CMA Intermediate · Corporate Accounting and Auditing

Underwriting of Securities: formula sheet

Full chapter guide

Key formulas

Commission limit on shares: Maximum commission on shares ≤ 5% of the issue price; Under Section 40(6) of the Companies Act, 2013 and Rule 11 of the Companies (Prospectus and Allotment of Securities) Rules, 2014. The commission must be authorised by the articles and disclosed in the prospectus.
Commission limit on debentures: Maximum commission on debentures ≤ 2.5% of the issue price; Same Section 40(6) and Rule 11 basis, and the same conditions: authorised by the articles and disclosed in the prospectus. Commission is calculated on the issue price, not the face value, unless the question says otherwise.
Underwriting commission: Commission = Rate % × Issue price of securities underwritten; Unless stated otherwise, commission is on the total amount underwritten, whether or not the public takes up the shares.
Underwriter's liability (basic): Underwriter's liability = Shares underwritten − Shares subscribed by the public; This applies when one underwriter covers the whole shortfall. The liability cannot be more than the shares underwritten, and it is nil if the public subscribes in full. Marked applications and unmarked applications, which matter when there are several underwriters, are handled in later topics.
Gross liability: Gross liability = Shares underwritten by the underwriter; If the question gives percentages, apply them to the underwritten shares, not necessarily the whole issue.
Liability after marked applications: Liability after marked = Gross liability − Own marked applications; Deduct only that underwriter's own marked applications.
Unmarked applications: Unmarked applications = Total applications − Total marked applications; Unmarked applications are shared in the ratio of gross liabilities.
Net liability: Net liability = Gross liability − Own marked − Share of unmarked applications; Check: total net liability = Underwritten shares − Total applications for the underwritten portion. This holds only if no underwriter's liability was set to nil; otherwise recompute after redistributing the surplus.
Partial underwriting split: Unmarked for underwritten part = Unmarked × Underwritten shares ÷ Total issue; This means the unmarked applications are split in the ratio of underwritten to non-underwritten shares (3 : 1 in Kaveri, so the underwritten part gets 3/4, which is 90,000 ÷ 1,20,000). Use only when the question gives no other instruction; state it as an assumption.
Amount payable: Amount = Net liability in shares × Issue price; Issue price includes premium, if any.
Gross liability: Gross liability = Total shares offered × Underwriter's share (%); If part of the issue is not underwritten, apply the percentage only to the underwritten shares, as the question states.
Net liability: Net liability = Gross liability − Marked applications − Share of unmarked applications − Firm underwriting shares; Do the deductions in this order. If the result is negative, the net liability is nil and the surplus is re-allocated.
Unmarked applications share: Share of unmarked = Total unmarked applications × (Underwriter's gross liability ÷ Total gross liability); Use the gross liability ratio unless the question gives another ratio.
Total shares taken by an underwriter: Shares taken = Net liability + Firm underwriting shares; Firm shares are shares he takes anyway. Journal entries and amounts due use this total.
Check for the whole issue: Total net liabilities = Shares offered − Public applications (marked + unmarked) − Total firm underwriting; Use this to check your table before moving on.
Underwriting commission: Commission = Gross shares underwritten × Issue price × Commission rate; It is calculated on the full gross liability, including firm shares, unless the question says otherwise.

Quick revision

Underwriting is an agreement to take up unsubscribed securities for a commission.
Gross liability is the number of shares an underwriter agreed to underwrite.
Marked applications carry the stamp of a particular underwriter and are credited to that underwriter.
Unmarked applications = total applications received minus all marked applications. Firm underwriting counts as marked applications of that underwriter and is part of the total applications received. Unmarked applications are allocated among underwriters in the ratio of their gross liabilities.
Net liability = gross liability − marked applications (including firm underwriting) − share of unmarked applications.
Firm underwriting is treated as marked applications of that underwriter, and it is deducted only from that underwriter's liability, once.
If an underwriter's net liability comes out negative, take it as nil and adjust the surplus against the other underwriters in the ratio of their gross liabilities, not exceeding each one's liability, unless the question says otherwise.
Check your answer in under-subscription: shares issued − total applications received (including firm underwriting and marked applications) = total shares taken up by the underwriters, where the underwriters' liability covers the shortfall. Count firm underwriting once: do not add it again if the stated total already includes it. If the issue is fully subscribed, underwriters take up nil.
Commission is payable on the issue price of the securities underwritten (not those taken up), at the rate given.
Section 40(6) of the Companies Act, 2013 permits underwriting commission, subject to the Rules. Rule 11 of the Companies (Prospectus and Allotment of Securities) Rules, 2014 fixes the maximum at 5% of the issue price for shares and 2.5% of the issue price for debentures, subject to authorisation by the articles and disclosure in the prospectus. When these conditions are met, it is payable on the securities underwritten, whether or not the underwriters have to take up any.
Commission is a cost of issue and is recorded in the books of the company, with the underwriters' shares recorded as allotted to them.
In the objective section, attempt every question, as there is no negative marking.

Common mistakes

Mixing up the commission limits for shares and debentures. Fix: Remember that debentures carry the lower limit, 2.5%, and shares the higher, 5%, both on the issue price under Section 40(6) and Rule 11.
Treating firm underwriting as the same as conditional underwriting. Fix: In firm underwriting the underwriter takes the agreed shares whether or not the public subscribes. In conditional underwriting the duty arises only on a shortfall.
Sharing unmarked applications in the ratio of net liabilities or equally. Fix: Always use the ratio of gross liabilities, taken before any deduction.
Treating total applications as unmarked. Fix: Compute unmarked = total applications − total marked before doing anything else.
Counting marked applications again in the unmarked pool. Fix: Always do unmarked = total applications − total marked applications.
Deducting firm underwriting from the total public applications instead of from the underwriter's own gross liability. Fix: Treat firm shares as the underwriter's own application. Deduct them in his column only.

Exam tips

Learn the two commission limits by heart: shares 5%, debentures 2.5% of the issue price, under Section 40(6) and Rule 11. They are common MCQ items.
In a written answer, give a one-line definition, the parties, the purpose and the types in that order to earn step marks.
Read the question for the base of commission: issue price, not face value, unless told otherwise.
State that commission must be authorised by the articles and disclosed in the prospectus.
Do not confuse firm underwriting with the firm (partnership) that may act as underwriter.
Write the assumption in one line when the question is silent on how unmarked applications are shared in a partial issue. Examiners reward a clear, consistent treatment.
Always show the table with Gross, Marked, Unmarked and Net columns. Step marks come from these columns even if the final figure is wrong.
Do the total check. A mismatch tells you immediately that the unmarked pool or the ratio is wrong, unless a liability was set to nil.