A lease is a type of agreement where a person has a right to use an asset for quite a certain period of time from another person who is the owner of the asset in return for a definite payment. So, the owner here is the Lessor. While, the user is the Lessee and the amount paid by the lessee for acquiring the lessor’s asset is termed as royalty, which he pays to the lessor.
Accounting Treatment in Books of Lessor
Royalty is the sum that is payable by the lessee to the lessor for the use of his rights vested in the lessor. Royalty is a type of periodic payment, which is generally paid on grounds of sale or output. Example: Royalty is paid for extraction of mines from the minefield, for use of patents, for using the technical know-how, also to an author for the sale of his books.
The accounting treatment used here is – Royalty received by the lessor is credited to Trading or Manufacturing Account as it is considered as regular business income in the books of the lessor. While, the royalty that is received on the basis of sales is credited to the Profit and Loss Account.
Again, minimum rent is the amount that is paid by the lessee to the lessor irrespective of any benefit derived from the asset. Thus, this rent payable is known as Dead Rent or Rock Rent.
The Landlord also may allow the lessee the right to recoupment of short-workings. Here, the lessor will receive only the minimal rent until the period of recoupment.
Royalty Meaning in Accounting
Royalty is the periodical payment by the user of the asset to the actual owner or the creator of the same asset for its use in his tenure. The owner or the author of the asset like mine, patent, book, artistic work, and others may allow the third party like the licensee, publisher, etc to use its own creation in return for a consideration, and that is meant by royalty.
The royalty payment is made by the user to the owner. While, the consideration that is paid in lieu of using the asset of the owner is determined in terms of the number of items that are produced or sold.
Parties in Royalties Accounting
The parties who are engaged in this royalty are the lessor and a lessee, we will discuss both of their role in detail now –
1. Lessor
Lessor as mentioned already, is the person who creates or owns the asset, in particular, he also provides the right of using the asset to the third party who is known as the lessor or the landlord. Further to detail, the lessor receives consideration from the third party for using the rights to use his own asset. Examples included in lessons are the owner of the mine or a quarry, an author of a book, could be an artist in the case of music composition.
2. Lessee
Next about Lessee, Lessee is an important person here, who initiates the contract. He is the person who uses the asset and thus makes a contract to repay the owner of the asset with royalty. He pays a royalty to the creator or the owner in lieu of consideration for using such an asset. Examples of Lessees can be publishers, miners, etc.
Accounting Treatment of Royalties
The accounting treatment for royalty which will be in the books of the lessee will be royalty paid on the basis of output is debited to Trading or Manufacturing Account as it is considered as normal business expenditure. Whereas, the royalty which is paid on the basis of sales, is debited to the Profit & Loss A/c.