Company Accounts - Underwriting of Shares and Debentures

 

COMPANY ACCOUNTS

UNDERWRITING OF

SHARES AND DEBENTURES

 

Part A: Discussion of basic theories and related rules and provisions of the Indian Companies Act, 2013 along with the relevant computation tables

Part B: 5 Illustrations with solutions

Part A

Definition

Underwriting is an agreement to subscribe to the securities (shares or debentures) of a company when existing shareholders of the company or the public do not subscribe to the securities offered to them.

 

If the whole or certain portion of the shares or debentures of the company is not applied for by the public, the underwriters themselves apply for the same or persuade others to apply for such shares and debentures. The underwriters are entitled to get commission at prescribed rates against this service they render according to the agreement.

 

Underwriting commission

No underwriting commission is payable on the shares taken up by the promoters, employees, directors, business associates, etc. Commission is payable on the whole issue underwritten irrespective of the fact that whole of the issue may be taken over by the public.

 

As per Rule 13 of The Companies (Prospectus and Allotment of Securities) Rules, 2014, maximum ceiling rates of underwriting commission are as follows:

 

Securities	Maximum ceiling rates of underwriting commission
(A)    Equity / Preference Shares	five per cent of the price at which the shares are issued, or a rate authorised by the articles, whichever is less
(B)    Debentures	two and a half per cent of the price at which the debentures are issued, or as specified in the company’s articles, whichever is less

 

“Marked” and “unmarked” applications

“Marked” applications are those applications which bear the stamp of an underwriter. If the issue is not fully subscribed, “marked” applications shall be applied in reduction of the underwriter’s liability.

 

“Unmarked” applications are those applications which bear no stamp of an underwriter. These applications are received by the company directly from the public.

 

When there are more-than-one underwriters the unmarked applications are divided amongst the underwriters in the ratio of their gross liability. When the issue is fully subscribed, the distinction between marked and unmarked applications becomes immaterial.

 

“Conditional” and “firm” underwritings

There are two types of underwriting agreements:

a)  Conditional underwriting, and

b)  Firm underwriting.

 

Under the conditional underwriting agreement, the underwriter agrees to take up balance of agreed proportion of shares not taken up by the public. If the shares are fully subscribed by the public, the underwriter does not take up any share.

 

Under the firm underwriting agreement, the underwriter agrees to take up a specified number of shares irrespective of the results of the public response to the issue.

 

“Full” and “partial” underwriting

When the whole issue is underwritten by the underwriter(s) it is called full underwriting. When a part of the whole issue is underwritten by the underwriter(s) it is called partial underwriting. In this case the company is treated as having underwritten the balance of shares.

 

Determination of liability of underwriters

(In case of full underwriting)

 

If benefit of firm underwriting is given to individual underwriter

 

Statement showing the liability of underwriters

(In terms of number of shares / debentures)

Particulars	Total	A	B	C
GROSS LIABILITY	***	***	***	***
Less: Marked application         (excluding firm underwriting)	***	***	***	***
	***	***	***	***
Less: Unmarked application         (in the ratio of gross liability)	***	***	***	***
	***	***	***	***
Less: Firm underwriting         (actual number of shares /         debentures firm underwritten)	***	***	***	***
	***	***	***	***
Surplus of one underwriter allocated to others (in the ratio of gross liability)	***	***	***	***
NET LIABILITY	***	***	***	***
Add: Firm underwriting        (actual number of shares /        debentures firm underwritten)	***	***	***	***
TOTAL LIABILITY	***	***	***	***

 

If benefit of firm underwriting is not given to individual underwriter

 

Statement showing the liability of underwriters

(In terms of number of shares / debentures)

Particulars	Total	A	B	C
GROSS LIABILITY	***	***	***	***
Less: Marked application         (excluding firm underwriting)	***	***	***	***
	***	***	***	***
Less: Unmarked application         (in the ratio of gross liability)	***	***	***	***
	***	***	***	***
Less: Firm underwriting         (in the ratio of gross liability)	***	***	***	***
	***	***	***	***
Surplus of one underwriter allocated to others (in the ratio of gross liability)	***	***	***	***
NET LIABILITY	***	***	***	***
Add: Firm underwriting        (actual number of shares /        debentures firm underwritten)	***	***	***	***
TOTAL LIABILITY	***	***	***	***

 

Determination of net amount due from (or due to) the underwriters

Statement showing the net amount due from (or due to) the underwriters

Particulars	Total	A	B	C
Number of shares / debentures to be subscribed (TOTAL LIABILITY)	***	***	***	***
	Rs	Rs	Rs	Rs
Total application money due [Application money per share × Total liability]	***	***	***	***
Less: Amount paid on firm application	***	***	***	***
Balance of total application money due	***	***	***	***
Less: Underwriting commission (on issue price of shares underwritten)	***	***	***	***
Net amount due from (due to) the underwriters	***	***	***	***

 

Determination of liability of underwriters

(In case of partial underwriting)

a)       In this case also underwriting may be with or without firm underwriting.

