Ot Company acquired rights to a patent from Crey under a licensing agreement that required an advance royalty payment when the agreement was signed. Ot remits royalties earned and due under the agreement on October 31 each year. Additionally, on the same date, Ot pays, in advance, estimated royalties for the next year. Ot adjusts prepaid royalties at year-end. Information for the year ended December 31, year 2, is as follows:
| Date | Amount | |
| 01/01/Y2 | Prepaid royalties | $ 65,000 |
| 10/31/Y2 | Royalty payment (charged to royalty expense) | 110,000 |
| 12/31/Y2 | Year-end credit adjustment to royalty expense | 25,000 |
In its December 31, year 2 balance sheet, Ot should report prepaid royalties of
A. $25,000
B. $40,000
C. $90,000
D. $85,000
Answer:C
C is corrent. On 1/1/Y2, the balance of prepaid royalties was $65,000. Ott makes no entries to this account until year-end, so the 12/31/Y2 balance before adjustment was still $65,000. On 10/31/Y2, Ott made a $110,000 royalty payment which included payment in advance for year 3 royalties. However, under Ott’s system, all such payments are debited to royalty expense when paid, and any necessary adjustments to prepaid royalties are made at year-end. At 12/31/Y2, Ott made a credit adjustment to royalty expense:
| Prepaid royalties | 25,000 | |
| Royalty expense | 25,000 |
Therefore, the 12/31/Y2 balance of prepaid royalties is $90,000 ($65,000 + $25,000).
