UNIT IV
Accounting for Leases
What is a lease?
A lease is a contract that allows an asset / asset owner to use the asset / asset in exchange for something, usually money or other asset, by another party. The two most common types of leases in accounting are operating leases and finance (capital leases) leases. This step-by-step guide covers all the basics of lease accounting.
Benefits of leasing
Disadvantages of leasing
One of the major drawbacks of leasing is the cost of the agency. In a lease, the lessor transfers all rights to the lessee for a specific period of time, causing moral hazard problems. The lessee who manages the asset is not the owner of the asset, so the lessee may not be able to pay attention to it as if it were his own asset. This separation between asset ownership (lessor) and asset management (lessee) is called the agency cost of the lease. This is an important concept in lease accounting.
What is a finance lease?
Finance leasing is a way of providing finance. In effect, a leasing company (lessor or owner) buys asset for a user (usually called an employer or lessee) and rents them to them for an agreed period of time.
Finance leases are a statement of Standard Accounting Practice 21.
"Practically all risks and rewards of ownership of an asset to a lessee."
This basically means that the lessee is in much the same position as if he had bought the asset.
The lessee pays a rent that covers the original cost of the asset during the initial or major period of the lease. You are obliged to pay all of these rents, including balloon payments at the end of the contract. When all of this is paid, the lender will recover the investment in the asset.
The customer promises to pay these rents during this period and technically the finance lease is defined as non-cancellable, although it may be possible to terminate early. At the end of the lease
What happens at the end of the primary finance lease term is different and depends on the actual contract, but the possible options are:
When an asset is sold, the customer may be given a rent rebate equivalent to the majority of the sale price (minus disposal costs), as agreed in the lease agreement.
If the asset is held, the lease enters the second period.
Secondary rentals can be much lower than primary rentals (“pepper cone” rentals). Alternatively, the same rental may continue to be leased monthly.
Finance lease example
Finance leases are commonly used to finance vehicles, especially hard-working commercial vehicles. The company wants the benefits of leasing, but does not want the responsibility to return the vehicle to the lender in good condition.
Besides commercial vehicles, finance leases can be used for many other assets. An example is shown below.
The Health Club was considering investing in new gym equipment. The total loan amount is £ 20,000 and the contract is set to pay for 60 months without deposits. Importantly, the balloon payment was set to £ 0. This means that the client (or most likely a gym user!) Is free to sweat the device, knowing that they are not responsible when concluding the contract. After 60 months the option is to sell the equipment – keep the money made or enter the peppercorn (secondary) rental period in a relatively small amount.
Operating lease
In contrast to finance leases, operating leases do not transfer virtually all risks and rewards of ownership to the lessee. It usually runs for less than the full economic life of the asset, and the lessor expects the asset to have resale value (known as residual value) at the end of the lease term.
This residual value is predicted at the beginning of the lease and the lessor bears the risk of whether the asset will achieve this residual value at the end of the contract.
Operating leases are common when assets such as aircraft, vehicles, construction plants, and machinery have residual value. Customers can use the asset for the agreed term in exchange for rent payment. These payments do not cover the full cost of the asset as in the case of a finance lease.
The operating lease may include other services included in the contract. Vehicle maintenance contract.
Ownership of the asset remains with the lessor and the asset is returned at the end of the lease when the leasing company rehires it under another contract or sells it to release the residual value. Alternatively, the lessee may continue to rent the asset at the fair market rent agreed at that time.
Accounting rules are currently under consideration, but at this time operating leases are off-balance sheet arrangements and finance leases are on the balance sheet. For accounting under international accounting standards, IFRS 16 will bring operating leases to the balance sheet. Learn more about IFRS16.
A common form of operating lease in the vehicle sector is contract employment. This is the most common way to fund company cars and is growing steadily.
Why choose one sort of lease over the other?
This is a complex question, and each asset investment needs to be considered individually to see which type of financing is most beneficial to the organization. However, there are two important considerations. The type and lifetime of the asset, and the way the leased asset is reflected within the organization's account.
Asset type and lifespan
As mentioned above, it is important to remember that in operating leases the risks and rewards of owning an asset remain with the lessor, and in finance leases these are primarily transferred to the lessee.
Very generally, if an asset has a relatively short service life within the business, an operating lease may be a more commonly selected option before it needs to be replaced or upgraded. This is because the asset is likely to hold a significant portion of its value at the end of the contract, thus lowering the rent during the lease term. This is priced to the overall cost of the contract, as the lessor bears the risk in terms of the residual value of the asset.
This “cost of risk” can be significantly reduced for assets that can affect their condition at the time of return to the lessor and therefore have a high degree of certainty in estimating the residual value. Asset types to which this applies include automobiles, commercial vehicles, and IT equipment.
If an asset is likely to have a longer useful life in the business, its residual value consideration is less important as it is likely to be a much smaller percentage of its original value. This may mean that the lessee is willing to take this risk internally rather than paying the lessor. Here, finance leasing is a more obvious choice.
Because the rent paid on a finance lease pays off all or most of the capital, it is often possible to set a secondary lease period and maintain the use of the asset at a significantly reduced cost.
Accounting for finance and operating leases
The treatment of the two different lease types depends on the accounting standards that your organization complies with.
For organizations reporting to International Financial Reporting Standards (IFRS), the introduction of IFRS 16 from 1 January 2019 requires that both operating and finance leases be reflected in the company's balance sheet and income statement. Means. Prior to this, operating leases were treated as "off-balance sheet" items.
