Royalty Accounts

ROYALTY
Definition of Royalty

Some business which the owner has a right or monopoly towards some goods or services can allow
other firms to exercise the right. The owner will get a gratuity based on how far the rights have been
exercised.

In other words, it is a transaction whereby an owner gives a right to other company or user to use
his/her own properties, and in return, the user will then give a compensation or payment which is
known as royalty.

According to Accounting Standard Board, royalty is the remuneration payable to a person in respect of
the use of long term assets such as patent, trademarks, copyrights and computer software.

The main forms of royalty are:

a) Mining royalty – to extract mineral and ore from earth

b) The book publisher gives gratuity to the author / writer

c) For the use of a design

Royalty Agreement

A royalty agreement will normally contain clauses dealing with the following:

a) Minimum rent – guaranteed amount which the landlord, inventor or author is to receive whatever the
output maybe.

b) Royalty per unit per output

c) Right to recoup short-workings

d) Right to subject part or whole of tenancy agreement

 Minimum Royalty and Short Workings

 The payment of royalty is based on the unit of output produced. However, if the sum of royalty
is less than the minimum rent (if any), then the payment will be based on the minimum rent
(minimum royalty – minimum rent).

 The difference between the royalty and the minimum rent is known as ‘Short Working’.
Normally, the tenant may obtain the right to recover the short-workings.

Example 1 : Royalty without any minimum rent

A landlord granted a lease to mining company whereby he is to receive kshs.05 per ton of ore mined.

The output for the first 3 years is:

1st year 10,000 tons

2nd year 20,000 tons

3rd year 24,000 tons

Calculate the royalty to be paid

Solution :

The landlord will receive the royalty of:

1st year kshs 500 (10,000 x kshs 0.05)

2nd year kshs 1,000 (20,000 x kshs 0.05)

3rd year kshs 1,200 (24,000 x kshs 0.05)

kshs 2,700

Example 2 : With a minimum rent – also with the rights to recoup short-workings

A landlord granted a lease to mining company whereby he is to receive kshs 0.05 per ton of ore mined.
 The output for the first 3 years is:

1st year 10,000 tons

2nd year 20,000 tons

3rd year 24,000 tons

Assume that the minimum rent is kshs 800.

Solution :

Calculation of Minimum Short workings

Year Payment
Royalty rent Current Written off Recoverable
10,000x kshs
1 800 800 300 - -
0.05 = kshs 500
20,000x kshs
2 0.05 = kshs 800 800 - - 200
1,000
24,000x kshs
3 0.05 = kshs 800 1,100 - - 100
1,200

Accounting Records For Royalty

Preparation of Accounts in Payer’s (Grantee) Book

Payer (grantee) is the party exercising the right. Grantee has to open the accounts for:

(a) Royalty Account – an expense account

(b) Land Lord’s (Grantor / Owner) Account – a liability account in the name of the owning party

(c) Short-Workings Account (if short-working is involved) – an asset account

Example 3 :
The lessee of a mine is to pay kshs 1 for each ton of ore extracted. The minimum rent is to be kshs 400
per annum. Any payments for short working are recoupable only in the two years following that in
which they occurred. The following is the production in the first five years

Year Output(tones)
1 310
2 560
3 280
4 440
5 450

Required
(a) Royalty Account
(b) Land Lord’s Account
(c) Short-Workings Account
(d) Operating Account for the year ended 31/12….
(e) Statement of Financial Position as at 31/12….

Solution :

The following table shows the effect of extraction figures contained in column (a). As the minimum rent
is kshs 400, then obviously column (b) must never show a figure less than kshs 400.

Calculation of Minimum Short workings

Year Payment
Royalty rent Current Written off Recoverable
1 310 400 400 90 - -
2 560 400 470 - - 90
3 280 400 400 120 - -
4 440 400 400 - - 40
5 450 400 400 - 30 50

Royalty Account

Year 1 kshs Year 1 kshs

31/12 Landlord 310 31/12 Operating a/c 310

Year 2 Year 2
31/12 Landlord 560 31/12 Operating a/c 560

Year 3 Year 3
31/12 Landlord 280 31/12 Operating a/c 280

Year 4 Year 4
31/12 Landlord 440 31/12 Operating a/c 440

Year 5 Year 5
31/12 Landlord 450 31/12 Operating a/c 450
 Land Lord Account

Year 1 kshs Year 1 kshs

31/12 Cash / Bank 400 31/12 Royalty 310
Short workings 90
400 400

Year 2 Year 2
31/12 Royalty – SW Recoverable 90 31/12 Royalty 560
Cash / Bank 470
560 560

Year 3 Year 3
31/12 Cash / Bank 400 31/12 Royalty 280
Short workings 120
400 400

Year 4 Year 4
31/12 Royalty – SW Recoverable 40 31/12 Royalty 440
Cash / Bank 400
440 440

Year 5 Year 5
31/12 Royalty – SW Recoverable 50 31/12 Royalty 450
Cash / Bank 400
450 450

Short Working Account

Year 1 kshs Year 1 kshs

31/12 Landlord 90 31/12 Balance c/d 90

Year 2 Year 2
1/1 Balance b/d 90 31/12 Landlord 90

Year 3 Year 3
31/12 Landlord 120 31/12 Balance c/d 120

Year 4 Year 4
1/1 Balance b/d 120 31/12 Landlord 40
Balance c/d 80
120 120
Year 5 Year 5
1/1 Balance b/d 80 31/12 Landlord 50
P&L – SW written off 30
80 80
 Operating Account for the year ended 31/12….

