Accounting Treatment in the Books of Lessee

In a royalty agreement, the lessee (tenant) pays the lessor (landlord) for the use of land, property, or other resources. The lessee records journal entries for royalty payments, minimum rent (also known as dead rent), short workings, and recoupment of short workings in their books of accounts. These transactions are reflected in both the Journal Entries and Ledger Accounts.

Key Components in Lessee’s Books:

1. Royalty Payments:

Payments made by the lessee based on the actual production or sales of goods or resources.

2. Minimum Rent (Dead Rent):

The minimum payment that must be made to the lessor, regardless of production levels.

3. Short Workings:

The difference when the royalty based on actual production is less than the minimum rent.

4. Recoupment of Short Workings:

The process by which the lessee recovers the short workings in future years when actual production exceeds the minimum rent.

Example Scenario

Consider a situation where:

• Minimum Rent (Dead Rent) = ₹100,000
• Actual Royalty (based on production) = ₹80,000 in Year 1, ₹120,000 in Year 2
• Short Workings in Year 1 = ₹20,000 (₹100,000 – ₹80,000)
• Recoupment of Short Workings in Year 2 = ₹20,000

Journal Entries in the Books of Lessee

Ledger Accounts in the Books of Lessee:

1. Royalty Account

2. Minimum Rent Account

3. Short Workings Account

4. Lessor’s Account

5. Short Workings Recouped Account

6. Bank Account

Explanation of Journal Entries

1. Year 1 Entries:
   • The first entry records the royalty amount based on actual production.
   • The second entry records the minimum rent payable to the lessor.
   • The short workings are recorded when the actual royalty is less than the minimum rent.
   • Finally, the payment to the lessor is recorded by crediting the bank account.
2. Year 2 Entries:
   • The actual royalty exceeds the minimum rent, so no short workings are created.
   • The short workings from Year 1 are recouped by reducing the royalty payment in Year 2.

Explanation of Ledger Accounts

• Royalty Account reflects the actual royalty amounts based on production.
• Minimum Rent Account shows the minimum rent payable each year.
• Short Workings Account records the shortfall between minimum rent and actual royalty.
• Lessor’s Account tracks payments made to the lessor and any amounts owed.
• Short Workings Recouped Account tracks the amount of short workings recovered in subsequent years.
• Bank Account reflects the cash payments made to the lessor.