COMPANY ACCOUNTS—UNDERWRITING OF SHARES AND DEBNTURES

INTRODUCTION In case of public limited companies the minimum subscription must be received in order to get certificate of commencement of business. Companies in order to ensure minimum subscription, resort to underwriting.

UNDERWRITING Underwriting is an agreement, entered into, by a company with a financial agency, or individual or partnership firm, in order to ensure that if the public will not subscribe for the entire issue, of shares or debentures, made by the company, the underwriters will do the same. The financial agency is known as the Underwriter and it agrees to buy that part of the company’s issues which is not subscribed by the public, in consideration of a specified underwriting commission.

BENEFITS OF UNDERWRITING It relieves the company from the risk and uncertainty of marketing the securities. Underwriters have an intimate and specialized knowledge of the capital market. They offer valuable advice to the issuing company in the preparation of the prospectus, time of floatation etc.

It builds up investors' confidence in the issue of securities. The issuing company is assured of the availability of funds. Important projects are not delayed for want of funds. They also provide publicity service to the companies which have entered into underwriting agreements with them.

COMPLETE UNDERWRITING TYPES OF UNDERWRITING COMPLETE UNDERWRITING PARTIAL UNDERWRITING FIRM UNDERWRITING PARTIAL UNDERWRITING ALONG WITH FIRM UNDERWRITING

Complete underwriting-- If the whole issue of shares or debentures of a company is underwritten, it is called complete underwriting. Partial underwriting-- If part of issue of shares or debentures of a company is underwritten, it is said to be partial underwriting.

Firm underwriting– When an underwriter agrees to buy a definite number of shares or debentures in addition to the shares and debentures he has to take under the underwriting agreement, this is called firm underwriting. Partial underwriting along with firm underwriting-- In this type of underwriting, individual underwriter does not get the benefit of firm underwriting in determination of number of shares or debentures to be taken up by him.

DISCLOSURE REQUIREMENTS (provisions of the Companies Act, 1956 regarding disclosure of underwriting agreement) Disclosure in the Prospectus. Disclosure in the Statutory Report. Disclosure of Sums Payable.

UNDERWRITING COMMISSION Underwriting commission is a payment, which is given by the company, to underwriters for their services of underwriting. Companies can give maximum 5% commission to underwriters for selling its shares.

PAYMENT OF UNDERWRITING COMMISSION According to sec 76 of the Companies Act, 1956,a company is authorized to pay such commission subject to following restrictions: The articles must authorize the payment of commission. The rate of commission must not exceed 5% of the issue price of shares or the amount or rate authorized by articles whichever is less and in case of debentures, 2.5% of the issue price or the amount or rate authorized by articles, whichever is less. In practice, SEBI has allowed the commission only at the rate of 2.5% of issue price of equity shares though Section 76 provides for maximum rate of 5%.

The commission paid or agreed to be paid must be disclosed in the prospectus and if no prospectus is issued, in the statement in lieu of prospectus. The number of shares or debentures which underwriters have agreed to subscribe absolutely or conditionally should be disclosed in the prospectus. A copy of the contract regarding the payment of commission should be delivered to the registrar.

As per SEBI guidelines: The commission is only payable if the shares or debentures are offered to the general public. No underwriting commission can be paid if the issue is privately placed. As per SEBI guidelines: Underwriting is not mandatory. In case the issue is not underwritten and minimum subscription of 90% of the offer to the public is not received, the entire amount received as subscription would have to be refunded if full. In case the issue is underwritten and if the company does not receive 90% of issued capital from the public subscription plus accepted development from underwriters, with in 120 days from the date of opening of the issue, the company shall refund the amount of subscription.

The lead managers must satisfy themselves about the net worth of the underwriters and the outstanding commitments and disclose the same to SEBI. The underwriters agreement may be filed with the stock exchange.