b)       In this case it is assumed that for the shares not underwritten the company itself is the underwriter. Therefore, unmarked applications are treated as marked by the company and, no credit is given to the underwriters for any such unmarked applications.

c)       The same formats as used in the case of full underwriting may be used in this case of partial underwriting.

d)       If number of share applications received is more than or equal to the number of shares issued, the underwriters’ liability will be nil (if there is no firm underwriting) or to the extent of firm underwriting only (if there is firm underwriting).

e)       If no information is given regarding marked and unmarked applications, the number of marked applications against each underwriter will be equal to –

      [Total number of applications received x %-age of underwriting given by the underwriter]

 

Important note:

If in the problem it is not mentioned whether the benefit of firm underwriting is given to the individual underwriters or not, it should be assumed that the benefit of firm underwriting is given to the individual underwriters.

Part B

 

Illustration: 1

Agile Movers Limited resolved to issue 10 lakh equity shares of Rs 10 each at a premium of Rs 1 per share. One 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 P, Q and R for a commission @ 2% of the issue price, 65% of the issue was underwritten by P, while Q’s and R’s shares were 25% and 10% respectively. Their firm underwriting was as follows:

P - 30,000 shares, Q - 20,000 shares and R - 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:

P - 1, 19,500 shares, Q - 57,500 shares and R - 10,500 shares.

 

Unmarked applications totalled 7, 00,000 shares. Accounts with the underwriters were promptly settled.

 

You are required to:

1. Prepare a statements calculating underwriters’ liability for shares other than shares underwritten firm.

2. Pass journal entries for all the transactions including cash transactions.

 

Solution: 1 

Illustration: 2

Maruti Ltd. came out with an issue of 45, 00,000 equity shares of Rs 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, B and C

 

Each underwriter took firm underwriting of 1, 00,000 shares each. Subscriptions for 31, 00,000 equity shares were received with marked forms for the underwriters as given below:

A - 7, 25,000 shares

B - 8, 40,000 shares

C - 13, 10,000 shares

Total - 28, 75,000 shares

 

The underwriters are eligible for a commission of 5%. The entire amount towards shares subscription has to be paid along with application.

You are required to:

(a) Compute the underwriters’ liability (number of shares); and

(b) Compute the amounts payable or due to underwriters.

 

Solution: 2

Illustration: 3

Braveheart Ltd. issued to public 1, 80,000 equity shares of Rs 100 each at par. Rs 50 per share were payable along with Application and the balance on Allotment. The issue was underwritten equally by L, M and N for a commission of 3%. They agreed for a Firm Underwriting of 10,000 Shares each. Applications for 1, 40,000 Shares excluding Underwriters’ Firm Underwriting were received as below:

Applications with marking of L’s Seal - 47,500

Applications with marking of M’s Seal - 42,500

Application with marking of N’s Seal - 38,000

Unmarked Applications - 12,000

 

Compute the Underwriters’ Liability and the amount payable / receivable.

 

Solution: 3

Illustration: 4

Labyrinth Ltd. came up with an issue of 20, 00,000 Equity Shares of Rs 10 each, at par. 5,00,000 equity shares were issued to the promoters and the balance offered to the public was underwritten by three underwriters P, G and K - equally.

Excluding Firm Underwriting of 50,000 Shares each, subscriptions totalled 12, 97,000 Shares including Marked Forms, which were as under:

P - 4, 25,000 Shares;

G - 4, 50,000 Shares; and

K - 3, 50,000 Shares.

 

Each of the underwriters had applied for the number of shares covered by Firm Underwriting. The amounts payable were: Rs 2.50 on application and Rs 2 on allotment. The agreed commission was 5%.

 

Pass Summary Journal Entries for:

(1)    Allotment of Shares to the Underwriters;

(2)    Commission due to each of them; and

(3)    Net Cash Paid and / or Received.

 

Solution: 4

Illustration: 5

Pristine Limited planned to set up a unit for manufacture of bulk drugs. For the purpose of financing the unit, the Board of Directors have issued 15, 00,000 Equity Shares of Rs 10 each. 30% of the issue was reserved for Promoters and the balance was offered to the public. A, B and C have come forward to underwrite the public issue in the ratio of 3: 1: 1 and also agreed for Firm Underwriting of 30,000, 20,000, 10,000 shares, respectively. The Underwriting Commission was fixed at 4%. The amount payable on application was Rs 2.50 per share.

 

The details of subscriptions are:

Marked Forms of A: 5, 50,000 shares;

Marked Forms of B: 2, 00,000 shares; and

Marked Forms of C: 1, 50,000 shares.

 

Unmarked Forms were received for 50,000 Shares.

 

From the above, you are required to show the allocation of liability among underwriters with workings.

 You are also required to –

1.   Determine the liability of the Company towards the payment of commission to the Underwriters; and

2.   Pass Journal Entries in the books of the Company for Underwriters’ net liability and the receipt or payment of cash to or from the underwriters.

Solution: 5