Capital vs. Capitalization: Meaning, Examples, Journal Entries & Common Errors

This article explains the key differences between capital and capitalization in accounting and finance. It covers definitions, examples, journal entries, common adjustments, and typical errors accountants make, helping businesses and students understand how to properly treat these accounts.

Understanding the difference between capital and capitalization is critical for business owners, investors, and accountants. Although the two terms sound similar, they have different meanings, uses, and accounting treatments.

1. What is Capital?

Capital refers to the financial resources or assets a business uses to fund its operations, investments, and growth.

Types of Capital:

1. Equity Capital – Owners’ or shareholders’ money invested in the business.

   • Example: Shareholders contribute 500,000 birr to start a company.

2. Debt Capital – Borrowed money such as loans and bonds.

   • Example: The company borrows 200,000 birr from a bank.

3. Working Capital – The difference between current assets and current liabilities.

   • Example: If Current Assets = 150,000 birr and Current Liabilities = 100,000 birr → Working Capital = 50,000 birr.

4. Fixed Capital – Long-term investments in assets like buildings, machinery, and land

   Journal Entry Example for Capital Contribution:

   When the owner invests 100,000 birr cash:

   Dr. Cash                  100,000

        Cr. Owner’s Capital             100,000

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   2. What is Capitalization?

   Capitalization refers to how a business records, structures, and values its financial resources.

   Types of Capitalization:

   1. Financial Capitalization (Corporate)
   • The mix of debt and equity a company uses.
   • Example: If equity = 2 million birr, debt = 1 million birr → Capitalization = 3 million birr.
   2. Market Capitalization (Stock Market)

   To calculate this market capitalization, we use the next Formula:

   Market Cap=Share Price × Outstanding Shares

   Example: 1 million shares × 100 birr = 100 million birr.

   3. Accounting Capitalization
   • Recording an expenditure as an asset (to be depreciated over time) instead of expensing it immediately.
   • Example: Buying machinery for 500,000 birr is capitalized as an asset. Paying rent of 10,000 birr is expensed.

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   Journal Entry Example for Capitalized Asset:

   When the company buys machinery for 500,000 birr:

                                            Dr. Machinery (Asset)     500,000

                                                                             Cr. Cash/Bank                    500,000

   Depreciation later:

                         Dr. Depreciation Expense   50,000

                                            Cr. Accumulated Depreciation       50,000

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   3. Common Adjustments in Capital and Capitalization

   1. Adjustment for Owner’s Drawings
   • If the owner withdraws 20,000 birr for personal use:

   Dr. Owner’s Drawing     20,000

                   Cr. Cash/Bank                  20,000

   • At year-end, drawings reduce capital:

   Dr. Owner’s Capital     20,000

                    Cr. Owner’s Drawing             20,000

   2. Adjustment for Capitalized vs. Expensed Costs
   • Example: A company spends 100,000 birr on office renovation. If it extends useful life, it should be capitalized as an asset. If it’s just repainting, it should be expensed.

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   4. Common Errors Accountants Make

   1. Confusing Capital with Revenue Expenditure
   • Mistake: Capitalizing small repairs (like painting) instead of expensing them.
   • Effect: Overstates assets and profits.
   2. Incorrect Treatment of Owner Withdrawals
   • Mistake: Recording drawings as an expense instead of reducing capital.
   • Effect: Overstates expenses and understates owner’s equity.
   3. Wrong Market Capitalization Reporting
   • Mistake: Using book value of shares instead of market price.
   • Effect: Misleads investors.
   4. Not Adjusting for Depreciation on Capitalized Assets
   • Mistake: Capitalizing an asset but forgetting to depreciate.
   • Effect: Assets overstated, expenses understated.

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   5. Key Differences Between Capital and Capitalization

   Aspect	Capital	Capitalization
   Definition	Money/resources used in business	Structure/valuation of capital
   Accounting Entry	Owner’s investment recorded as equity	Asset recognition & financing mix
   Examples	Cash, equipment, loans	Market cap, asset capitalization
   Financial Impact	Increases business resources	Determines financial structure & asset reporting
   Common Errors	Treating drawings as expense	Capitalizing wrong costs, missing depreciation

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   ✅ In summary:

   • Capital is the money or resources a business has.
   • Capitalization is how those resources are valued, structured, or recorded.
   • Proper accounting treatment prevents errors like overstating assets or understating expenses.