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Underwriting – Meaning, Types & Liability Calculation

Introduction

Underwriting is an agreement where a person (Underwriter) agrees to take up the shares/debentures which are NOT subscribed by the public. It acts as insurance against under-subscription.

  • Consideration: Underwriting Commission.
  • Maximum Commission: Shares (5%), Debentures (2.5%).

1. Important Terms

A. Marked Applications

Applications that bear the stamp of a specific underwriter. These are credited to that specific underwriter.

B. Unmarked Applications

Direct applications received by the company (without any stamp). These are distributed among underwriters in their Gross Liability Ratio.

C. Gross Liability (GL)

The total number of shares an underwriter agreed to cover initially.

D. Firm Underwriting

A definite commitment by the underwriter to take up a specified number of shares irrespective of public response.

2. Calculation of Net Liability

This is the standard format for 15-mark problems.

Format:

ParticularsA (Shares)B (Shares)C (Shares)Total
Gross Liability (GL)(Given Ratio)(Given Ratio)(Given Ratio)Total Issue
Less: Marked Applications(Actuals)(Actuals)(Actuals)(Total Marked)
Balance............
Less: Unmarked Applications(In GL Ratio)(In GL Ratio)(In GL Ratio)(Total Unmarked)
Result (Surplus/Deficit)............
Less: Surplus of any U/W(Credit to others in GL Ratio)
Net Liability(Shares to be taken).........
Add: Firm Underwriting(If treated as Marked).........
Total LiabilityFinal Answer.........

3. Treatment of Firm Underwriting

There are two ways to treat "Firm Underwriting" shares in calculation:

  1. Treated as Marked Applications:
    • Available benefit is given to the respective underwriter.
    • Deducted along with Marked Applications.
  2. Treated as Unmarked Applications:
    • Benefit is shared by all.
    • Not deducted individually.

(Note: Unless specified, follow the instruction "Benefit of Firm Underwriting given to individual underwriter" - Method 1).

4. Journal Entries

1. Commission Due:

Underwriting Commission A/c ...Dr  (Total GL x Issue Price x %)
    To Underwriter A/c                 (Amount Payable)

2. Liability Due (Shares taken):

Underwriter A/c ...Dr              (Net Liab Shares x Issue Price)
    To Share Capital A/c               (Face Value)

3. Settlement (Net Payment): (Usually Liability > Commission, so U/W pays Company).

Bank A/c ...Dr                     (Net Amount)
    To Underwriter A/c                 (Net Amount)

Exam Notes: Writing the Answer

Common Mistake: Students often confuse Unmarked Applications distribution.

  • Rule: Unmarked Applications are ALWAYS distributed in Gross Liability Ratio.
  • Surplus: If one underwriter gets a negative figure (Surplus), that surplus is distributed to other underwriters in their Gross Liability Ratio.

Summary

  • Goal: Find how many shares Underwriters must buy.
  • Formula: GL - Marked - Unmarked = Net Liability.
  • Commission: Calculated on Gross Liability (Not Net Liability).

Quiz Time! 🎯

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