Year kshs
1 Royalty 310
2 Royalty 560
3 Royalty 280
4 Royalty 440
5 Royalty 450

Statement of Comprehensive Income (Profit & Loss Account) for the year ended 31/12….

kshs
Expenses
Year 5 Royalty – SW written off 30

Statement of Financial Position as at 31/12….

kshs
Current Assets
Year 1 Short Workings 90
Year 2 Short Workings 120
Year 3 Short Workings 80

Preparation of Accounts in Receiver’s Book

Receiver is the party that received right. Receiver has to open the accounts for:

(a) Royalty Received Account – a revenue account

(b) Tenant Account – a debtor account in the name of the owning party

(c) Short-Workings Account (if short-working is involved) – a liability account

Based on Example 3 the record in receiver ‘s book is :

Royalty Receive Account

Year 1 kshs Year 1 kshs
31/12 P&L 310 31/12 Tenant 310

Year 2 Year 2
31/12 P&L 560 31/12 Tenant 560

Year 3 Year 3
31/12 P&L 280 31/12 Tenant 280

Year 4 Year 4
31/12 P&L 440 31/12 Tenant 440

Year 5 Year 5
31/12 P&L 450 31/12 Tenant 450

Tenant Account

Year 1 kshs Year 1 kshs

31/12 Royalty Receivable 310 31/12 Bank / Cash 400
Short Working 90
400 400

Year 2 Year 2
31/12 Royalty Receivable 560 31/12 Bank / Cash 470
Short Working 90
560 560

Year 3 Year 3
31/12 Royalty Receivable 280 31/12 Bank / Cash 400
120 Short Working
400 400

Year 4 Year 4
31/12 Royalty Receivable 440 31/12 Bank / Cash 400
Short Working 40
440 440

Year 5 Year 5
31/12 Royalty Receivable 450 31/12 Bank / Cash 400
Short Working 50
450 450
 Short Working Account

Year 1 kshs Year 1 kshs

31/12 Bal c/d 90 31/12 Tenant 90

Year 2 Year 2
31/12 Tenant 90 1/1 Bal b/d 90

Year 3 Year 3
31/12 Bal c/d 120 31/12 Tenant 120

Year 4 Year 4
31/12 Tenant 40 1/1 Bal b/d 120
Bal c/d 80
120 120

Year 5 Year 5
31/12 Tenant 50 1/1 Bal b/d 80
P & L – written off 30
80 80

Statement of Comprehensive Income (Profit & Loss Account) for the year ended 31/12….

Revenue Kshs
Year 1 Royalty receive 310
Year 2 Royalty receive 560
Year 3 Royalty receive 280
Year 4 Royalty receive 440
Year 5 Royalty receive 450
Royalty receive – written off 30

Statement of Financial Position as at 31/12….

Current Liability kshs

Year 1 Short Working 90
Year 3 Short Working 120
 Year 4 Short Working 80

EXERCISES

QUESTION 1

Arthur was given a license to manufacture and sell wheat on a land owned by Merlin Bhd.

1. the payment of royalty was kshs 0.60 per ton of wheat

2. a minimum payment of rent was kshs 1,200 per annum

3. short workings can only be recovered / recouped until the end of year 2.

During the first 3 years of the contract, the following quantities were obtained:

Year Tonne
2011 500
2012 2,400
2013 4,000

The accounting year for Arthur Bhd and the landlord ends on 31st December and the landlord received
payment on the same date.

Required:

a) Prepare a royalty table for the above transaction.

b) Prepare the appropriate accounts in the book of Arthur Bhd.

 QUESTION 2

Puan Jasmin is a designer for a chemical liquid mixer. She has allowed Alamria Company to make and
sell the appliances with a condition that the company pays royalty of kshs 0.60 per units of mixer sold.
The minimum rent was determined at kshs 3,500 per annum. Any short workings will be recouped in a
period of 2 years after the occurrence of the short workings.

Beginning in year 4, they agreed to change the annual minimum rent from kshs 3,500 to kshs 4,000. This
is because their products are already known by people and also other companies make the product in
demand. Other conditions do not change. The company’s accounting year ends on 31st December every
year and the payment made on the same date.

Mixers that have been sold for 7 years until 31st December 2005 were:

Year 2007 2008 2009 2010 2011 2012 2013

Units sold 5,000 5,750 6,800 7,000 6,500 9,200 9,000

1. You are required to prepare the relevant accounts in the book of ALamria Company:

a) Royalty Payable Account

b) Short Working Account

c) Puan Jasmin Account

2. What is the meaning of ‘short working’ and why the landlord set a minimum rent every year?