Today, most SMEs comply with UK GAAP, which is generally accepted in the UK. Changes in leasing treatment are filtered to companies applying UK GAAP only when converting to the IFRS / FRS 101 Reduction Disclosure Framework instead of FRS 102. The expectation from the FRC is that the earliest adoption in the UK could be 2022/23. But until then, it will monitor and monitor international impact.
For companies that currently need to reflect operating leases in their accounts, the impact is as follows:
Balance Sheet – The lessee must show the “right to use” the asset as an asset and the obligation to pay the lease payments.
As a responsibility.
Income Statement – The lessee displays the depreciation of the asset and the interest on the lease liability. Depreciation is usually done on a straight-line basis.
For companies unaffected by these changes, the ability to raise funds while keeping their assets off-balance sheet can be a factor in deciding whether to choose an operating lease or a finance lease.
Annual investment allowance
Many organizations seek to maximize the benefits of corporate tax by using the Annual Investment Allowance (AIA) when acquiring new assets. These allowances provide the organization with an immediate tax deduction for 100% of the cost of newly acquired assets. Since January 1, 2019, the allowance has increased to £ 1 million annually.
However, to be eligible for this remedy, the asset must be "purchased" rather than "leased". That is, assets financed on both operational and finance leases are not eligible for AIA, but assets acquired using financing methods such as contract purchases and employment purchases.
Financial Leasing and Operating Leasing – Key Differences
As you can see, there are some differences between financial and operating leases. Let's look at the important differences between them –
Key takeaways:
Meaning of Hire Purchase System
If you purchase a TV for cash, you pay, say, Rs. 15,000. But if you wish to make the payment by instalments of say, Rs. 3,000 each, every year, you may be required to pay four instalments, that is Rs. 20,000 in all. The extra amount of Rs. 3,000 is for interest. If you choose the latter mode of the payment, you should debit Rs. 5,000 to interest and treat the TV as valued at Rs. 15,000 (and not at Rs. 20,000). In case payment is to be made by instalments, there may be two kinds of arrangements. Each instalment may be treated as a ‘hire’ the purchaser becoming the owner only if he pays all the instalments. In other words, property does not pass to him even if one instalment remains unpaid. The seller will have the right to take away the goods in case of default in respect of any instalment. This is known as ‘Hire Purchase’ system.
The other arrangement may be that property passes immediately on the signing of the contract. The seller will not have the right to repossess the goods in case an instalment is not paid. His right will be to sue the purchaser for the money due. This is known as the Instalment System
Instalment system
The installment system is almost the same as the employment purchase system. The main difference between the two is that in the installment payment system, the buyer takes ownership as soon as the contract with the seller is signed. If he fails to pay in instalments, the seller can only get the article back with the help of the court.
Rental purchase and installment payment systems promote active sales of durable consumer goods. Products such as motorcycles, TVs, radios, refrigerators, bicycles and furniture are sold in large quantities through rental purchase and installment payment systems.
The products sold in these systems
Benefits of Employment Purchase and Installment Systems
1. Rental purchase and installment payment schemes allow buyers to purchase items that are out of reach.
2. It also allows businesses to find buyers for their products. Companies are not always able to find a cash party for products that are inherently expensive.
3. It expands the market.
4. Middlemen are excluded
5. It helped financial companies develop their business. Today's financial companies are widely funding several articles under the job purchase and installment payment system.
6. The price will be stable.
7. By renting and selling convenient items and luxury items in installments, people's living standards will improve.
8. Sellers can increase their sales. In addition, rental purchases and installment sales are more profitable.
9. Nowadays, most business houses offer many offers, like free gifts, exclusively for rental purchase customers.
Disadvantages of employment purchase and installment payment system
1. Employment purchase and installment payment systems tempt buyers to purchase products that go beyond their means. So it will be a luxury.
2. The buyer pays a very high price for the article under such a scheme. This is because he has to pay interest on his unpaid balance.
3. The need for time is a savings. Plans like buying jobs waste people.
4. Employment purchase price is higher than cash price. Interest is charged to the purchaser of the employment purchase system. Interest rates are often high.
5. If the buyer fails to pay, the goods sold in the rental purchase system will be reclaimed by the rental vendor. Buyers incur huge losses on seized goods.
6. Employment purchases and installment transactions are tedious. You need to conclude a contract and give a guarantee. More legal proceedings are to be passed.
7. The default rate under the employment purchase and installment payment system is higher. This is because only people with inadequate means buy under this system.
8. The purchaser must carry out some legal proceedings. He may have to find a guarantor. The contract must be prepared and signed by both the seller and the buyer, and it must be witnessed. The ownership document remains with the vendor / financial company until the employer liquidates the membership fee.
Interest: In either case (hire purchase or instalment) interest must be separated from the principal sum due. Since payments continue over two or more financial year’s interest must be calculated for each year separately. Usually, information is available regarding cash price and the rate of interest. Calculation of interest then becomes easy.
Summary
Hire Purchase: Property does not pass to him even if one instalment remains unpaid. The seller will have the right to take away the goods in case of default in respect of any instalment. This is known as ‘Hire Purchase’ system. The other arrangement may be that property passes immediately on the signing of the contract. The seller will not have the right to repossess the goods in case an instalment is not paid. His right will be to sue the purchaser for the money due. This is known as the Instalment System.
To ascertain Cash Price, rate of interest and instalments being given. Sometimes the cash price is not given. Since the asset cannot be debited with more than the cash price, it must be ascertained. The process is to take the last year first and separate interest from principal out of the total sum due.
