CMA Intermediate · Corporate Accounting and Auditing

Underwriting of Securities for CMA Intermediate

Underwriting is an agreement where a person or firm promises to take up the shares or debentures that the public does not subscribe, in return for commission. To solve problems, find each underwriter's gross liability, adjust for marked and unmarked applications, settle surplus and shortfall, then compute commission and pass entries.

What this chapter covers

This chapter deals with how a company makes sure its public issue of shares or debentures is fully subscribed. The company appoints underwriters. They agree to take up the unsubscribed portion up to a stated number of securities. In return they earn commission. You learn how to compute each underwriter's liability, and how to record the commission and the securities taken up.

Most questions are numerical. A typical problem gives the issue size, the portion underwritten by each underwriter, the total applications received, and the applications carrying each underwriter's stamp (called marked applications). You then work out the net liability of each underwriter in a fixed layout. Firm underwriting and partial underwriting add extra steps, but the method is the same.

The chapter links to the rest of Corporate Accounting and Auditing through the issue of shares and debentures. Underwriting commission is a cost of issue, so you must be comfortable with share capital entries, securities premium and the rules in the Companies Act, 2013 on the commission payable. The chapter is also self-contained, so it is a good place to secure marks with practice.

Underwriting problems follow a predictable pattern, so a student who learns the layout can score full or near-full marks. The calculations are short compared with many other numerical chapters. The chapter also appears in the objective section, where one wrong step in the liability calculation costs a 2-mark question, and no negative marking means you should always attempt it. Time spent here pays back quickly, and it strengthens your command of share issue accounting that the rest of the paper depends on.

Underwriting of Securities: topics in the order to study them

1Underwriting of Shares and Debentures: BasicsStart here to learn the terms: underwriter, marked and unmarked applications, firm underwriting and commission, which every later problem uses.
2Underwriting Liability: Partial and Full UnderwritingNext, learn the core liability calculation for a single underwriter and for several underwriters, since this is the base of every problem.
3Underwriting Problems with Firm Underwriting and Under-subscriptionStudy this after the basic liability layout, because firm underwriting and shortfall add steps on top of it.
4Underwriting Commission and Accounting EntriesFinish with commission and journal entries, which need the final liability figures from the earlier topics.

How to prepare Underwriting of Securities

Treat this chapter as one method with small variations. Learn the layout first, then practise it until the steps are automatic.

Read the basics and write down the definitions in your own words: underwriter, marked application, unmarked application, firm underwriting.
Learn the standard liability layout in order: gross liability, less marked applications, less share of unmarked applications, net liability. Write it out from memory.
Solve a single-underwriter problem, then a problem with two or three underwriters. In a case of under-subscription, check your answer: shares issued minus total applications received (including firm underwriting and marked applications) equals the total shares taken up by the underwriters, where the underwriters' liability covers the shortfall. Count firm underwriting once: if the stated total already includes it, do not add it again. If the issue is fully subscribed, underwriters take up nil and this check does not apply.
Add firm underwriting. Treat the firm underwritten shares as marked applications of that underwriter and include them in the total applications received. If the question gives the total without them, add them first. Deduct them from the total, along with the other marked applications, to get unmarked applications. Then run the same layout. In the net liability, firm underwriting is already part of that underwriter's marked applications, so do not deduct it a second time.
Handle surplus and shortfall: if one underwriter's net liability is negative, set it to nil and adjust the surplus against the other underwriters in the ratio of their gross liabilities, not exceeding each one's remaining liability, unless the question says otherwise. Then recompute their net liabilities.
Compute commission on the issue price of the securities underwritten, at the given rate, then pass entries for commission and for shares taken up by underwriters.
Finish with timed practice of two full problems, and attempt the objective questions on definitions and quick calculations.

Common mistakes in Underwriting of Securities

Giving marked applications a share of the unmarked applications as well.
Fix: First find unmarked applications as total applications received less all marked applications, including firm underwriting. Divide only that figure in the ratio of gross liabilities.
Forgetting to treat firm underwriting as marked applications.
Fix: Treat the firm underwriting as marked applications of that underwriter, include it in the total applications received, and deduct it from the total to get unmarked applications. In that underwriter's net liability, it is part of the marked applications, so deduct it once there.
Keeping a negative net liability in the final answer.
Fix: A negative figure means no liability. Set it to nil and adjust the surplus against the other underwriters in the ratio of their gross liabilities, not exceeding each one's remaining liability, unless the question says otherwise.
Calculating commission on the wrong base.
Fix: Use the issue price of the securities underwritten, not those taken up, unless the question says otherwise. Section 40(6) permits 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% for debentures, subject to authorisation by the articles and disclosure in the prospectus.
Skipping the final check on totals.
Fix: In a case of under-subscription, check that shares issued minus total applications received (including firm underwriting and marked applications) equals the total shares taken up by the underwriters, where their liability covers the shortfall. Count firm underwriting once, and do not add it again if the stated total already includes it. If the issue is fully subscribed, underwriters take up nil.

Last-day revision: Underwriting of Securities

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.

Underwriting of Securities practice questions

Underwriting of Securities: frequently asked questions

What is underwriting of securities in simple words?

It is a promise by an underwriter to buy the shares or debentures that the public does not take up, up to an agreed limit. The company pays commission for this assurance. It helps the company raise the capital it needs.

What are marked and unmarked applications?

Marked applications carry the stamp of an underwriter and are credited to that underwriter. Firm underwriting counts as marked applications of that underwriter. Unmarked applications are the total applications received less all marked applications. They are allocated among underwriters in the ratio of their gross liabilities.

How do I treat firm underwriting in a problem?

Treat the firm underwritten shares as marked applications of that underwriter and include them in the total applications received. Deduct them from the total, along with the other marked applications, to get unmarked applications. In the net liability they are part of that underwriter's marked applications, so deduct them once: gross liability − marked applications (including firm underwriting) − share of unmarked applications.

Is this chapter more numerical or theory?

It is mostly numerical, with a small theory part on definitions and commission. Practise the layout well, and also revise the terms for the objective section.