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CH- Underwriting of Shares

UNDERWRITING OF SHARES

Underwriters and Brokers

The persons or institutions underwriting a public issue of shares or debentures are called
‘Underwriters’. The underwriters may be individuals, partnership firms or joint stock
companies. But, an issue of shares or debentures is hardly underwritten by a single individual as
it involves more risk and attaches greater responsibility. Generally, an issue of shares or
debentures of a company is underwritten by two or more firms jointly. Some specialized
financial institutions set up by the Government in the public sector are also playing an active
role these days in underwriting shares or debentures of a company.

Brokers merely promise or try to procure subscriptions to the shares or debentures issued; they
do not take any responsibility of subscribing to the shares or debentures of the company. They
simply procure subscriptions for shares or debentures from the public on behalf of the
company and in exchange of their service rendered to the company, they get remuneration
called brokerage.

Types of Underwriting
An underwriting agreement may be of any one of the following types:
(a) Complete Underwriting
If the whole of the issue of shares or debentures of a company is underwritten, it is said to be
complete underwriting.
In such a case, the whole of the issue of shares or debentures may be underwritten by –
(a) one firm or institution, agreeing to take the entire risk;
(b) a number of firms or institutions, each agreeing to take risk only to a limited extent.

(b) Partial Underwriting

If only a part of the issue of shares or debentures of a company is underwritten, it is said to be
partial underwriting.
The part of the issue of shares or debentures may be underwritten by -
(a) One person or institution;
(b) A number of firms or institutions each agreeing to take risk only to a limited extent.
In case of partial underwriting, the company is treated as “Underwriter” for the remaining part
of the issue.

(c) Firm Underwriting

It refers to a definite commitment by the underwriter or underwriters to take up a specified
number of shares or debentures of a company irrespective of the number of shares or
debentures subscribed for by the public. In such a case, the underwriters are committed to take
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up the agreed number of shares or debentures in addition to unsubscribed shares or

debentures, if any. Even if the issue is over-subscribed, the underwriters are liable to
take up the agreed number of shares of debentures.

Underwriting Commission
The consideration payable to the underwriters for underwriting the issue of shares or
debentures of a company is called underwriting commission. Such a commission is paid at a
specified rate on the issue price of the whole of the shares or debentures underwritten
whether or not the underwriters are called upon to take up any shares
or debentures. Thus, the underwriters are paid for the risk they bear in the placing of shares
before the public.
Underwriting commission may be in addition to brokerage.

Payment of Underwriting Commission

Section 40 (6) of the Companies Act 2013, provides that a company may pay commission to any
person in connection with the subscription or procurement of subscription to its securities,
whether absolute or conditional, subject to the following conditions which are prescribed under
Companies (Prospectus and Allotment of Securities) Rules, 2014:
(a) the payment of such commission shall be authorized in the company’s articles of
association;
(b) the commission may be paid out of proceeds of the issue or the profit of the company or
both;
(c) the rate of commission paid or agreed to be paid shall not exceed, in case of shares, five
percent (5%) of the price at which the shares are issued or a rate authorised by the articles,
whichever is less, and in case of debentures, shall not exceed two and a half per cent (2.5 %) of
the price at which the debentures are issued, or as specified in the company’s articles,
whichever is less;

(d) the prospectus of the company shall disclose -

– the name of the underwriters;
– the rate and amount of the commission payable to the underwriter; and
– the number of securities which is to be underwritten or subscribed by the underwriter
absolutely or conditionally.
(e) there shall not be paid commission to any underwriter on securities which are not offered to
the public for subscription;
(f) a copy of the contract for the payment of commission is delivered to the Registrar at the
time of delivery of the prospectus for registration.

Thus, the Underwriting commission is limited to 5% of issue price in case of shares and 2.5% in
case of debentures.
The rates of commission given above are maximum rates. The company is free to negotiate
lower rates with underwriters.
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Marked and Unmarked Applications

When the issue of shares or debentures of a company is underwritten by two or more persons,
it is usual that the applications for shares or debentures sent through the underwriters should
bear a stamp of the respective underwriters. Otherwise, it would be very difficult for the
company to determine how many applications have been received through a particular
underwriter and, unless this is determined properly, the company would face a problem in
determining the liability of the individual underwriters. Thus, the applications bearing the
stamp of the respective underwriters are called “Marked Applications” while the applications
received directly by the company which do not bear any stamp of the underwriters are called
“Unmarked Applications”.