Entries in Books:
Actual Cash Price Paid Method: This method follows a technical approach and does not treat the hire purchaser as owner until he makes the payment of last instalment. Under this method, the asset is recorded at the cash price actually paid.
Books of the Vendor. The vendor follows no special method for recording sales on hire purchase, especially in case of sale of large items. He debits the purchaser with the cash price and credits him with the amount received. Every year the interest due is debited.
Books of Purchaser
First Method. The purchaser can also follow the system adopted by the vendor and make entries like ordinary purchase of an asset. Only, he should credit the vendor with interest due every year and debit him with cash as and when paid. The above given example can be worked out in the following way (ledger accounts.)
Second Method. Under the second method, entries are passed only when payment is due or made. At this time, the vendor is credited with the amount due. Interest for the period is debited to interest Account and the balance (principal) is debited to the Asset Account. On payment, of course, the vendor is debited and Cash (or Bank) credited.
Key takeaways:
In contrast to finance leases, operating leases do not transfer virtually all risks and rewards of ownership to the lessee. It usually runs for less than the full economic life of the asset, and the lessor expects the asset to have resale value (known as residual value) at the end of the lease term.
This residual value is predicted at the beginning of the lease and the lessor bears the risk of whether the asset will achieve this residual value at the end of the contract.
Operating leases are common when assets such as aircraft, vehicles, construction plants, and machinery have residual value. Customers can use the asset for the agreed term in exchange for rent payment. These payments do not cover the full cost of the asset as in the case of a finance lease.
The operating lease may include other services included in the contract. Vehicle maintenance contract.
Ownership of the asset remains with the lessor and the asset is returned at the end of the lease when the leasing company rehires it under another contract or sells it to release the residual value. Alternatively, the lessee may continue to rent the asset at the fair market rent agreed at that time.
Accounting rules are currently under consideration, but at this time operating leases are off-balance sheet arrangements and finance leases are on the balance sheet. For accounting under international accounting standards, IFRS 16 will bring operating leases to the balance sheet. Learn more about IFRS16.
A common form of operating lease in the vehicle sector is contract employment. This is the most common way to fund company cars and is growing steadily.
Why choose one sort of lease over the other?
This is a complex question, and each asset investment needs to be considered individually to see which type of financing is most beneficial to the organization. However, there are two important considerations. The type and lifetime of the asset, and the way the leased asset is reflected within the organization's account.
Asset type and lifespan
As mentioned above, it is important to remember that in operating leases the risks and rewards of owning an asset remain with the lessor, and in finance leases these are primarily transferred to the lessee.
Very generally, if an asset has a relatively short service life within the business, an operating lease may be a more commonly selected option before it needs to be replaced or upgraded. This is because the asset is likely to hold a significant portion of its value at the end of the contract, thus lowering the rent during the lease term. This is priced to the overall cost of the contract, as the lessor bears the risk in terms of the residual value of the asset.
This “cost of risk” can be significantly reduced for assets that can affect their condition at the time of return to the lessor and therefore have a high degree of certainty in estimating the residual value. Asset types to which this applies include automobiles, commercial vehicles, and IT equipment.
If an asset is likely to have a longer useful life in the business, its residual value consideration is less important as it is likely to be a much smaller percentage of its original value. This may mean that the lessee is willing to take this risk internally rather than paying the lessor. Here, finance leasing is a more obvious choice.
Because the rent paid on a finance lease pays off all or most of the capital, it is often possible to set a secondary lease period and maintain the use of the asset at a significantly reduced cost.
Accounting for finance and operating leases
For organizations reporting to International Financial Reporting Standards (IFRS), the introduction of IFRS 16 from 1 January 2019 requires that both operating and finance leases be reflected in the company's balance sheet and income statement. Means. Prior to this, operating leases were treated as "off-balance sheet" items.
Today, most SMEs comply with UK GAAP, which is generally accepted in the UK. Changes in leasing treatment are filtered to companies applying UK GAAP only when converting to the IFRS / FRS 101 Reduction Disclosure Framework instead of FRS 102. The expectation from the FRC is that the earliest adoption in the UK could be 2022/23. But until then, it will monitor and monitor international impact.
For companies that currently need to reflect operating leases in their accounts, the impact is as follows:
Balance Sheet – The lessee must show the “right to use” the asset as an asset and the obligation to pay the lease payments.
As a responsibility.
Income Statement – The lessee displays the depreciation of the asset and the interest on the lease liability. Depreciation is usually done on a straight-line basis.
For companies unaffected by these changes, the ability to raise funds while keeping their assets off-balance sheet can be a factor in deciding whether to choose an operating lease or a finance lease.
Annual investment allowance
Many organizations seek to maximize the benefits of corporate tax by using the Annual Investment Allowance (AIA) when acquiring new assets. These allowances provide the organization with an immediate tax deduction for 100% of the cost of newly acquired assets. Since January 1, 2019, the allowance has increased to £ 1 million annually.
However, to be eligible for this remedy, the asset must be "purchased" rather than "leased". That is, assets financed on both operational and finance leases are not eligible for AIA, but assets acquired using financing methods such as contract purchases and employment purchases.
Key takeaways:
Royalty must be paid by the user to the owner of the property or to which the owner has special rights. Royalty agreements are created between the owner and the user of such property or right. When payments are made to purchase rights or assets that are treated as capital expenditures rather than royalties.
Payments made by the lessee for royalties are normal business expenses and are deducted from the royalties’ account. This is a nominal account and at the end of the fiscal year you need to transfer the balance of your royalty account to your regular trading and profit and loss accounts. Loyalties are sent strictly to the manufacturing or production account based on the production or production. If royalties are paid on a sales basis, it will be part of the selling cost.
