover the excess payment made to the lessor for complying with the minimum rent clause in earlier years. Generally, a time period (fixed or fluctuating) is stipulated in the agreement for this. 

If the lessee fails to recover the Short Workings within the decided time, the Short Working’s lapse and are debited to the P&L Account.

5. What is a licensing agreement in royalty accounting terms?

The involved parties sign a contract or an agreement laying out the royalty fees and payment amounts. 

A licensing agreement is where the terms of royalty payments are laid out. The licensing agreement defines the restrictions and limits of the royalties. This includes the duration of the agreement, its geographic limitations, the type of products and the rates of royalty cuts. The royalty rate usually is the percentage of the sales or a per-unit payment. The factors that can affect royalty rates include the exclusivity of rights, risks involved, market demand, available alternatives and innovation levels of the product.