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

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ISSUE OF BONUS SHARES

Bonus may be paid in cash or in shares:

            Cash bonus is given when the company has sufficient cash to pay without affecting the working capital

Capital Bonus (Bonus Share)

            If cash is insufficient and if payment of cash bonus is likely to affect the working capital the company may issue bonus shares instead of cash bonus. Capital bonus is given by making partly paid shares fully paid without getting cash from the shareholders or it is given by issue of fully paid shares.

            Bonus shares are those shares which are issued by a company free of charge to the existing shareholders of a company out of its large reserves created out of past profits.

Circumstances of issuing Bonus Shares

1. When the company wishes to capitalize its reserves

2. When the company has not sufficient cash reserves

3. When value of fixed assets of a company exceeded its capital, the difference is capitalized by issuing bonus shares

4. To avoid problems like demand by the workers for higher wages

SEBI Guidelines for Issue of Bonus Shares

1. The bonus issue can be made only out of free reserves built out of the genuine profits or securities premium collected in cash.

2. Reserves created by revaluation of fixed assets are not available for issue of bonus shares

3. The bonus issue cannot be made unless the partly-paid shares, if any, existing, are made fully paid-up

4. The declaration of bonus issue, in lieu of dividend, cannot be made

5. Once the company announces bonus issue after the approval of Board of Directors, the proposal must be implemented within a period of six months from the date of such approval and it does not have option of changing the decision

6. If there is no provision in the Articles for the capitalization of reserves, the company must pass a Resolution at its General Body Meeting to make provisions in the Articles

7. If consequent to the issue of bonus shares, the subscribe and paid-up capital exceeds the authorized capital, a Resolution shall be passed by the company at its General Body Meeting for increasing the authorized capital

Funds or Sources for Bonus Issue

A .Revenue Reserves/Profits

            1. Credit balance in the profit and loss account

            2. General Reserves

            3. Credit balance in the Sinking Fund Account for the redemption of a liability    after the redemption of the liability

            4. Dividend equalization reserve

 B. Capital Reserves/profits

            1. Profit prior to incorporation

            2. Profit on sale of fixed assets or business

            3. Capital Redemption Reserve created for redemption of preference share

            4. Security Premium collected in cash only

Note: Capital Redemption Reserve Account and Security Premium Account can be utilized only for issuing fully paid bonus shares

Accounting Treatment

            Bonus share can be issued at par or at premium. Bonus share can be given:

a) By making partly paid shares as fully paid

b) By issuing fully paid shares

When fully paid bonus shares are issued

1. For the transfer of amount for the issue of bonus shares (on declaration of bonus)

            Profit and Loss A/c                             Dr

            General Reserve A/c                           Dr

            Capital Redemption Reserve A/c       Dr

            Security Premium A/c                         Dr

            Capital Reserve A/c                            Dr

            Any other Reserve A/c                        Dr

                        To Bonus to Shareholders A/c

2.  on issue of bonus shares

            Bonus to Shareholders A/c                 Dr

                        To Share Capital

                        To Security Premium A/c        (if bonus shares are issued at premium)

When Bonus is given to convert partly paid shares into fully paid

1. On the declaration of bonus

           

Profit and Loss A/c                             Dr

            General Reserve A/c                           Dr

            Capital Reserve A/c                            Dr

                                    To Bonus to Shareholders A/c

2. On making the final call due

            Share Final Call A/c                            Dr

                        To Share Capital

3. On utilization of bonus to make the share paid-up

            Bonus to Shareholders A/c                 Dr

                        To Share Final Call A/c

Journal Entry for Cash Bonus

       1)  P&L Appropriation A/c                      Dr

                        To Bonus Payable

       2)  Bonus Payable A/c                              Dr

                        To Bank

Based on Financial Accounting Books

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Budgeting and Budgetary Control

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What is the meaning of useful life of a non-current (fixed) asset?

In the calculation of depreciation of a non current asset, we need to know about the useful life of the asset.

Depreciation is the diminution in the value of an asset over period of time by internal factors (like wear and tear) or/and by external factors (like technology advancement).

The useful life of an asset means the period of time during which the asset can be used in a profitable way. That mean after this period, the cost of maintaining an asset will exceed the benefits expected to be achieved by the use of that asset.

