What Is a Capital Account?
The capital account, in international macroeconomics, is the part of the balance of payments which records all transactions made between entities in one country with entities in the rest of the world. These transactions consist of imports and exports of goods, services, capital, and as transfer payments such as foreign aid and remittances. The balance of payments is composed of a capital account and a current account—though a narrower definition breaks down the capital account into a financial account and a capital account.
In accounting, the capital account shows the net worth of a business at a specific point in time. It is also known as owner's equity for a sole proprietorship or shareholders' equity for a corporation, and it is reported in the bottom section of the balance sheet.
- The capital account, on a national level, represents the balance of payments for a country.
- The capital account keeps track of the net change in a nation's assets and liabilities during a year.
- The capital account's balance will inform economists whether the country is a net importer or net exporter of capital.
How Capital Accounts Work
Changes in the balance of payments can provide clues about a country’s relative level of economic health and future stability. The capital account indicates whether a country is importing or exporting capital. Big changes in the capital account can indicate how attractive a country is to foreign investors and can have a substantial impact on exchange rates.
Because all the transactions recorded in the balance of payments sum to zero, countries that run large trade deficits (current account deficits), like the United States, must by definition also run large capital account surpluses. This means more capital is flowing into the country than going out, caused by an increase in foreign ownership of domestic assets. A country with a large trade surplus is exporting capital and running a capital account deficit, which means money is flowing out of the country in exchange for increased ownership in foreign assets.
It is important to remember that the U.S. trade deficit is the consequence of foreign investors finding U.S. assets particularly attractive, and driving up the value of the dollar. Should America's relative appeal to foreign investors fade, the dollar would weaken and the trade deficit would shrink.
Capital Account vs. Financial Account
In recent years, many countries have adopted the narrower meaning of capital account used by the International Monetary Fund (IMF). It splits the capital account into two top-level divisions: the financial account and capital account. The capital and financial accounts measure net flows of financial claims (i.e., changes in asset position).
An economy's stock of foreign assets versus foreign liabilities is referred to as its net international investment position, or simply net foreign assets, which measures a country's net claims on the rest of the world. If a country’s claims on the rest of the world exceed their claims on it, then it has positive net foreign assets and is said to be a net creditor. If negative, a net debtor. The position changes over time as indicated by the capital and financial account.
The financial account measures increases or decreases in international ownership of assets, whether they be individuals, businesses, governments, or central banks. These assets include foreign direct investments, securities like stocks and bonds, and gold and foreign exchange reserves. The capital account, under this definition, measures financial transactions that do not affect income, production, or savings, such as international transfers of drilling rights, trademarks, and copyrights.
Current vs. Capital Account
The current and capital accounts represent two halves of a nation's balance of payments. The current account represents a country's net income over a period of time, while the capital account records the net change of assets and liabilities during a particular year.
In economic terms, the current account deals with the receipt and payment in cash as well as non-capital items, while the capital account reflects sources and utilization of capital. The sum of the current account and capital account reflected in the balance of payments will always be zero. Any surplus or deficit in the current account is matched and canceled out by an equal surplus or deficit in the capital account.
The current account deals with a country's short-term transactions or the difference between its savings and investments. These are also referred to as actual transactions (as they have a real impact on income), output, and employment levels through the movement of goods and services in the economy. The current account consists of visible trade (export and import of goods), invisible trade (export and import of services), unilateral transfers, and investment income (income from factors such as land or foreign shares).
The credit and debit of foreign exchange from these transactions are also recorded in the balance of current account. The resulting balance of the current account is approximated as the sum total of balance of trade.
Capital Accounts in Accounting
In accounting, a capital account is a general ledger account that is used to record the owners' contributed capital and retained earnings—the cumulative amount of a company's earnings since it was formed, minus the cumulative dividends paid to the shareholders. It is reported at the bottom of the company's balance sheet, in the equity section. In a sole proprietorship, this section would be referred to as owner's equity and in a corporation, shareholder's equity.
In a corporate balance sheet, the equity section is usually broken down into common stock, preferred stock, additional paid-in capital, retained earnings, and treasury stock accounts. All of the accounts have a natural credit balance, except for treasury stock that has a natural debit balance. Common and preferred stock are recorded at the par value of total shares owned by shareholders. Additional paid-in capital is the amount shareholder's have paid into the company in excess of the par value of stock. Retained earnings is the cumulative earnings of the company overtime, minus dividends paid out to shareholders, that have been reinvested in the company's ongoing business operations. The treasury stock account is a contra equity account that records a company's share buybacks.