[Lighthaven]

Tomahawk Exporters, Inc. is the owner of patent #1234. On January 1, Year 1, Tomahawk entered into a patent license agreement with Cherokee Manufacturers, Inc. The agreement calls for an initial lump-sum payment of $100,000 and an ongoing royalty of 5% of the selling price of any product produced under patent #1234. These payments are to be made yearly on January 31 covering all sales made in the previous calendar year. The $100,000 is non-refundable but can be applied against any on-going 5% royalty payments. During Year 1, Cherokee’s sales of licensed product amounted to $1,800,000. How much royalty revenue should Tomahawk record in Year 1?

a. $0

b. $ 90,000

c. $190,000

d. $100,000

Answer: Choice “b” is correct. Royalty revenue for the year = $1,800,000 x .05 = $90,000. Since the initial $100,000 payment can be applied against future royalty payments, it should be recorded as “Deferred Revenue” (a liability). The fact that it is non-refundable does not change the accounting.

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I’m confused on what the $100,000 represents. I know it says it can be applied to future royalty payments. Does that mean reduce royalty revenue on Tomahawk’s books…? I know that can’t be right though because it’s a deferred revenue (which I’m also a little confused on). Any help would be greatly appreciated!

AUD - 83
REG - 81 (2x)
FAR - 78
BEC - 85

And that's all she wrote.