UNDERWRITING OF SHARES AND DEBENTURES

Underwriting is an agreement where by the underwriters ensure the company that in case the shares and debentures offered to the public, are not subscribed by the public to the extent, the balance of shares and debentures will be taken up by the underwriters.

The firms or persons who are engaged in underwriting are called underwriters. The commission payable to underwriters for underwriting is known as underwriting commission.

Advantages of Underwriting

1. The company is sure of getting the value of shares issued

2. It enhances goodwill of the company

3. It facilitates wide distribution of securities

4. The company gets expert advice from underwriters in the matter of marketing securities

5. It fulfills requirement of minimum subscription

Provisions regarding Underwriting

1. A company cannot pay any commission on the issue of shares unless permitted by its Articles.

2. Commission cannot be paid to any person for shares or debentures which are not offered to the public for subscription.

3. The commission is limited to 5% of issue price in case of shares and 2 ½ % in case of debentures. However, in practice, SEBI has allowed underwriting commission only at the rate of 2.5% of issue price of equity shares.

4. The amount or rate of commission should be disclosed in the prospectus.

5. The directors must state in the prospectus that the underwriters are capable of meeting their obligations under the underwriting contract.

Types of Underwriting

1. Open Underwriting (Conditional Underwriting)

Under this type of underwriting, the underwriter agrees to take up shares or debentures only when the issue is not subscribed by the public in full.

2. Firm Underwriting

When an underwriter agrees to buy a definite number of shares or debentures in addition to the shares or debentures he has to take under the underwriting agreement, it is called firm underwriting. Even if the issue is over subscribed, underwriters are liable to take up the agreed number of shares in case of firm underwriting.

Marked or Unmarked Application

Generally shares or debentures of a company are underwritten by two or more underwriters in an agreed ratio. Usually the forms are stamped with the name of the underwriters in order to distinguish the forms of one underwriter from that of others. Such stamped applications when received are called marked applications. The application forms which are received by the company without any name of the underwriter are called unmarked applications

Journal Entries in the books of the Company

1. In case the whole of shares or debentures are not taken up by the public, the remaining is allotted to underwriters. The entry is:

            Underwriters A/c                                                  Dr

                                To Share Capital A/c

                                To Debentures A/c

                (Balance of shares and debentures allotted to underwriters)

2. For commission due:

            Underwriting Commission A/c                          Dr

                                To Underwriters

3. For payment of commission:

                Underwriter A/c                                                    Dr

                                To Bank                                                                (cheque)

                                To Share Capital A/c                          (shares)

                                To Debentures A/c                              (debentures)

4. For the balance amount due from underwriters received:

                Bank A/c                                                               Dr

                                To Underwriters A/c

Determination of Liability in respect of Underwriting Contract

a) When issue is fully underwritten (without Firm Underwriting)

            When the entire issue has been underwritten by one underwriter, the liability of the underwriter is calculated as follows:

Liability = No. of shares underwritten – Total no. of application

If the entire issue has been underwritten by two or more underwriters, all unmarked applications are divided between them in the ratio of gross liability of individual underwriter.

Liability of each underwriter is calculated as follows:

Gross liability according to the agreed ratio                                       ………..

Less: Marked applications                                                               ………..

            Balance left                                                                          ………..

Less: Unmarked application in the ratio of gross liability                    ………..

                        Net liability                                                                          ………...

b) When the issue is fully underwritten (with Firm Underwriting)                                     

  Liability of each underwriter is calculated as follows:

Gross liability according to the agreed ratio                                       ………..

Less: Marked applications (excluding firm underwriting)                       ………..

            Balance left                                                                          ………..

Less: *Unmarked application in the ratio of gross liability                  ………..

                        Net liability                                                                          ………...

            Add: Firm underwriting                                                                    …….......                      

Total liability                                                                                               …………

* No. of Unmarked application = Total subscription excluding firm underwriting – Marked application excluding firm underwriting + Application under firm underwriting.

c) When the issue is partially underwritten

Liability = Gross Liability – Marked application + Firm underwriting (if there is firm underwriting)

Note: If no information is given regarding marked and unmarked application, marked application is calculated as follows:

Marked applications = Total No. of application received x % of underwriting

Underwriting Account

            This account is prepared by the underwriter to ascertain the profit or loss on underwriting. It is a nominal account and is prepared like a P/L A/c                      

FROM VARIOUS FINANCIAL ACCPUNTING BOOKS