Preston Company owns a royalty interest in an oil well. The contract stipulates that Preston will receive royalty payments semiannually
on Jan 31 and July 31. The Jan 31 payment will be for 20% of the oil sold to jobbers between the previous June 1 & Nov 30, and the Jul 31 payment will be for oil sold between the previous Dec 1 and May 31. Royalty receipts for 2008 amounted to $80,000 to $100,000 on Jan 31 and Jul 31 respectively.
On Dec 31 2007, accrued royalty revenue receivable amounted to $15,000. Production reports show the following oil sales:
June 1 - Nov 30, 2007 $400,000
Dec 1 - May 31, 2008 $500,000
June 1 - Nov 30, 2008 $425,000
Dec 1 - Dec 31, 2008 $70,000
What amount should Preston report as royalty revenue for 2008?
Preston company has the option of following one of three alternative methods for accounting of its royalty income, and the answer to the question posed will depend on which particular method is used. The three alternatives accounting methods are based in income accrued, due and payment received.
In the income accrued method whatever is the royalty applicable on production from January 1, 2008 to December 31, 2008, will be treated as revenue for the year 2008. From the figures provided it is not possible to ascertain this figure as income for the period December 1, 2007 to December 31, 2007, has not been reported separately. Because of this we can assume that Preston is not following this method. However, if we assume that the figure of $15,000 described as "accrued royalty revenue receivable" on December 31, 2007 represents 20% royalty on production for December 1, 2007 to December 31, 2007, then production for this period can be assumed to be $75,000. In that case accrued revenue for the year 2008 can be calculated as follow:
Income for Dec 1 - May 31, 2008: $100,000
Less Income for Dec 1 - Dec 31 2008: $15,000
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $85,000
Add: Income for June 1 - Nov 30, 2008 $84,500
Add: Income for Dec 1 - Dec 31, 2008 $14,000
Total accrued income for 2008 $183,500
In the income due method, whatever royalty payments become due for payment in a year are treated as income for the year. By this method the royalty payments that become due in the year 2008 include $80,000 due on on January 31 2008 for the production fro June 1, 2007 to November 30, 2007, and $100,000 due on July 31, 2008 for the production from December 1, 2007 to May 31, 2008., giving a total of $180,000.
In the income payment received method the payment against income actually received during a year are treated as income for the year. Information on this is also not available. Therefor, we assume that Preston is not using this method.
Therefore we can say that Preston is using the income payment due method for accounting of its income. Therefor, it should report $180,000 as royalty revenues for the year 2008. Any amount against royalty on production up to May 31, 2008, that remain unpaid up to December 31, 2008 will then be reported as Amount receivable against royalty.