Let's talk about royalties in accounting

July 23, 2015

In many business areas intellectual property developed by a company or individual is licensed to another party under royalty agreements. The article below describes what royalties are and provides general rules for accounting for royalty arrangements.

1. The nature of royalties

Royalties are periodic payments to the seller for the right to use intellectual property.

Royalty arrangements are designed to benefit both the seller and the buyer of intellectual property rights, giving opportunity for the one party to increase its market share or expand into a new market, while the other party diversifies its product range and gains access to specific services or goods difficult to produce on its own.

Royalties are common in the publishing industry because publishers often do not employ writers and instead prefer to work with independent authors. Other examples of royalty related industries include (but are not limited to):

  • Music industry, where artists earn their royalties from the sale of their music works on CDs or online.
  • Broadcasting media, where composers earn royalties each time their composition is broadcasted.
  • Video game industry, where game producers usually receive royalties for additional sales of their newly developed video games if they meet certain revenue targets.
  • Mobile application industry, where mobile operators get royalties for selling third party apps in their virtual stores.
  • Film industry, where there are such royalty players as actors, producers, writes of scripts etc.
  • Mineral resources industry, where companies usually pay landowners some royalty rate for the right to extract natural resources, such as petroleum, natural gas, silver or other.
  • Other industries, where royalties are paid to designers, sport teams and celebrities for the right to use their logo or trademark on promotional materials, clothes or commodities.

The way royalties are determined highly depends on the industry. Sometimes license contracts stipulate royalties as a percentage of net income, and sometimes royalties depend upon the number of items used or sold. Also, it is common to make upfront payments for future royalties. For instance, if a book generates more royalties than the advance royalty payment to the author, then additional royalty amounts are to be paid; however, if it is not the case, then the advance is generally not refundable by the author.

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