Before proceeding to the accounting treatment of royalty, it is better to understand the following terms:
1. Minimum Rent
Minimum rent is also known as dead rent, fixed rent, flat rent, rock rent and contract rent. A minimum sum guaranteed to the lessor by the lessee in order to make the lessor receive a minimum amount in any particular period, whether he derived any benefit or not, out of the right is known as minimum rent. It is a pre-determined rent and being disclosed in the royalty agreement where both parties have their consent. But if the production or sale is more than the minimum quantities previously agreed upon, then the royalty will be paid for the actual production. In other words, when the royalty is less than the minimum rent, the lessee pays the minimum rent, but when the royalty exceeds the minimum rent, royalty is payable.
2. Redeemable Dead Rent/Shortworking
Shortworking is that amount by which the minimum rent exceeds actual royalty. In other words, whenever the minimum rent is more than the actual royalty, the difference is called redeemable dead rent. Suppose, if a mine owner agreed to let the mine to a lessee for $ 20,000 for extraction of 1,000 kg. of coal and lessee actually produced only 600kg. of coal. Then $ 8,000(i.e. $20 X 400kg.) is known as shortworking. Shortworking is also called 'royalty suspense' by lessor.
If the actual royalty exceeds minimum rent, it is known as surplus. In the above example, suppose the output for a particular period is 1,500 kg. then $ 10,000 ($ 20 X 500) is referred as surplus.
4. Recoupment Of Shortwirking
Generally, a royalty agreement contains a provision for carrying forward of shortworking with a view to adjust in the future in. In the subsequent years, such shortworking is adjusted against the surplus royalty. This process of adjustment is called recoupment of shortworking.
5. Strike And Lock Out
Strike is the outcome of labor force unrest in the work and it is being called by the labor unions. On the other hand, lock out is the right of the owner of the assets fulfilling legal necessities to close down the working site.But the result of both the cases show the production stoppage. In such event, the actual production could be badly affected and may not be sufficient to pay the minimum rent. Under such condition, the lessor may accept royalty on the basis of actual output. The provision to this effect must be presented in the royalty agreement.