Types of royalty:
There are the following types of royalties-
Copyright-Copyright provides legal rights to the author (of his book), the photographer (of his photographs), or any such type of intellectual work. The copyright royalties must be paid by the publisher (borrower) to the author (lender) or photographer of the book based on the sale by the publisher.
Mining royalties-Mine or quarry lessees pay mine or quarry lenders. This is usually based on production volume.
Patent royalties-Patent royalties are paid by the lessee to the lessor based on the production or production of each item.
Royalty basics
In the case of patents, the book publisher pays royalties to the author of the book based on the number of books sold. Therefore, the patentee gets royalties based on production, and the mine owner gets royalties based on production.
Important terms
The following are important terms used in Royalty contracts-
royalty
Regular payments may be based on sales or output and are called royalties. Royalty is paid from the mine borrower to the lender, from the book publisher to the author, from the manufacturer to the patentee, and so on.
landlord
A landlord is someone who has legal rights to mines, quarries, patents, and copybook rights.
Tenet
Author or Publisher; A borrower or patentee who obtains a right (usually a commercial or personal right) from the owner on a lease for consideration is called Tenet.
Lease premium
If there are additional payments additionally to the royalties paid by the lessee to the lessor, they're called lease premiums and are treated as capital expenditures and are amortized annually through the income statement in an appropriate manner.
TDS (tax deducted by Source)
If TDS (Tax withholding) is applied under the Income Tax Act, the lessee is obliged to deduct the TDS according to the applicable tax rate and then pay the lessor and the lessee deposits it in the credit of the central government. The amount of royalties is the total amount of royalties (including TDS) and will be charged to the income statement.
For example, if the royalty amount is 1,000,000 /-& the TDS rate is 10%, the lessee pays Rs. 900,000 /-For lenders. The royalty charge on the income statement will be rupees. Balance of 1,000,000 /-and Rs. 100,000 /-will be credited to the central government account.
Stop work
In some cases, work may be stopped due to uncontrollable situations such as strikes or floods. In this case, the minimum rent must be revised as stipulated in the contract.
The revision of the minimum rent is-
Reduction of minimum rent in proportion to suspension of work.
Based on a fixed percentage; or
Fixed amount for the year of suspension.
Sublease
The landlord or lessor may allow the lessee to sublease a portion of the mine or land as a sub-lessee. In this case, the borrower is the lender of the sub-borrower and the borrower of the landlord.
In such cases, as a borrower, he maintains the following books-
As a borrower
As a sub lender
Lender
A person who creates or owns an asset and provides a third party with the right to use such asset is called a lessor or landlord. In addition, the lessor receives compensation from a third party for using the right to use his property.
Examples of lenders include mine or quarry owners, book authors, artists in the case of musical works, and so on.
Borrower
A lessee is a person who uses the property of the creator or owner in lieu of consideration for the use of such property. Examples of borrowers include publishers, miners, and so on.
Key takeaways
Royalty accounting
For borrowers, royalties are normal business spending. Loyalties paid based on the output are debited to Trading or Manufacturing A / c. On the other hand, royalties paid on the basis of sales are debited to the income statement.
Minimum rent or fixed rent
The amount that the lessee must pay to the lessor, regardless of whether the lessee has benefited from the asset. Therefore, it is also called dead rent or rock rent. The minimum rent can be fixed annually or changed annually according to the terms of the contract.
If the actual royalty for the year is lower than the minimum rent, the lessee pays the minimum rent to the lessor.
If the actual rent for one year exceeds the minimum rent, the lessee pays the lessor the actual rent.
Short time work
This is an excess of the minimum rent that exceeds the royalties actually paid. Calculated only if the lessor is allowed to adjust for future royalties. Short working hours = minimum rent – actual rent
Recovery of short working hours
The right to collect means the right of the lessor to carry over and offset short-term work from the surplus of royalties above the minimum rent given to the lessee. There are two types:
Fixed Recovery Right: When the lessor allows the lessee to adjust short-term work for a limited period of time, it is known as a fixed recovery right.
Variable Recovery Rights: If the lessor allows the lessee to adjust short-term work for any year in the next few years, it is known as variable recovery rights.
Key takeaways:
Accounting in the lessee's books
Royalty means that one person pays another person on a regular basis to use the rights to a resource. The person who gives the right to use the resource is the lender, and the person who uses it is the borrower. This section describes the accounting treatment in the lessee's books.
Accounting Treatment in the Books of Lessee
Date | Particular |
| Amount | Amount |
1.When Royalty is Payable | Royalty A/c (Actual Royalty) | Dr. | xx |
|
| Short-workings A/c | Dr. | xx |
|
| To Lessor A/c (Minimum Rent) |
|
| xx |
| (Being payment due) |
|
|
|
2.For Payment to Lessor | Lessor A/c | Dr. | xx |
|
| To Bank A/c |
|
| xx |
| (Being amount paid) |
|
|
|
3. For Transferring Royalty | Trading/Profit and Loss/Manufacturing/Production A/c | Dr. | xx |
|
| To Royalty A/c |
|
| xx |
| (Being amount transferred to relevant account) |
|
|
|
4. When Short-workings is recouped | Royalty A/c | Dr. | xx |
|
| To Short-workings A/c (Recoupment) |
|
| xx |
| To Lessor A/c – actual payment |
|
| xx |
| (Being recoupment done) |
|
|
|
5. For irrecoverable short-working | Trading/Profit and Loss/Manufacturing/Production A/c | Dr. | xx |
|
| To short-working A/c (amt. lapsed) |
|
| xx |
| (Being amount charged to relevant account) |
|
|
|
Note: (Entry 4 and 5 only)
The above journals assume that there are subsequent minimum rent and short-term payback provisions written to the lessee.
