Determining the Liability of the Underwriters | Accounting

The liability of the underwriter or underwriters will be determined in the following ways. They are:- 1. Complete Underwriting 2. Partial Underwriting 3. Firm Underwriting. 

Way # 1. Complete Underwriting:

(a) When the whole issue of shares or debentures is underwritten by a single underwriter:

When the full issue is underwritten by one underwriter, then his liability will be equal to the number of shares or debentures underwritten minus shares or debentures applied for. If the issue is fully subscribed or oversubscribed, there will be no liability for the underwriter to take up any share or debenture.

(b) When the whole issue of shares or debentures is underwritten by two or more underwriters:

In such a case, the liability of the respective underwriters can be determined in either of the following two ways:

(i) The gross liability of each underwriter according to the agreed ratio should be reduced first by the marked applications and then credit should be given in respect of the unmarked applications sent directly to the company by way of deduction from the balance left in the ratio of gross liability.

The liability of each underwriter in such a case will be as follows:

Gross liability ………..

Less: Marked Applications ………..

Balance left ………..

Less: Unmarked Applications ……….. (in the ratio of gross)

NET LIABILITY ………..

(ii) The gross liability of each underwriter according to the agreed ratio should be reduced first by the marked applications and then credit should be given in respect of the unmarked applications sent directly to the company by way of deduction from the balance left in the ratio of gross liability as reduced by the marked applications.

The liability of each underwriter in such a case will be as follows:

Gross liability ……….

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

Note:

Liability of the underwriters varies under the above two methods. It is, therefore, desirable that the particular method to be followed should be clearly mentioned in the underwriting agreement.

Illustration 1 (Full Underwriting):

A Company incorporated on 1st January, 2004 issued a prospectus inviting applications for 5, 00,000 Equity Shares of Rs. 10 each.

The whole issued was fully underwritten by four persons:

A — 2, 00,000 Shares

B — 1, 50,000 Shares

C — 1, 00,000 Shares

D — 50,000 Shares

Applications were received for 4, 50,000 shares of which marked applications were as follows:

A — 2, 20,000;

B — 90,000;

C — 1, 10,000

D — 10,000

Find out the liabilities of individual underwriters.

Solution:

(1) The net liability of the underwriters is ascertained by giving credit to unmarked applications in the ratio of gross liability.

Total shares applied – Marked Application = Unmarked Applications 4, 50,000 – 4,30,000 = 20,000 shares

Note:

When the entire issue is underwritten by a single underwriter, there is no necessity to distinguish between marked and unmarked application and the liability for the underwriter would be 50,000 shares.

(2) However, if the credit given to the underwriters in proportion to the gross liability of the underwriters as reduced by the marked applications, the statement would appear as follows:

Way # 2. Partial Underwriting:

(a) When a part of the issue of shares or debentures is underwritten by one person only. In such a case, only a part of the whole issue is underwritten only by one underwriter and the balance amount is deemed to have been underwritten by the company itself. In such a situation the unmarked applications are treated as marked application from the point of view of the company.

The liability is determined as follows:

Net Liability = Gross Liability – Marked Applications

Illustration 2:

A company issued 10,000 shares of which 75% was underwritten by an underwriter. Applications for 6,000 shares were received out of which 4,800 shares were marked by the underwriter. Determine the net liability of the underwriter.

Solution:

Gross Liability = 75% of 10,000 = 7,500 shares

Less: Marked Applications = 4,800

Net Liability = 2,700

(b) When a part of the issue of shares or debentures underwritten by a number of underwriters.

In such a case, only a part of the whole issue is underwritten by a number of underwriters and for the balance, the company is said to have underwritten the same. As such the company is said to have underwritten the same.

As such the unmarked applications are treated as marked so far as the company is concerned.

Illustration 3 (Partial Underwriting):

A Company issued 1, 00,000 shares of Rs. 100 each.

These shares were underwritten as follows:

X — 30,000 shares and Y — 50,000 shares.

The public applied for 70,000 shares. Determine the liability of X, Y and the Company.

Solution:

Marked applications are not given in the problem. Therefore, applications be credited to underwriters including the Company on the basis of gross liability. The Company itself to be treated as an underwriter for 20,000 shares.

Way # 3. Firm Underwriting:

It is an underwriting agreement where the underwriter or underwriters agree to buy a certain number of shares or debentures irrespective of the number of shares or debentures subscribed by the public. It is a case of firm underwriting.

Thus in firm underwriting, the underwriters agree that a certain number of shares be allotted to them, whether or not the issue is over-subscribed. The liability of the underwriters in such a case will be the unsubscribed shares or debentures plus the shares or debentures under firm underwriting.

In the calculation of net liability, the shares under firm underwriting may be treated as marked or unmarked application. The liability of underwriters differs under the two methods. The steps involved under both the methods are given followed by an illustration worked out under both the methods.

Illustration 4:

Sam Limited invited applications form public for 1, 00,000 equity shares or Rs. 10 each at a premium of Rs. 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.

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.

Illustration 5 (Firm Underwriting):

The Bharat Ltd. issued 10,000 shares of Rs. 100 each. The entire issue was underwritten as follows:

A — 50%; B – 30% and C — 20%

In addition, there was firm underwriting as follows:

A — 1,000 shares; B — 750 and C — 500 shares

The total subscription including firm underwriting was 8,000 shares and the subscription included the following marked applications:

A — 1,500; B — 2,000 and C — 750 Find the liability of underwriters.

Solution:

Illustration 6:

A Company has authorised capital of Rs. 50, 00,000 divided into 1, 00,000 shares of Rs. 50 each. The Company issued for subscription 50,000 shares at a premium of Rs. 10 each.

The entire issue was underwritten as follows:

X — 30,000 shares (Firm underwriting — 5,000 shares)

Y — 15,000 shares (Firm underwriting — 2,000 shares)

Z — 5,000 shares (Firm underwriting — 1,000 shares)

Out of the total issue, 45,000 shares including firm underwriting were subscribed. The following were the marked forms;

X — 16,000 shares; Y — 10,000 shares; Z — 4,000 shares. Calculate the liability of each underwriter.

Total subscribed forms – Total Marked forms = Unmarked forms

45,000 – (16,000 + 10,000 + 4,000) = 15,000

Total Issue – Total unmarked = Gross Liability

50,000 – 15,000 = 35,000

Illustration 7:

A company made a public issue of 1, 25,000 equity shares of Rs. 100 each, Rs. 50 payable on application. The entire issue was underwritten by four parties, A, B, C and D, in the proportion of 30%, 25%, 25% and 20% respectively. Under the terms agreed upon, a commission of 2% was payable on the amounts underwritten.

A, B, C and D has also agreed on ‘firm’ underwriting of 4,000, 6,000, Nil and 15,000 shares respectively.

The total subscription, excluding firm underwriting, including marked applications were for 90,000 shares. Marked applications received were as under: – A 24,000, B 20,000, C 12,000 and D 24,000. Ascertain the liability of the individual underwriter and also show the journal entries that you would make in the books of the company. All workings should form part of your answer.

Solution:

Illustration 8:

A Company issues 10,000 shares of Rs. 100 each at par and 500 debentures of Rs. 1,000 each at Rs. 950. The whole of the issue has been underwritten by P. Jones and Company. The whole of the shares are applied for, but applications for 400 debentures were received. All the applications were accepted. Commission payable to the underwriters is the maximum amount permissible.

Give journal entries to record the above transactions and prepare the Balance Sheet at this stage, assuming that all amounts due have been received.