Problems including Strikes and Lockouts, but excluding Sub-lease
15/10/2024Businesses or Individuals pay royalty fees to the owner of an asset (such as intellectual property, natural resources, or land) based on usage or output. However, there are specific real-world challenges like strikes and lockouts that may affect the calculation and payment of royalties. These challenges often lead to complications in maintaining minimum rent agreements and managing short workings.
Strike
Strike is a work stoppage caused by the refusal of employees to work, usually due to a labor dispute with the employer. During a strike, production often ceases or drastically reduces, leading to reduced output or no production at all.
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Implication on Royalty Accounting:
In situations where royalty is based on output (e.g., extraction of minerals or manufacturing), a strike can significantly reduce production. This may result in actual royalty falling below the minimum rent, leading to short workings. The lessee may not be able to generate sufficient revenue to cover the minimum rent.
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Accounting Treatment During Strikes:
If a strike continues for a prolonged period, agreements may provide for certain exemptions from paying minimum rent. The lessee may be required to negotiate with the lessor to allow for deferment or waiver of short workings. However, if such provisions are not in place, the lessee will need to account for short workings as usual.
Lockout
Lockout is when an employer prevents employees from working during a dispute. This situation is similar to a strike in terms of its effect on production but is initiated by the employer rather than the workers.
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Implication on Royalty Accounting:
Like strikes, lockouts can lead to reduced or halted production, resulting in lower actual royalties and possibly short workings. The lessee may not meet the minimum royalty obligation during the lockout period.
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Accounting Treatment During Lockouts:
Depending on the terms of the agreement, a provision for lockouts might be in place, allowing for the deferment of short workings or an exemption from minimum rent obligations. If there are no provisions, the lessee will have to account for short workings as normal.
Journal Entries in Case of Strikes and Lockouts:
Let’s explore how royalty accounting would be handled in cases of strikes and lockouts, assuming no provision exists for exemptions or deferments.
Example Scenario
- Minimum Rent: ₹100,000
- Normal Output-Based Royalty Rate: ₹50 per unit
- Output During Strike (Year 1): 1,200 units
- Output During Lockout (Year 2): 1,500 units
Year 1: Strike Leads to Short Workings
Due to the strike, the output is lower than expected, leading to actual royalty falling below the minimum rent.
| Particulars | Debit (₹) | Credit (₹) |
| Royalty Account Dr. | 60,000 | – |
| To Lessor’s Account | – | 60,000 |
| (Being actual royalty payable based on output of 1,200 units at ₹50/unit) | – | – |
| Short Workings Account Dr. | 40,000 | – |
| To Lessor’s Account | – | 40,000 |
| (Being short workings transferred to Short Workings Account) | – | – |
| Lessor’s Account Dr. | 100,000 | – |
| To Bank Account | – | 100,000 |
| (Being minimum rent paid to lessor) | – | — |
Year 2: Lockout Again Leads to Short Workings
A lockout reduces production, again resulting in lower royalty than the minimum rent.
| Particulars | Debit (₹) | Credit (₹) |
| Royalty Account Dr. | 75,000 | – |
| To Lessor’s Account | – | 75,000 |
| (Being actual royalty payable based on output of 1,500 units at ₹50/unit) | – | – |
| Short Workings Account Dr. | 25,000 | – |
| To Lessor’s Account | – | 25,000 |
| (Being short workings transferred to Short Workings Account) | – | – |
| Lessor’s Account Dr. | 100,000 | – |
| To Bank Account | – | 100,000 |
| (Being minimum rent paid to lessor) | – | – |
Floating Recoupment of Short Workings in Case of Strikes and Lockouts
The lessee may recoup short workings in the future when production resumes or exceeds the minimum rent requirement.
Year 3: Recoupment of Short Workings (Floating Method)
- Output: 3,000 units
- Royalty Rate: ₹50 per unit
- Royalty Payable: ₹150,000
- Recoupment of Short Workings from Year 1 and Year 2: ₹40,000 + ₹25,000 = ₹65,000
| Particulars | Debit (₹) | Credit (₹) |
| Royalty Account Dr. | 150,000 | – |
| To Lessor’s Account | – | 150,000 |
| (Being actual royalty payable based on output of 3,000 units at ₹50/unit) | – | – |
| Short Workings Recouped Account Dr. | 65,000 | – |
| To Short Workings Account | – | 65,000 |
| (Being short workings recouped from Year 1 and Year 2) | – | – |
| Lessor’s Account Dr. | 150,000 | – |
| To Bank Account | – | 150,000 |
| (Being payment made to lessor) | – |
Special Considerations During Strikes and Lockouts
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Deferment or Waiver Clauses:
Many royalty agreements include provisions for waiver or deferment of minimum rent during strikes or lockouts. In such cases, the lessee would not be required to record short workings.
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Force Majeure Clauses:
Strikes and lockouts are often covered under force majeure clauses, allowing for temporary suspension of contractual obligations.
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Provision for Adjusting Short Workings:
The lessee may negotiate an extension of the recoupment period if strikes or lockouts severely impact production.
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Contractual Clauses:
In some agreements, the contract might specify that the lessee is not liable for short workings in case of strikes or lockouts.