1. Meaning of Underwriting
- Underwriting
of securities
means an agreement between a company and an underwriter where the
underwriter guarantees to subscribe (buy) the unsubscribed portion
of shares or debentures issued by the company.
- It ensures
that the company is able to raise the minimum required capital even if the
public subscription is less than expected.
👉 In simple words: Underwriter = risk-taker who ensures full subscription of securities.
2. Parties Involved
- Company → Issues
shares/debentures.
- Underwriter(s) → Financial
institution, broker, bank, or person who guarantees subscription.
- Investors/Public → Actual
subscribers.
3. Need / Advantages of Underwriting
- Provides assurance
of full subscription.
- Builds confidence
of investors.
- Facilitates faster
raising of capital.
- Ensures better
distribution of securities.
- Shifts risk
of non-subscription from company to underwriter.
4. Types of Underwriting
|
Type |
Explanation |
Example |
|
1. Complete
Underwriting |
Underwriter
agrees to take entire issue if public doesn’t subscribe. |
If company
issues 1,00,000 shares, underwriter guarantees all. |
|
2. Partial
Underwriting |
Only part of
the issue is underwritten. |
Out of 1,00,000
shares, only 60,000 underwritten. |
|
3. Firm Underwriting |
Underwriter
agrees to buy a certain number of shares/debentures in addition to
unsubscribed ones. |
Underwriter
agrees to buy 10,000 shares regardless of public subscription. |
|
4. Joint
Underwriting |
Two or more
underwriters together underwrite the issue, liability is divided. |
Underwriter A
takes 60%, B takes 40%. |
|
5.
Sub-underwriting |
Main
underwriter transfers part of risk to sub-underwriters. |
A (main) passes
30,000 shares liability to B (sub). |
5. Important Terms
- Marked
Applications
→ Applications bearing stamp/code of underwriter → credited to that
underwriter.
- Unmarked
Applications
→ Applications without stamp → distributed in agreed ratio.
- Gross
Liability
= Proportionate shares underwritten.
- Less: Marked
Applications.
- Less: Share
of Unmarked Applications.
- Net
Liability
= Balance to be subscribed by underwriter.
- Less: Firm
Underwriting (if applicable).
- Final
Liability
= Actual number of shares to be taken up.
6. Firm Underwriting Treatment
When underwriter
agrees to buy fixed number of shares (firm underwriting):
- If public
subscription is less than issue size, firm shares are added to
liability.
- If issue is fully
subscribed, firm shares are treated as additional subscription by the
underwriter (credited to them).
7. FIRM UNDERWRITING
a) When a firm underwriting (included in total subscription) is treated on par with unmarked applications.
The format for
calculating total liability for each underwriter will be as follows:
|
Particulars |
A |
B |
Total |
|
Gross Liability |
XXX |
XXX |
XXX |
|
(–) Unmarked
Applications (Total application received – marked application) |
XXX |
XXX |
XXX |
|
Balance |
XXX |
XXX |
XXX |
|
(–) Marked
Applications |
XXX |
XXX |
XXX |
|
Net Liability |
XXX |
XXX |
XXX |
|
(+) Firm
Underwriting |
XXX |
XXX |
XXX |
|
Total Liability |
XXX |
XXX |
XXX |
b) When a firm underwriting (included in total subscription) is treated on par with marked applications.
The format for
calculating total liability will be as follows:
|
Particulars |
A |
B |
Total |
|
Gross Liability |
XXX |
XXX |
XXX |
|
(–) Unmarked
Applications (Total application received – marked application + Firm
Underwriting) |
XXX |
XXX |
XXX |
|
Balance |
XXX |
XXX |
XXX |
|
(–) Marked
Applications (Marked application + Firm Underwriting) |
XXX |
XXX |
XXX |
|
Net Liability |
XXX |
XXX |
XXX |
|
(+) Firm
Underwriting |
XXX |
XXX |
XXX |
|
Total Liability |
XXX |
XXX |
XXX |
8. Journal Entries (Underwriting of Securities)
1. Application money received
Bank A/c Dr. XXX
To
Share Application A/c XXX
(Being share application money received)
(Marked + Unmarked applications × Application
amount)
If company decided to receive firm
underwriting applications along with general public
No separate entry (Firm underwriting is treated as part of total subscription: Marked + Unmarked + Firm Underwriting × Application amount)
2. Shares issued to promoters
Bank A/c Dr. XXX
To
Share Capital A/c XXX
(Being shares issued to promoters – No underwriting adjustment needed)
3. Shares issued to underwriters
Underwriters A/c Dr. XXX
To
Share Application A/c XXX
(Being shares issued to underwriters – Total
liability × Application amount)
If Company decide
to receive firms underwriting along with general public
(Net liability × Application amount)
4. Underwriting commission due
Underwriting Commission A/c Dr. XXX
To
Underwriters A/c XXX
(Being underwriting commission booked – Gross
liability × Issue price × Commission rate)
5. Settlement with Underwriters
Now, underwriters’ account is settled for:
·
Shares taken
(liability)
·
Commission receivable
a. When underwriter pays net amount (Liability > Commission)
Bank A/c Dr. XXX
To Underwriters A/c XXX
(Being balance received from underwriter after adjusting commission)
b. When underwriter is to be paid (Commission > Liability)
Underwriters A/c Dr. XXX
To Bank A/c XXX
(Being balance paid to underwriter after adjusting liability)
