Chapter = 9

Capitalization

Gerstenberg says

“For all practical purposes capitalization sometimes means the total accounting value of all the capital regularly employed in the business”

According to this definition, Capitalization includes share capital, borrowed capital and different types of reserves and surplus.

Difference CapitalizationCapitalization in business is meant by the total amount of capital

invested which include share capital, debt capital and reserves and surplus.

CapitalCapital means the net worth of a business. Capital structureCapital structure means the mutual relationship among the long-term

sources of capital which include owned capital, preference share capital and long term loans.

Financial structureThe financial structure means the composition of liability side of balance

sheet.

Theories of Capitalization

Cost theory of CapitalizationCapitalized value of Earnings theory

Types of Capitalization

Over CapitalizationUnder Capitalization

Bonneville and Dewey says

“When a business is unable to earn a fair rate of return on its outstanding securities, it is over capitalized.”

Real value of Total Assets < Book value of Total Assets

Par value of sharesMarket value of sharesBook value of shares Real value of shares

Causes of Over CapitalizationPromotion of the company with inflated assetsHigh promotion expensesOver estimating earnings at the time of promotion Capitalising earnings at lower ratesFormation or expansion of the company during inflationary

periodShortage of capitalDefective depreciation policyLiberal dividend policyFiscal policy of the Govt.Excess Capital

Consequences of the Over-Capitalization

Effects on the companyEffects on shareholdersEffects on Society

Remedies for Over-Capitalization

Reduction in Bonded DebtReduction in the Rate of Interest of

DebenturesRedemption of High Dividend Preferred StockReduction in par value of sharesReduction in the Number of sharesPloughing Back of Profits

Under Capitalization

Bonneville and Dewey says“Under Capitalization is not an economic

problem but a problem in adjusting the capital structure.”

Causes of Under Capitalization

Under estimation of earningsUse of high capitalization ratePromotion of company during DeflationUnder estimation of capital requirementsConservative dividend policyHigh standard of efficiencyLow promotion expenses

Effects of Under Capitalization

Effects on the companyEffects on the shareholdersEffects on society

Remedies for Under-Capitalization

Issue of bonus sharesSplitting of shares