Underwriting -
An Insurance Of Capital Issues:

Underwriting of shares and debentures is like an insurance of capital issues. In an Underwriting agreement, the undertaker ensures that the capital issues (shares and debentures) offered to the public will be subscribed for. The underwriting firm undertakes the responsibility of the unsubscribed portion (if any). Underwriting of shares and debentures is guaranteeing that the unsubscribed portion of capital issues will be taken up by and paid by the Undertaker.

For this contract, the consideration that is paid to the Underwriter is called "Underwriting Commission". It is maximum 5% of issue price in case of shares and 2.5% of issue price in case of debentures. The amount of compensation is the difference between the sold price and price paid to companies for securities. The entire process can be done through negotiations between the underwriters and issuing company (it is also called Negotiating underwriting). Underwriters will get an amount while they purchase their securities at the lowest negotiated price.

Firm Underwriting:

'Firm' underwriting refers to the commitment given by the Underwriter to the issuing Company to take up a specified number of shares irrespective of the number of shares subscribed for by the public. In such a case, unless it has been otherwise agreed, the underwriter's liability is determined without taking into account the number of shares taken up 'firm' by him, i.e. the underwriter is obliged to take up the number of shares he has applied for 'firm' and the number of shares he is obliged to take up on the basis of the underwriting agreement.

Partial Underwriting:

Under partial underwriting along with firm underwriting, unless otherwise agreed, individual underwriter does not get the benefit of firm underwriting in determination of number of shares/debentures to be taken up by him.

Accounting Treatment of Underwriting Of Shares In The Books of Company:

When Company Gets Money From Public For Selling Shares Under The Contract Of Underwriting:

Bank A/c------------------------Dr.

 To Share Capital A/c

(Being X number of equity shares @ Rs. X issued as per Board's Resolution Number ...Dated...)

Note:

  1. Bank A/c is debited as Real A/c "Debit What Comes In"
When Underwriter Takes The Liability Of Unsold Shares:

Underwriter's A/c---------------Dr.

 To Share Capital A/c

(Being the balance of shares not subscribed by the public taken up by the underwriter as per the agreement)

Note:

  1. Underwriter's A/c is debited as because the company will be receiving the amount of money for the shares taken over by the undertaker.
When Underwriting Commission Gets Due:

Underwriting Commission A/c------------Dr.

 To Underwriter's A/c

(Being commission due to the underwriter)

Note:

  1. Underwriting Commission is debited treating it as expense for the company
  2. Underwriter's A/c is credited as because the amount of commission is payable to the underwriter. It's a liability so it is credited.
When The Net Amount Due From Underwriter Received:

Bank A/c---------------Dr.

 To Underwriter's A/c (Total receivable amount on takeover shares by underwriter - Underwriter's commission)

(Being the net amount due from the underwriter received)

When The Cost Of Issue Gets Transferred:

Cost of Issue of Shares/Debenture A/c---------Dr.

 To Underwriter's commission A/c

(Being commission due to the underwriter)