The balance of payments for a country compares to what a balance sheet is for a company. For example, the balance of payments for the United States accounts for all international transactions between individuals, businesses and government agencies. Each transaction carries a corresponding debit and credit – debits for money leaving, and credits for money entering.
Some differences exist between how certain governments present the balance of payments. The International Monetary Fund (IMF) has one standard for recording international transactions, and its method is different from the structure of international economic accounts at the U.S. Bureau of Economic Analysis.
Like all double-entry accounting systems, the debits and credits in the balance of payments should theoretically balance. This does not always occur due to the inconsistencies and difficulties in accounting estimates. However, any deficit or surplus in the current account should be offset by an alternative surplus or deficit in the capital and financial accounts.
Generally, there are three types of accounts listed under the balance of payments. The most well-known is the current account, which documents all payments for goods and services between actors in different countries. The second is the capital account, which tracks capital transfers and non-financial assets between businesses and individuals in different countries. The last is the financial account, which tracks reserve assets from monetary authorities. Sometimes, the capital and financial accounts are combined.
There are four sub-accounts in the current account:
- Merchandise trading
- Service purchases
- Income receipts
- Unilateral transfers
Unilateral transfers can include foreign aid or gifts and are particularly difficult to balance out in the other accounts.
Merchandise and services are what most people think of when they hear "the trade deficit." If the U.S. purchases $100 billion worth of goods and services from the rest of the world, but the rest of the world only purchases $75 billion worth of goods and services from the U.S., then the country operates with a current account deficit of $25 billion.
The income receipts sub-account tracks income from financial assets, such as dividends from stocks or interest payments from bonds.
Most capital accounts show two sub-accounts:
- Capital transfers
- Non-financial assets
Capital transfers are not the same as financial investments. Capital transfers include items such as debt forgiveness, transfer of title for fixed assets, inheritance taxes and uninsured damage to fixed assets.
Non-financial assets are defined as non-produced assets, such as natural resources, patents, copyrights, franchises and leases. All valuable intellectual property is recorded here, although determining value can be tricky.
Recording the financial account suffers from the most inconsistency among different balance of payments methods. In the U.S, the financial account tracks assets owned by the U.S. that are held abroad and all foreign-owned assets held in the United States.