Following rates for the payment of underwriting commission are in force On amounts developing on the underwriters (%) On amounts subscribed by the public (%) EQUITY SHARES PREFERENCE SHARES/ CONVERTIBLE AND NON CONVERTIBLE DEBENTURES For amounts upto 5 lacs For amounts in excess of 5 lacs 2.5 2 1.5 1

MARKED OR UNMARKED APPLICATIONS Shares or debentures issued by a company are usually underwritten by two or more firms of underwriters in an agreed ratio. Every underwriter wants to sell the maximum number of shares and debentures in order to reduce his risk. Marked applications-- Generally the forms are stamped with the name of the underwriters in order to distinguish the forms of one underwriter from that of others and to determine the liability of the individual underwriter. Such stamped applications when received are called marked applications.

Unmarked applications: The application forms which are received by the company without any name of the underwriter are called unmarked applications.

Determining the liability of underwriters COMPLETE UNDERWRITING: If the whole issue of the shares or debentures is underwritten only by one underwriter: The liability of underwriters will be determined by deducting the total application money received from the shares or debentures offered to public. It will be more clear from the following illustration:

Illustration 1: Solution : on the next slide. A company issues 50,000 shares of Rs.10 each at par. The whole issue has been underwritten by X & Co. for a commission of 4%. The company received applications only for 47,000 shares. All the applications were accepted. Give the journal entries to record the above transactions. Solution : on the next slide.

DATE PARTICULARS LF AMOUNT (DR) AMOUNT (CR) Bank A/c Dr. To Equity Share Capital A/c (being application money of 47000 shares@ 10each received) ________________________ X & Co. A/c Dr. To Equity Share Capital (being the allotment of 3000 shares of 10each not taken up by public) Comm. on issue of shares A/c Dr. To X & Co. A/c (being commission due to X &Co. @4% on 50000 shares of 10 each) Bank A/c Dr. To X & Co. (being balance due from X & Co. received) 4,70,000 30,000 20,000 10,000

(II) If the whole issue of the shares or debentures is underwritten by number of underwriters in an agreed ratio: There are two ways of determining liability: The liability of each underwriter in this way will be: Gross liability according to agreed ratio ….. Less: Marked applications ….. Balance left ….. Less: unmarked application (in the ratio of Gross liabilty) ….. Net liability .....

(ii) The liability of each underwriter in this other way will be: Gross liability according to agreed ratio ….. Less: Marked applications ….. Balance left ….. Less: unmarked applications(in the ratio of balance left,i.e., gross liability as reduced by marked applications) …… Net liability …..

PARTIAL UNDERWRITING: If a part of the issue of shares or debentures is underwritten only by one underwriter: In this case liability to be determined can be understood with the help of following illustration: Illustration: A entered into an underwriting agreement with B Ltd. for 60% of the issue of rs.50,00,000 15% debentures with a firm underwriting of rs. 5,00,000. Marked applications were for rs. 35,00,000 debentures. Calculate the liability of the underwriter and the commission payable to him.

Solution: Net liability of A being 60% of rs. 50,00,000 i. e Solution: Net liability of A being 60% of rs.50,00,000 i.e., 30,00,000rs. Since the issue is oversubscribed and there is a firm underwriting the liability of underwriter will be limited to the extent of firm underwriting i.e. 5,00,000 rs. Commission 2.5% of 30,00,000rs = 75,000 rs.

(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 70% or 80%) is underwritten by a number of underwriters and the balance (i.e.30% or 20%)is concerned, the company itself is the underwriter of the same. All unmarked applications are treated as marked applications so far as the company is concerned. The method of determining net liability is similar to the method II (a)

FIRM UNDERWRITING Firm underwriting means 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. In case of firm underwriting the underwriters get priority over the general public, if shares or debentures are oversubscribed.

