capital investment

How to Account for Capital Investment

Capital investment is money or funds invested in a business with an expectation of income and recovered through earnings generated by the business over several years.

Capital investment is also made to acquire fixed or non-fixed assets. Plant, machinery, and land are the examples of capital goods so you can say that capital investment is the money which is paid to purchase the capital asset or a fixed asset.

Capital investment can be made through different ways. This can include equity investors, banks, financial institutions, and venture. While capital investment is usually earmarked for capital or long-life assets, a portion may also be used for working capital purposes. It is generally understood that capital investment is used for capital expenditure rather than for day-to-day operations (working capital) or other expenses.

There are two more terms which are mostly confused with capital investment.

  1. Working capital
  2. Financial investment

Working capital is used to perform the day to day activities so increase in working capital would not be considered as capital investment and financial investment is made in mutual funds, fixed deposits, bonds and stock. An amount in shape of Interest is earned on such investment.

Whereas the capital investment is made in property, plant, machinery, and other capital assets and recovered over several years by getting profit from the business. As mentioned earlier capital investment is used to make a capital expenditure. These costs do not show in a p & L or income statement as an expense. Assets are shown in the balance sheets, and their depreciation value is shown in the P & L or income statement.

On the other hand, the invested amount becomes the part of owner’s equity on the balance sheet. Owner’s equity includes the initial investment made by you, your partners, any additional pain in capital and retained earnings.

Let’s take an example A and B are two partners running a biscuit manufacturing unit on by making 50%, 50% investment. They are outsourcing the packaging of the biscuits to a third party. The balance sheet is showing equal amount under equity head on the 2nd year closing. In a 3rd year, they decide to install their own packaging plant on their vacant place. Plant cost is $30,000, and B invests all the money.

Treatment of the investment can be made as the packaging plant would be debited by the $30,000 and B’s capital accounts would be credited with the same amount. The Packaging plant is a long-term fixed asset and would appear on the assets side of the balance sheets and equity on liabilities side would be increased by $30000 in as the share of B’s capital.

Capital investment encompasses a wide variety of funding options that also increases its scope beyond the basic definition. While funding for capital investment is generally in the form of common or preferred equity issuance, it may also be through straight or convertible debt.

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