Royalty Accounting

zWhen the assets, property or name of someone is used by another person to earn revenue, this is called Royalty. The person whose asset or property is used is called Licensor while the party using the royalty right to generate revenue is called Licensee.

Dead Rent – In royalty accounting, by dead rent we mean the minimum amount which the licensee has to pay to the Licensor regardless whether the Licensee generates the profit or not. It is also called minimum rent.

Short Working – When the amount earned by the licensee is less than the dead rent, the difference is called Short working.

Recoupment of short working – In future periods, licensee has the right to adjust the short working payment amount as a result of good sales. This adjustment of short working in future periods is called recoupment of short working.

Example

  1. ABC is a book publisher in North America. Mr. C writes a book on cost accounting and gives it to ABC to print and market this product in the market. Both ABC and Mr. C enter into an agreement such that ABC will payout $ 5 royalty for each book sold in the market. Here the book belongs to Mr. C but he is giving the right to publisher to market the book and pay him $ 5 on account of royalty being the owner of the book.
  2. DCF is a major fast food chain all over the world. Basically, it has its origin in the United States but in order to expand globally, it gives the right to use its name and manufacturing methodology under a franchise agreement. This franchise agreement is a royalty setup whereby the buyer of the right to use DCF name pays certain % or amount to the DCF on account of royalty.

Question

Alpha is a well known accounting book writer. Recently, it has entered into a royalty agreement with a publisher to publish and market his newly written book on Derivative Instrument. The conditions of the agreement are as follows:

1. The agreement is for 06 years,

2. The publisher will pay $ 5 for each book sold to the owner  of the book,

3. In order to protect the efforts and hard work of the writer, publisher will pay at least $ 50,000 to the Licensor/ owner of the book,

The sales from year 1 to year 5 are 5,000, 15,000, 16,000, 10,000 and 20,000 books respectively. Prepare the necessary table showing the short working and recoupment. Also pass journal entries to record the transactions.

Solution

We will prepare the table to better understand the question and find out the required information as follows:
 

Years Sold Actual Royalty Dead Rent Royalty payable Short working Recoupment Royalty Paid
1 5,000 25,000  50,000 50,000  25,000  50,000
2 15,000 75,000  50,000 75,000  25,000  50,000
3 16,000 80,000  50,000 80,000  80,000
4 10,000 50,000  50,000  50,000  50,000
5 20,000 100,000  50,000  100,000  100,000
               

 

 Royalty Accounting Journal Entries

Year Particulars Debit Credit
1 Royalty expense 25,000  
  Prepaid loyalty 25,000  
  Royalty payable   50,000
       
  Royalty payable 50,000  
  Cash   50,000
       
2 Royalty expense 75,000   
  Prepaid loyalty   25,000
  Royalty payable   50,000 
       
  Royalty payable 50,000  
  Cash   50,000
       
Royalty expense  80,000   
  Royalty payable    80,000 
       
4 Royalty expense  50,000   
  Royalty payable    50,000 
       
Royalty expense  100,000   
  Royalty payable    100,000