Output-based loyalty must be debited to the manufacturing or production account, while sales-based loyalty must be treated as selling expenses and must be debited to the trading or profit and loss account.
Accounting in the lessor's books
A lease is a contract in which one person obtains the right to use the asset for a period of time from another person or the owner of the asset in return for payment. The owner is the lessor. The user is a borrower. The amount paid is royalties.
Royalty is the amount the lessee pays the lessor for the use of the rights granted to the lessor. It is a regular payment. It is generally paid on a production or sale basis. Royalty is paid for mining mines, using patents, using technical know-how, selling authors' books, and more.
For lessors, royalties are normal business income. Loyalties received based on the output will be credited to Trading or Manufacturing A / c. On the other hand, royalties received based on sales are credited to Profit & Loss A / c.
The minimum rent is the amount that the lessee must pay to the lessor, regardless of whether the lessee has benefited from the asset. Therefore, it is also called dead rent or rock rent.
The lender can grant the borrower the right to recover short-term work. In this case, the lessor will only receive the minimum rent until the payback period. The following entries are made assuming that the lessor grants the lessee the right to collect.
Journal Entries in the books of the Lessor
Date | Particulars |
| Amount (Dr.) | Amount (Cr.) |
1. For Royalty due | Lessee’s A/c (Minimum Rent) | Dr. | xx |
|
| To Royalty receivable A/c (Actual Royalty) |
|
| xx |
| To Short-workings Allowable A/c |
|
| xx |
| (Being royalty due from the lessee and short-workings allowed) |
|
|
|
2. For payment received | Bank A/c | Dr. | xx |
|
| To Lessee’s A/c |
|
| xx |
| (Being money received from the lessee) |
|
|
|
3. When short-workings are recouped | Short-workings Allowable A/c | Dr. | xx |
|
| To Lessee A/c |
|
| xx |
| (Being amount of short-workings recouped) |
|
|
|
4. For irrecoverable short-workings | Short-workings Allowable A/c | Dr. | xx |
|
| To Profit and Loss A/c |
|
| xx |
| (Being the amount of short-workings lapsed) |
|
|
|
5. For transferring Royalty at the year end | Royalty receivable A/c | Dr. | xx |
|
| To Trading/ P&L /Manufacturing A/c |
|
| xx |
| (Being royalty received transferred to the Trading/ P&L /Manufacturing A/c at end of the year) |
|
|
|
The four-year production was 9000, 13000, 25000, 27000 and 50000, respectively. Enter journals and ledger accounts in AB Ltd.’s books.
A1) Calculation of royalties, minimum rent, short-term work.
Year | Quantity in tonnes | Rate per tonne | Royalty | Minimum Rent | Short-workings |
1 | 9000 | 5 | 45000 | 100000 | 65000 |
2 | 13000 | 5 | 65000 | 100000 | 45000 |
3 | 25000 | 5 | 125000 | 100000 |
|
4 | 27000 | 5 | 135000 | 100000 |
|
5 | 50000 | 5 | 250000 | 100000 |
|
Computation of Recoupment, Short-workings carried forward, Transferred to P&L Account
Year
| Recoupment | Short-working carried forward | Transferred to P&L Account | Payment to Lessor |
1 |
| 65000 |
| 100000 |
2 |
| 100000 |
| 100000 |
3 | 25000 | 75000 |
| 100000 |
4 | 35000 |
| 40000 | 100000 |
5 |
|
|
| 250000 |
Journal Entries Year: 1
Date | Particular |
| Amount (Dr.) | Amount (Cr.) |
31 Dec | Royalty A/c | Dr. | 45000 |
|
| Short-workings A/c | Dr. | 65000 |
|
| To Lessor A/c |
|
| 100000 |
| (Being payment due) |
|
|
|
31 Dec | Lessor A/c | Dr. | 100000 |
|
| To Bank A/c |
|
| 100000 |
| (Being amount paid) |
|
|
|
31 Dec | Profit and Loss A/c | Dr. | 45000 |
|
| To Royalty A/c |
|
| 45000 |
| (Being amount charged to relevant a/c) |
|
|
|
Journal Entries Year 2
Date | Particular |
| Amount (Dr.) | Amount (Cr.) |
31 Dec | Royalty A/c | Dr. | 65000 |
|
| Short-workings A/c | Dr. | 45000 |
|
| To Lessor A/c |
|
| 100000 |
| (Being payment due) |
|
|
|
31 Dec | Lessor A/c | Dr. | 100000 |