If the entire issue of shares or debentures is underwritten by only one underwriter, the marking
of applications is immaterial since he is to get credit of all the applications whether sent
through him or received directly in determining his liability. But, the issue of shares or
debentures is, generally, underwritten by more than one underwriter as the risk is distributed
among the underwriters in an agreed ratio. In such a case, it is essential that the applications
sent through the underwriters should be marked properly so as to determine their respective
liability correctly.

Determining the Liability of Underwriters

The liability of the underwriter or underwriters would be determined in the following ways:

Complete Underwriting

(a) If the whole of the issue of shares or debentures is underwritten only by one underwriter:
In such a case, the underwriter will be liable to take up all the shares or debentures that have
not been subscribed for by the public. For determining his liability, it is not material to know
how many applications are sent through him and how many applications are received directly
by the company. Thus, the liability of the underwriter in such a case will be as follows:

Liability = Shares or debentures offered – Total applications received.

It is to be noted here that if the shares or debentures are oversubscribed or fully subscribed by
the public, the underwriter is free from his liability and cannot be called upon to take up any
shares or debentures of the company. But he will be entitled to get his commission on the total
issue price of the shares or debentures. He must of course take up the shares or debentures as
per “Firm Underwriting”.
Automatically, this will reduce his liability in case there is under subscription.

(b) If the whole of the issue of shares or debentures is underwritten by a number of

underwriters in an agreed ratio:
In such a case, the liability of the respective underwriters can be determined as
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follows:
The gross liability of each underwriter according to the agreed ratio should be reduced first by
the marked applications and then credit may be given in respect of unmarked applications sent
directly to the company by way of deduction from the balance left in the ratio of their gross
liability. Thus, the liability of each underwriter in such a case will be as follows:

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

Less: Marked applications .................
Balance left ..................
Less: Unmarked applications in the ratio of gross liability ..................
Net liability ..................

Sometimes credit to unmarked application is given in the ratio of gross liability as reduced by
the marked applications. The individual liability calculated in this way will differ from the
liability calculated as per the earlier procedure.

Note:- In case some figure is in minus then transfer that figure to other underwriters’ account
in the ratio of gross liability inter se. This gives the liability of underwriters on account of short
fall in the public subscription.

Partial Underwriting
(a) If a part of the issue of shares or debentures is underwritten only by one underwriter: In
such a case, only a part of the whole issue, say 60% or 70% is underwritten only by one
underwriter and so far as the balance 40% or 30% of the issue is concerned, the company itself
is said to have underwritten the same. As such, the unmarked applications are treated as
marked as far as the company is concerned.

In such a case, the gross liability of the underwriter will be that part of the issue of shares or
debentures which is underwritten, say 60% or 70% and the net liability will be determined by
deducting the marked applications (the applications sent through him) from the gross liability.
Thus, the net liability will be determined as follows:

Net liability = Gross liability (say 60% or 70% of the issue) – Marked applications.

It is to be noted here that if the marked applications exceed or equal the number of shares or
debentures underwritten the underwriter is free from his liability and cannot be called upon to
take up any shares or debentures of the company. Similarly, if all the shares or debentures are
subscribed the underwriter is free from his liability in spite of the fact the marked applications
are less than the number of shares or debentures underwritten.

(b) If the part of the issue of shares or debentures is underwritten by a number of

underwriters: In such a case only a part of the whole issue, say 60% or 70% or 80% is
underwritten by a number of underwriters and so far as the balance 40% or 30% or 20% is
concerned, the company itself is said to have underwritten the same. As such, the unmarked
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applications are treated as marked so far as the company is concerned. In such a case, the
method of determining the net liability of the respective underwriters is similar to the method
discussed (a) above.

