Balance of Payment
Balance of payment is the summary statement of the transactions made by all the residents of a country with the rest of the world during a particular period of time. The transactions of millions of people of a nation cannot appear on the balance of payments statements. A country needs to keep the record of its transactions with other countries in a systematic manner.
Balance of Payments Accounting Principles:
1. Debits and Credits:
Transactions which involve the receipt of payments from foreign countries are credited and recorded as a positive figure. Whereas, transactions which involve making payments to foreign countries are debited and recorded as a negative figure.
2. Double Entry Bookkeeping:
As per this principle, each transaction is recorded in the balance of payments with two entries. Transactions that give rise to a receipt of payment by a domestic resident are credited. However, transactions that give rise to payment to be made by a domestic resident are debited.
BOP= Current account + Capital account + Financial account + Net errors and emissions + official reserve account
The balance of payment can be segregated into current account, capital account, financial account, net errors and omissions account and official reserves account.
1. Current Account:
Current account records the balance of goods and services exported by a country. The services offered by a country to other countries are also recorded as the exports balance of services in their current account. Balance of goods and services imported by a country from foreign countries is the second component of a current account. Import of goods and services from foreign countries create lacks of competitive advantage. Unilateral transfer payments such as financial aids, grants and gifts given to another country are recorded on the debit side of current accounts. The net income balance of a country resulting from investments in the form of dividends, profits, reinvested earnings, and interest on debts. Also, remittances received from its residents who are working abroad are also recorded in credit side of current account.
2. Capital Account:
The capital account records the net capital flow due to the sale and purchase of capital assets in between the residents and foreigners. Transactions such as purchase of assets, such as patent, trademarks, franchises and leases are recorded on debit side of the capital account. However, the sales of capital assets by the residents are recorded on credit side of the capital account. Also, debt forgiveness or cancellation by creditors are recorded on credit side of the capital account. Overall, activities like sales of fixed assets creates inflow of capital so they are recorded on credit side of the capital account. Likewise, activities that creates outflow of capital such as purchase of assets are recorded on debit side of the capital account.
3. Financial Account:
Financial account involves the direct investment and portfolio investment. Direct investment records the net balance of capital which is dispersed from one country to another for the purpose of exerting control over the assets. Purchase of financial assets like stocks, money market instruments and government bonds are recorded on debit side of financial account. Inversely, sales of financial assets are recorded on credit side of financial account.
4. Errors and Omissions Account:
The major accounts of the balance of payment are current accounts, capital accounts and financial accounts. Due to inaccurate numbers in the sources of data or due to errors in the compilation of the balance of payments, the balance of payment may not be balanced. Therefore, an additional account called net errors and omissions is created to balance the capital flows.
5. Official Reserve Account:
Official reserves account consists of gold and foreign currency. Central bank of a country keeps a reserve of gold and foreign currencies. When the balance of payments are in surplus, the central bank withdraws the foreign exchange reserves to finance the deficit balance of payments.