|
| To Bank A/c |
|
| 100000 |
| (Being amount paid) |
|
|
|
31 Dec | Profit and Loss A/c | Dr. | 65000 |
|
| To Royalty A/c |
|
| 65000 |
| (Being amount charged to relevant a/c) |
|
|
|
Journal Entries Year 3
Date | Particular |
| Amount (Dr.) | Amount (Cr.) |
31 Dec | Royalty A/c | Dr. | 125000 |
|
| To Short-workings A/c |
|
| 25000 |
| To Lessor A/c |
|
| 100000 |
| (Being payment due) |
|
|
|
31 Dec | Lessor A/c | Dr. | 100000 |
|
| To Bank A/c |
|
| 100000 |
| (Being amount paid) |
|
|
|
31 Dec | Profit and Loss A/c | Dr. | 125000 |
|
| To Royalty A/c |
|
| 125000 |
| (Being amount charged to relevant a/c) |
|
|
|
Journal Entries Year 4
Date | Particular |
| Amount (Dr.) | Amount (Cr.) |
31 Dec | Royalty A/c | Dr. | 135000 |
|
| To Short-workings A/c |
|
| 35000 |
| To Lessor A/c |
|
| 100000 |
| (Being payment due) |
|
|
|
31 Dec | Lessor A/c | Dr. | 100000 |
|
| To Bank A/c |
|
| 100000 |
| (Being amount paid) |
|
|
|
31 Dec | Profit and Loss A/c | Dr. | 135000 |
|
| To Royalty A/c |
|
| 135000 |
| (Being amount charged to relevant a/c) |
|
|
|
31 Dec | Profit and Loss A/c | Dr. | 40000 |
|
| To short-working A/c |
|
| 40000 |
| (Being amount charged to relevant a/c) |
|
|
|
Journal Entries Year 5
Date | Particular |
| Amount (Dr.) | Amount (Cr.) |
31 Dec | Royalty A/c | Dr. | 250000 |
|
| To Lessor A/c |
|
| 250000 |
| (Being payment due) |
|
|
|
31 Dec | Lessor A/c | Dr. | 250000 |
|
| To Bank A/c |
|
| 250000 |
| (Being amount paid) |
|
|
|
31 Dec | Profit and Loss A/c | Dr. | 250000 |
|
| To Royalty A/c |
|
| 250000 |
| (Being amount charged to relevant a/c) |
|
|
|
Ledgers account in Lessee Books
Lessor A/c
Date | Particulars | Amount |
| Date | Particulars | Amount |
Year1 | To Bank a/c | 100000 |
| Year1 | By Royalty a/c | 45000 |
|
|
|
|
| By Short-workings | 65000 |
|
| 100000 |
|
|
| 100000 |
Year2 | To Bank a/c | 100000 |
| Year2 | By Royalty a/c | 65000 |
|
|
|
|
| By Short-workings | 45000 |
|
| 100000 |
|
|
| 100000 |
Year3 | To Bank a/c | 100000 |
| Year3 | By Royalty a/c | 100000 |
|
| 100000 |
|
|
| 100000 |
Year4 | To Bank a/c | 100000 |
| Year4 | By Royalty a/c | 100000 |
|
| 100000 |
|
|
| 100000 |
Year5 | To Bank a/c | 250000 |
| Year5 | By Royalty a/c | 250000 |
|
| 250000 |
|
|
| 250000 |
Short-workings A/c
Date | Particulars | Amount |
| Date | Particulars | Amount |
Year1 | To Lessor a/c | 65000 |
| Year1 | By balance c/d | 65000 |
|
| 65000 |
|
|
| 65000 |
Year2 | To balance b/d | 65000 |
| Year2 |
|
|
| To Lessor a/c | 45000 |
|
| By balance c/d | 100000 |
|
| 100000 |
|
|
| 100000 |
Year3 | To balance b/d | 100000 |
| Year3 | By Royalty a/c | 25000 |
|
|
|
|
| By balance c/d | 75000 |
|
| 100000 |
|
|
| 100000 |
Year4 | To balance b/d | 75000 |
| Year4 | By Royalty a/c | 35000 |
|
|
|
|
| By P&L a/c | 40000 |
|
| 75000 |
|
|
| 75000 |
Royalty A/c
Date | Particulars | Amount |
| Date | Particulars | Amount |
Year1 | To Lessor | 45000 |
| Year1 | By P&L | 45000 |
|
| 45000 |
|
|
| 45000 |
Year2 | To Lessor | 65000 |
| Year2 | By P&L | 65000 |
|
| 65000 |
|
|
| 65000 |
Year3 | To Lessor | 100000 |
| Year3 | By P&L | 125000 |
| To Short-workings | 25000 |
|
|
|
|
|
| 125000 |
|
|
| 125000 |
Year4 | To Lessor | 100000 |
| Year4 | By P&L | 135000 |
| To Short-workings | 35000 |
|
|
|
|
|
| 135000 |
|
|
| 135000 |
Year5 | To Lessor | 250000 |
| Year5 | By P&L | 250000 |
Q2) X Ltd. had the right to publish and sell books for five years from Bharat. The minimum rent is £ 20000. Royalty is £ 5 per book. Bharat is X Ltd in the first four years. Recognized the right to regain short-term work to. The sales for 5 years are as follows.
Year | Books sold |
1 | 2500 |
2 | 3000 |
3 | 4500 |
4 | 5000 |
5 | 6000 |
Calculate royalties’ payments and short-term work. In addition, we will give you the journals required for Bharat's books for 5 years. You also need to set up an X Ltd account. The book is closed on March 31st every year.