Estimated or actual useful life can be used in the calculation of depreciation.

So, after the useful life of an asset it is better to consider replacement of the asset

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Company Accounts - Basics

Meaning and Definition of Company

            A company is a voluntary association of many persons. It is an artificial person recognized by law with a distinctive name, a common seal, a common capital and having perpetual succession.

            Indian Companies Act 1956 defines a company as “Company formed and registered under this Act or an existing company”

Characteristics of a company

            Refer above

Types of companies: - can be classified --

A. On the basis of incorporation

1. Chartered company:-incorporated under a special charter by the Head of the State

2. Statutory company:-created by special Act in Parliament. Eg: SBI, RBI, LIC

3. Registered company: - formed and registered in India with the Registrar of Companies under the provisions of the Companies Act

B. On the basis of liability of members

1. Company limited by shares: - here the members’ liability is limited to the extent of value of shares held by them

2. Company limited by guarantee: - liability of member is limited to the amount of guarantee stated in the memorandum

3. Unlimited company: - liability of member is unlimited

C. On the basis of public interest

1. Private company: A private company is one which by its Articles,

            a) Limits the number of members to 50

            b) Prohibits the invitation to the public to subscribe its shares or debentures &

            c) Restricts the transferability of its shares.

2. Public company: - one which is not a private company

Minimum Subscription

            It is the minimum amount of capital fixed by the directors to be raised from the members by way of subscription. It must be stated in the Articles of Association and Prospectus. No allotment of shares can be made unless the minimum subscription is realized from the applicants of shares.

The amount of minimum subscription must cover the following:

1. The purchase price of any property purchased or to be purchased which is to be met out of the proceeds of the issue.

2. Preliminary expenses payable by the company.

3. Commission on shares payable by the company.

4. Repayment of loans taken by the company in respect of the above mentioned matters.

5. Working capital

Share Capital

            The capital of a company known as share capital and is divided in to different units with definite value called shares. The main divisions of share capital are:

 1. Nominal or Registered or Authorized Capital: - the capital with which accompany is registered is called the authorized capital. It is the maximum amount of capital that a company can issue.

2. Issued capital: - part of authorized capital which is offered to the public for subscription. Remaining part is unissued capital

3. Subscribed capital: - part of issued capital for which applications are received from the public. Remaining part is unsubscribed capital

4. Called up capital: -The amount on the shares which is actually demanded by the company to be paid

5. Paid up capital: -part of called up capital which has actually been paid up by the shareholders. The sum still to be paid is known as calls in arrears

6. Reserve capital: - that portion of the uncalled capital which is kept in reserve and which will be called up only on winding up of the company. A limited company by passing a special resolution may set apart a portion of the uncalled capital as reserve capital

Types of shares: can be classified in to Preference Shares and Equity Shares

Preference Shares: -those shares which carry preferential right in respect of payment of dividend and repayment of capital in the event of winding up. The rate of dividend on preference share is fixed. This dividend is payable before any dividend is paid on equity shares. Preference share may of the following types:

1. Cumulative Preference Shares: In the case of this type of shares, the arrears of dividend, if any, are carried forward and paid out of the profits of subsequent years

2. Non- Cumulative Preference Shares:

3. Participating   Preference Shares: In addition to fixed rate of dividend, these shares have the right to participate in the surplus profit left after paying a reasonable rate of dividend on equity shares

4. Non-Participating   Preference Shares: These shares get only fixed rate of dividend

5. Redeemable Preference Shares: - are repayable after the expiry of the fixed period or at the option of the company.

6. Convertible Preference Shares: These shares are given right of conversion into equity shares within a specified period or at a specified date according to the terms of issue.

Equity Shares (ordinary shares)

            Equity shares are those which are not preference shares. They do not carry any preferential right in respect of dividend or repayment of capital. Dividend is paid after the payment on preference shares. The rate of dividend is not fixed. Equity shareholders get full voting power.

Sweat Equity Shares

            These are equity shares issued by the company to employees or directors at a discount or for consideration other than cash for providing know-how or making available rights in the nature of intellectual property rights or value additions.

Stock

            It is a consolidation of fully paid shares. Lord Hatherly defines “Stock is a set of shares put together in a bundle” It has no definite value

Differences between Stock and Shares

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