The BIOS correctly reads it as 131072 kB why not windows?

Because Windows is smart enough to tell you how much effective memory you have. The amount of effective memory present (physical memory - kernel) is a hell of a lot more important to know than the total amount memory.

but you are missing the point here.
Physical Memory - Total implies the physical total memory not effective memory. If you think it should be effective memory then why does it not read "Effective Memory - Total"?

I believe the term ''physical memory'' in OS terminology refers to nonvirtual memory, ie not part of the swap file.