A2) In Bharat's book
Date | Particulars |
| Amount (Dr.) | Amount (Cr.) |
1st Year |
|
|
|
|
31st Mar | X Ltd.’s A/c | Dr. | 20000 |
|
| To Royalty receivable A/c |
|
| 12500 |
| To Short-workings Allowable A/c |
|
| 7500 |
| (Being royalty due from X Ltd. and short-workings allowed) |
|
|
|
31st Mar | Bank A/c | Dr. | 20000 |
|
| To X Ltd.’s A/c |
|
| 20000 |
| (Being money received from X Ltd.) |
|
|
|
31st Mar | Royalty receivable A/c | Dr. | 12500 |
|
| To Profit &Loss A/c |
|
| 12500 |
| (Being royalty received transferred to the Profit &Loss A/c) |
|
|
|
2nd Year |
|
|
|
|
31st Mar | X Ltd.’s A/c | Dr. | 20000 |
|
| To Royalty receivable A/c |
|
| 15000 |
| To Short-workings Allowable A/c |
|
| 5000 |
| (Being royalty due from X Ltd. and short-workings allowed) |
|
|
|
31st Mar | Bank A/c | Dr. | 20000 |
|
| To X Ltd.’s A/c |
|
| 20000 |
| (Being money received from X Ltd.) |
|
|
|
31st Mar | Royalty receivable A/c | Dr. | 15000 |
|
| To Profit &Loss A/c |
|
| 15000 |
| (Being royalty received transferred to the Profit &Loss A/c) |
|
|
|
3rd Year |
|
|
|
|
31st Mar | X Ltd.’s A/c | Dr. | 22500 |
|
| To Royalty receivable A/c |
|
| 22500 |
| (Being royalty due from X Ltd.) |
|
|
|
31st Mar | Short-workings Allowable A/c | Dr. | 2500 |
|
| To X Ltd.’s A/c |
|
| 2500 |
| (Being amount of short-workings recouped) |
|
|
|
31st Mar | Bank A/c | Dr. | 20000 |
|
| To X Ltd.’s A/c |
|
| 20000 |
| (Being money received from X Ltd.) |
|
|
|
31st Mar | Royalty receivable A/c | Dr. | 22500 |
|
| To Profit &Loss A/c |
|
| 22500 |
| (Being royalty received transferred to the Profit &Loss A/c) |
|
|
|
4th Year |
|
|
|
|
31st Mar | X Ltd’s A/c | Dr. | 25000 |
|
| To Royalty receivable A/c |
|
| 25000 |
| (Being royalty due from X Ltd.) |
|
|
|
31st Mar | Short-workings Allowable A/c | Dr. | 5000 |
|
| To X Ltd.’s A/c |
|
| 5000 |
| (Being amount of short-workings recouped) |
|
|
|
31st Mar | Bank A/c | Dr. | 20000 |
|
| To X Ltd.’s A/c |
|
| 20000 |
| (Being money received from X Ltd.) |
|
|
|
31st Mar | Royalty receivable A/c | Dr. | 25000 |
|
| To Profit &Loss A/c |
|
| 25000 |
| (Being royalty received transferred to the Profit &Loss A/c) |
|
|
|
5th Year |
|
|
|
|
31st Mar | X Ltd.’s A/c | Dr. | 30000 |
|
| To Royalty receivable A/c |
|
| 30000 |
| (Being royalty due from X Ltd.) |
|
|
|
31st Mar | Bank A/c | Dr. | 30000 |
|
| To X Ltd.’s A/c |
|
| 30000 |
| (Being money received from X Ltd.) |
|
|
|
31st Mar | Royalty receivable A/c | Dr. | 30000 |
|
| To Profit &Loss A/c |
|
| 30000 |
| (Being royalty received transferred to the Profit &Loss A/c) |
|
|
|
31st Mar | Short-workings Allowable A/c | Dr. | 5000 |
|
| To Profit and Loss A/c |
|
| 5000 |
| (Being the amount of short-workings lapsed) |
|
|
|
X Ltd.’s A/c
Date | Particulars | Amount |
| Date | Particulars | Amount |
1st Year |
|
|
| 1st Year |
|
|
31 Mar | To Royalty receivable A/c | 12500 |
| 31 Mar | By Bank A/c | 20000 |
31 Mar | To Short-workings Allowable A/c | 7500 |
|
|
|
|
|
|
|
|
|
|
|
|
| 20000 |
|
|
| 20000 |
2nd Year |
|
|
| 2nd Year |
|
|
31 Mar | To Royalty receivable A/c | 15000 |
| 31 Mar | By Bank A/c | 20000 |
31 Mar | To Short-workings Allowable A/c | 5000 |
|
|
|
|
|
|
|
|
|
|
|
|
| 20000 |
|
|
| 20000 |
3rd Year |
|
|
| 3rd Year |
|
|
31 Mar | To Royalty receivable A/c | 22500 |
| 31 Mar | By Short-workings Allowable A/c | 2500 |
|
|
|
| 31 Mar | By Bank A/c | 20000 |
|
|
|
|
|
|
|
|
| 22500 |
|
|
| 22500 |
4th Year |
|
|
| 4th Year |
|
|
31 Mar | To Royalty receivable A/c | 25000 |
| 31 Mar | By Short-workings Allowable A/c | 5000 |
|
|
|
| 31 Mar | By Bank A/c | 20000 |
|
|
|
|
|
|
|
|
| 25000 |
|
|
| 25000 |
5th Year |
|
|
| 5th Year |
|
|
31 Mar | To Royalty receivable A/c | 30000 |
| 31 Mar | By Bank A/c | 30000 |
|
|
|
|
|
|
|
|
| 30000 |
|
|
| 30000 |
Working Notes:
Calculation of Royalty, Minimum Rent and Short-workings
Year | Books sold | Rate per book | Royalty | Minimum Rent | Short-workings |
1 | 2500 | 5 | 12500 | 20000 | 7500 |
2 | 3000 | 5 | 15000 | 20000 | 5000 |
3 | 4500 | 5 | 22500 | 20000 |
|
4 | 5000 | 5 | 25000 | 20000 |
|
5 | 6000 | 5 | 30000 | 20000 |
|
Computation of Recoupment, Short-workings carried forward and transferred to profit and loss A/c
Year | Recoupment | Short-workings carried forward | Transferred to P&L A/c | Payment to Bharat |
1 |
| 7500 |
| 20000 |
2 |
| 12500 |
| 20000 |
3 | 2500 | 10000 |
| 20000 |
4 | 5000 | 5000 | 5000 | 20000 |
5 |
|
|
| 30000 |
Q3) Bee Ltd. has acquired the right to publish and sell books from Smith for five years. The minimum rent was fixed at £ 20000. Royalty was fixed at £ 4 per book. Bee Ltd. reserves the right to regain what it worked for in the first four years. The sales for 5 years are displayed. Calculate royalties’ payments and short-term work.