Firm Underwriting
In the case of ‘firm underwriting’, the underwriters take up the agreed number of shares or
debentures ‘firm underwritten’ in addition to unsubscribed shares or debentures, if any. In such
an instance, an underwriter is not allowed to set off his firm underwriting against his liability
otherwise determined, that he will have to subscribe both for shares/debentures ‘underwritten
firm’ and for shares which he has to take under the underwriting contract, ignoring firm
underwriting.
While computing the individual liability of the underwriters, the ‘firm underwriting’ can be dealt
with in any of the following manner in the absence of any specific instructions:

(a) The ‘firm underwriting’ may be adjusted against the individual liability of each underwriter
separately or may be treated at par with marked applications.
When firm underwriting is treated at par with marked applications

In such a case, the statement of liability of underwriters will be as under:

Gross Liability (agreed ratio-total shares underwritten) ....................

Less: Marked applications including firm underwriting ....................
Balance left
Less: Unmarked application (ratio of gross liability) ....................
Net liability
Add: Firm underwriting ....................
Total Liability ....................

(b) The benefit of ‘firm underwriting’ may be shared by all underwriters or firm underwriting
may be treated at par with unmarked applications. In such case, the shares/debentures
underwritten firm will be included in the unmarked forms. In such case, the state of liability of
underwriters will appear as shown above except that shares/debentures underwritten firm by
each underwriter will not be specifically adjusted against his individual liability but will be
included in the total unmarked forms to be distributed amongst all underwriters in the ratio of
their gross liability.

Accounting Treatment relating to Underwriting of Shares or Debentures

(a) When the shares or debentures are allotted to the underwriters in respect of their liability:

Underwriters A/c Dr. ( with the value of the shares or debentures taken up by the underwriters)
To Share Capital A/c
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To Debentures A/c

(b) When commission becomes payable to the underwriters:

Underwriters Commission A/c Dr. (with the amount of commission due on the total
To Underwriters A/c issue price of the shares under-written)

(c) When the net amount due from the underwriters on the shares or debentures taken up by
them is received:

Bank A/c Dr .( with the net amount due)

To Underwriters A/c

Q1. Sunflow Ltd. issued 50,000 equity shares. The whole of the issue was underwritten as
follows:
Red 40%; White 30%; Blue 30%
Applications for 40,000 shares were received in all, out of which applications for 10,000 shares
had the stamp of Red; those for 5,000 shares that of White and those for 10,000 shares that of
Blue. The remaining applications for 15,000 shares did not bear any stamp.
Determine the liability of the underwriters.

Q2.A joint stock company resolved to issue 10 lakh equity shares of Rs. 10 each at a premium of
Re. 1 per share. Two lakh of these shares were taken up by the directors of the company, their
relatives, associates and friends, the entire amount being received forthwith. The remaining
shares were offered to the public, the entire amount being asked for with applications.

The issue was underwritten by X, Y and Z for a commission @ 2.5% of the issue price, 65%
of the issue was underwritten by X, while Y’s and Z’s shares were 25% and 10%
respectively. Their firm underwriting was as follows :
X 30,000 shares, Y 20,000 shares and Z 10,000 shares. The underwriters were to submit
unmarked applications for shares underwritten firm with full application money along
with members of the general public. Marked applications were as follows:
X 1,19,500 shares, Y 57,500 shares and Z 10,500 shares.
Unmarked applications totaled 6,00,000 shares. Accounts with the underwriters were
promptly settled.
You are required to:
(i) Prepare a statements calculating underwriters’ liability for shares other than shares
underwritten firm.
(ii) Pass journal entries for all the transactions including cash transactions.

Q3.Suprima Ltd. came out with an issue of 45,00,000 equity shares of 10 each at a premium
of Rs. 2 per share. The promoters took 20% of the issue and the balance was offered to the
public. The issue was equally underwritten by A & Co; B & Co. and C & Co. Each
underwriter took firm underwriting of 1,00,000 shares each. Subscriptions for 31,00,000
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equity shares were received with marked forms for the underwriters as given below:
Shares
A & Co. 8,00,000
B & Co. 7,00,000
C & Co. 13,75,000
Total 28,75,000
The underwriters are eligible for a commission of 3.5% on face value of shares. The entire
amount towards shares subscription has to be paid alongwith application. You are
required to:
(a) Compute the underwriters’ liabilities (number of shares)
(b) Compute the amounts payable or due to underwriters; and
(c) Pass necessary journal entries in the books of Suprima Ltd. relating to underwriting.

Q4.Monlit Ltd., issued 50,000 equity, shares of which only 60% was underwritten by Green.
Applications for 45,000 shares were received in all out of which application for 26,000 were
marked.
Determine the liability of Green.