MISCELLANEOUS ILLUSTRATIONS:

Illustration 1. B Ltd. made an issue of 10,000 14% Mortgage Debentures Of Rs. 100 each at 96. the whole of the issue was underwritten by M/s Smart Bulls. 8500 debentures applied for and allotted to the public. The underwriters discharged their liability and were paid their liability and were paid their commission which was at the rate of 2% on the nominal value of the debentures. Give journal entries. Solution. In the books of B Ltd. journal entries Dr. (Rs.) Cr. (Rs.) Underwriting commission A/C Dr. 20,000 To M/S Smart Bulls A/C 20,000 (Underwriting commission due to M/S Smart Bulls on 10,000 debentures of Rs.100 each) 14% Mortgage Debenture Application A/C Dr. 8,16,000 Discount on Issue of Debentures A/C Dr. 34,000 To 14% Mortgage Debentures A/C 8,50,000 ( Allotment of 8500 14% debentures of Rs.100 each at a discount of Rs.4 per debentures)

M/S Smart Bulls A/C Dr. 1,44,000 Discount on Issue of Debentures A/C Dr. 6,000 TO 14% Mortgage Debentures A/C 1,50,000 ( 1500 14% Debentures Of Rs.100 each taken up by the underwriters @ Rs.96 per debenture) Bank A/C Dr. 1,24,000 To M/S Smart Bulls A/C 1,24,000 ( Being balance due received from M/S Smart Bulls)

Illustration 2. X Ltd. Issued 10,000 shares of Rs Illustration 2. X Ltd. Issued 10,000 shares of Rs.100 each at a premium of Rs.15 each. 90% of the issue was underwritten by M/s Broker & Co. at a commission of 1% on the nominal face value. Applications were received for 8,000 shares and allotment was fully made. All the money received from allottees was received in one installment. The account with Broker & Co. were settled. Show the journal entries to record the transactions.

Solution. X Ltd. should itself be treated as an underwriter for 10% of the issue because M/s Broker & Co. have underwritten 90% of the issue. In the absence of any information, the applications for 8,000 shares should be treated marked 90% in the favour of underwriter and 10% in the favour of the company. Therefore M/s Broker & Co. are liable to take up 1800 shares calculated as follow: No. of Shares (a) issued by the company 10,000 (b) applications received for 8,000 (c) applications received in favour of M/s Broker & Co. 7,200

(d) Issue underwritten 90% 9,000 (e) M/s Broker & Co. liable to take up [(d) - (c)] 1,800 journal entries Dr. (Rs.) Cr. (Rs.) Bank a/c Dr. 9,20,000 To Share Application & Allotment A/C 9,20,000 ( Being amount received on 8,000 shares @ Rs. 115 shares) Share Application & Allotment A/C Dr. 9,20,000 To Share Capital A/C 8,00,000 To Securities Premium A/C 1,20,000 (Being transfer of amount received on 8,000 shared to share capital & securities premium a/c)

M/s Broker & Co. A/C Dr. 2,07,000 To Share Capital A/C 1,80,000 To Securities Premium 27,000 ( Being allotment of 1,800 shares of Rs.100 each @ a premium of Rs.15 per share to M/s. Broker & Co.) Underwriting Commission A/C Dr. 9,000 To M/s Broker & Co. 9,000 ( Being commission payable to the underwriters @ 1% on Rs.1,000) Bank A/C Dr. 1,98,000 To M/s Broker & Co. 1,98,000 ( Being amount due from M/s Broker & Co.)

Illustration 3. Super India Ltd. issued 70,000 equity shares Illustration 3. Super India Ltd. issued 70,000 equity shares. The whole of the issue was underwritten as follow— A: 50%, B: 25%, C: 25%. Applications for 60,000 shares were received in all, out of which application for 15,000 shares had the stamp A, those for 7,500 shares that of B & those for 15,000 shares that of C. the remaining applications for 22,500 shares did not bear any stamp. Determine the liability of the underwriters.

A(50%) B(25%) C(25%) Shares Shares Shares Gross liability in the agreed ratio 37,500 18,750 18,750 (50:25:25) Less: marked applications 15,000 7,500 15,000 Balance left 22,500 11,250 3,750 Less: unmarked applications in the value of gross liability(50:25:25) (11,250) (5,625) ( 5,625) Balance 11,250 5,625 (-1,875) Less: credit for C’s oversubscription To A & B in their gross ratio (50:25) (1,250) (625) (1,875) Net liability 10,000 5,000 -