Year | Books sold |
1 | 3000 |
2 | 4000 |
3 | 6000 |
4 | 6500 |
5 | 8000 |
A3)
Calculation of Royalty, Minimum Rent and Short-workings
Year | Books sold | Rate per book | Royalty | Minimum Rent | Short-workings |
1 | 3000 | 4 | 12000 | 20000 | 8000 |
2 | 4000 | 4 | 16000 | 20000 | 4000 |
3 | 6000 | 4 | 24000 | 20000 |
|
4 | 6500 | 4 | 26000 | 20000 |
|
5 | 8000 | 4 | 32000 | 20000 |
|
Computation of Recoupment, Short-workings carried forward and transferred to profit and loss A/c
Year | Recoupment | Short-workings carried forward | Transferred to P&L A/c | Payment to Smith |
1 |
| 8000 |
| 20000 |
2 |
| 12000 |
| 20000 |
3 | 4000 | 8000 |
| 20000 |
4 | 6000 | 2000 | 2000 | 20000 |
5 |
|
|
| 32000 |
Q4) From the information below, open and prepare the required account for the books of M / s Black Diamond Limited.
Analytical Table
Year | Output (Tons) | Royalties @ Rs. 1 Per ton | Short workings | Surplus | Recoupment | Un Recoupable Short workings | Payable to Landlord |
2010 2011 2012 2013 | 40,000 65,000 105,000 90,000 | 40,000 65,000 105,000 90,000 | 35,000 10,000 -- | 30,000 15,000 | -- -- 30,000 | 15,000 | 75,000 75,000 75,000 90,000 |
| 300,000 | 300,000 | 45,000 | 45,000 | 30,000 | 15,000 | 315,000 |
In the books of M/s Black Diamonds Ltd
Royalties Account
Date | Particulars | Amount | Date | Particulars | Amount |
31-12-2010 31-12-2011 31-12-2012 31-12-2013 | To Landlord A/c To Landlord A/c To Landlord A/c To Landlord A/c | 40,000 ======= 65,000 ======= 105,000 ======= 90,000 ======= | 31-12-2010 31-12-2011 31-12-2012 31-12-2013 | By Production A/c By Production A/c By Production A/c By Production A/c | 40,000 ======= 65,000 ======= 105,000 ======= 90,000 ======= |
Landlord Account
Date | Particulars | Amount | Date | Particulars | Amount |
31-12-2010 31-12-2011 | To Bank A/c To Bank A/c | 75,000 ---------- 75,000 ---------- 75,000 ---------- 75,000 ---------- | 31-12-2010 31-12-2011 | By Royalties A/c By Short workings A/c By Royalties A/c By Short workings A/c | 40,000 35,000 ---------- 75,000 ---------- 65,000 10,000 ---------- 75,000 ---------- |
31-12-2012 31-12-2012 31-12-2013 | To Short workings A/c To Bank A/c To Bank A/c | 30,000 75,000 ---------- 105,000 ---------- 90,000 ---------- 90,000 ---------- | 31-12-2012 31-12-2013 | By Royalties A/c By Royalties A/c | 105,000 ---------- 105,000 ---------- 90,000 ---------- 90,000 ---------- |
Date | Particulars | Amount | Date | Particulars | Amount |
31-12-2010 01-01-2011 01-01-2012 | To Landlord A/c To Balance b/d To Landlord A/c To Balance b/d | 35,000 ---------- 35,000 ---------- 35,000 10,000 ---------- 45,000 ---------- 45,000 ---------- 45,000 ---------- | 31-12-2010 31-12-2011 31-12-2012 31-12-2010 | By Balance C/d By Balance C/d By Landlord A/c By Profit & Loss A/c | 35,000 ---------- 35,000 ---------- 45,000 ---------- 45,000 ---------- 30,000 15,000 ---------- 45,000 -------- |
Q4) The M / s Hyderabad publication printed a book on Java at the lowest rent for Rs. 1,000,000 /-Annual royalties are paid in @ rupees. 20 books sold per book. In the first year of publication, Hyderabad publications sold 75,000 books, and in the second year, the number of books sold decreased to 45,000. The amount of royalties will be paid as follows-
Minimum Rent | Royalty Payable | |
Ist Year 75,000 Books X Rs. 20 per book = Rs. 1,5,00,000 | 1,0,00,000 | Rs. 1,5,00,000 |
IInd Year 45,000 Books X Rs. 20 per book = Rs. 9,00,000 | 1,0,00,000 | Rs. 1,0,00,000 |
Short working
The difference between the minimum rent and the actual royalty is known as underwork, where royalties are paid based on the minimum rent due to a shortage of production or sales. For example, if the calculated royalty is Rs. According to the sale of the book based on the above example is 900,000 /-, but the royalty paid is Rs. The minimum rent is 1000,000 and short-term work is rupees. 100,000 (Rs. 1,000,000–Rs. 9,00,000).
Rent
The rent paid annually or semi-annually to the landlord to use the land or surface is known as rent or surface rent.
References: