Accounting entries in the books of lessee

Accounting entries in the books of lessee

The lessee shall maintain the following accounts with the lessor:

Royalty account: This account records periodical payments made by the user of asset to owner based on output. It is a nominal account (expense account).

Lessor account: This account is used to record royalty payable amount paid to the lessor and short workings.

Short workings recoverable account: This account is used to record the excess amount of minimum rent over the actual royalties and any amount recovered thereof.

Accounting entries in the books of the lessee

i. When minimum rent is payable The lessee records the Minimum Rent as an expense, regardless of the actual royalties earned.

Journal Entry:

• Debit: Royalty Expense Account
• Credit: Royalty Payable Account

ii. When actual royalty is payable If the actual royalties based on usage or production exceed the Minimum Rent, the lessee records the excess as an additional expense.

Journal Entry:

• Debit: Royalty Expense Account
• Credit: Royalty Payable Account

iii. When short workings arise If the actual royalties are less than the Minimum Rent, the lessee records the Short Workings as an amount payable to the lessor, which will be settled in future periods.

Journal Entry:

• Debit: Royalty Payable Account
• Credit: Short Workings Account

iv. When short workings are recouped If the lessee recovers the Short Workings from future royalties, they make the adjustment in the books.

Journal Entry:

• Debit: Short Workings Account
• Credit: Royalty Payable Account

v. When royalty payments are made The lessee records the payment made to the lessor for royalty obligations.

Journal Entry:

• Debit: Royalty Payable Account
• Credit: Cash/Bank Account

vi. When short workings are irrecoverable If the lessee cannot recover the Short Workings within the agreed period, the outstanding balance is written off as an expense.

Journal Entry:

• Debit: Profit and Loss Account (or Write-Off Expense Account)
• Credit: Short Workings Account

Example 1

On 01st January 2015, BALI Ltd. acquired rights to extracts minerals from NALA Ltd. on the agreement that BALI Ltd. would pay royalty of TZS 150 per kilogram extracted. There was no minimum rent charged by NALA Ltd. on the contract. The following table presents the quantities of minerals extracted for a period of five years:

Year	Output (kgs)
2015	15,000
2016	17,000
2017	18,500
2018	14,000
2019	20,000

SOLUTION

Dr. Royalty Expense Account Cr.

Date	Details	TZS	Date	Details	TZS
31st Dec., 2015	NALA Limited	2,250,000	31st Dec., 2015	Manufacturing	2,250,000
31st Dec., 2016	NALA Limited	2,550,000	31st Dec., 2016	Manufacturing	2,550,000
31st Dec., 2017	NALA Limited	2,775,000	31st Dec., 2017	Manufacturing	2,775,000
31st Dec., 2018	NALA Limited	2,100,000	31st Dec., 2018	Manufacturing	2,100,000
31st Dec., 2019	NALA Limited	3,000,000	31st Dec., 2019	Manufacturing	3,000,000

Dr. NALA Ltd. Account Cr.

Date	Details	TZS	Date	Details	TZS
31st Dec., 2015	Bank	2,250,000	31st Dec., 2015	Royalty expense	2,250,000
31st Dec., 2016	Bank	2,550,000	31st Dec., 2016	Royalty expense	2,550,000
31st Dec., 2017	Bank	2,775,000	31st Dec., 2017	Royalty expense	2,775,000
31st Dec., 2018	Bank	2,100,000	31st Dec., 2018	Royalty expense	2,100,000
31st Dec., 2019	Bank	3,000,000	31st Dec., 2019	Royalty expense	3,000,000