Q5.Emess Ltd. issued 40,000 shares which were underwritten as:

P: 24,000 shares Q: 10,000 shares and R: 6,000 shares. The underwriters made applications for
firm underwriting as under:
P: 3,200 shares; Q: 1,200 shares; and R: 4,000 shares. The total subscriptions excluding firm
underwriting (including marked applications) were 20,000 shares.
The marked applications were - P: 4,000 shares; Q: 8,000 shares; and R: 2,000 shares.
Prepare a statement showing the net liability of underwriters.

Q6.Jumba Ltd. came up with public issue of 30,00,000 Equity shares of Rs. 10 each at Rs. 15
per share. A, B and C took underwriting of the issue in 3 : 2 : 1 ratio. Applications were
received for 27,00,000 shares. The marked applications were received as under:
A 8,00,000 shares
B 7,00,000 shares
C 6,00,000 shares
Commission payable to underwriters is at 5% on the face value of shares.
(i) Compute the liability of each underwriter as regards the number of shares to be
taken up.
(ii) Pass journal entries in the books of Jumba Ltd. to record the transactions relating
to underwriters.

Q7. Sam Limited invited applications from public for 1,00,000 equity shares of 10 each at a
premium of ` 5 per share. The entire issue was underwritten by the underwriters A, B, C and D
to the extent of 30%, 30%, 20% and 20% respectively with the provision of firm underwriting of
3,000, 2,000, 1,000 and 1,000 shares respectively.
The underwriters were entitled to the maximum commission permitted by law.
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The company received applications for 70,000 shares from public out of which applications for
19,000, 10,000, 21,000 and 8,000 shares were marked in favour of A, B, C and D respectively.
Calculate the liability of each one of the underwriters. Also ascertain the underwriting
commission @ 2.5% payable to the different underwriters.

Q8.Wye Co. Ltd., invited the public to subscribe to the following:

(i) 10,000 equity shares of ` 100 each at a premium of 5% and
(ii) Rs 2,50,000 in 14% Debentures of ` 100 @ 96.

60% of the shares and the whole of the issue of debentures were underwritten by M/s Sure and
Fast for the commission allowable by the Government. The applications from the public totalled
6,000 shares and 2,000 debentures. The underwriters fulfilled their obligations. Show the
journal entries that would appear in the books of the company. Underwritting commission is
paid at 2.5%.

Q9. ‘X’ Ltd., issued 1,00,000 equity shares of Rs. 10 each at par. The entire issue was
underwritten as follows:
A – 60,000 shares (Firm underwriting 8,000 shares)
B – 30,000 shares (Firm underwriting 10,000 shares)
C – 10,000 shares (Firm underwriting 2,000 shares)
The total applications including firm underwriting were for 80,000 shares. The marked
applications were as follows:
A- 20,000 shares; B- 14,000 shares; C- 6,000 shares.
The underwriting contract provides that credit for unmarked applications be given to the
underwriters in proportion to the shares underwritten. Determine the liability of each
underwriter

Q10.Dolly Ltd. issued 25,00,000 equity shares of Rs.10 each at par. 10,00,000 shares were
issued to the promoters and the balance offered to the public was underwritten by three
underwriters P, Q & R in the ratio of 2 : 4 : 4 with firm underwriting of 50,000, 60,000 and
70,000 shares each respectively. Total subscription received 12,88,000 shares including
marked application and excluding firm underwriting. Marked applications were as
follows:
P 3,00,000
Q 3,50,000
R 4,50,000
Unmarked and surplus applications to be distributed in gross liability ratio. Ascertain the
liability of each underwriter

Q11.ABC Ltd. came up with public issue of 3,00,000 Equity Shares of Rs.10 each at Rs. 15 per
share. P, Q and R took underwriting of the issue in ratio of 3 : 2: 1 with the provisions of
firm underwriting of 20,000, 14,000 and 10,000 shares respectively.
Applications were received for 2,40,000 shares excluding firm underwriting. The marked
applications from public were received as under:
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P - 60,000
Q - 50,000
R - 60,000
Compute the liability of each underwriter as regards the number of shares to be taken up
assuming that the benefit of firm underwriting is not given to individual underwriters.