MBA (Finance specialisation)
&
MBA – Banking and Finance
(Trimester)
Term VI
Module : – International Financial
Management
Unit I: Balance of Payment
Lesson 1.2
Balance of Payment
Introduction
 The Balance of Payments (BOP) is an accounting system
that records the economic transactions between the
residents and government of a particular country and the
residents and governments of the rest of the world during a
certain period of time,
usually a year.
 The BOP provides valuable information for the conduct of
economic
policy.
Balance of Payment
Balance of Payments Accounting
 Like other accounting statements, the BOP conforms to the
principle
of double entry bookkeeping.
 This means that every international transaction should produce
debit and credit entries of equal magnitude.
 It is important to mention here that BOP is neither an income
statement nor a balance sheet.
 It is a sources and uses of funds statement that reflects changes
in assets, liabilities and net worth during a specified period of time.
Balance of Payment
Debits and Credits
1.
2.
Credit Transactions (+) are those that involve the receipt of payment
from foreigners. The following are some of the important credit
transactions
a.
Exports of goods or services
b.
Unilateral transfers (gifts) received from foreigners
c.
Capital inflows
Debit Transactions (-) are those that involve the payment of foreign
exchange i.e., transactions that expend foreign exchange. The
following are some of the important debit transactions
a.
Import of goods and services
b.
Unilateral transfers (or gifts) made to foreigners
c.
Capital outflows
Balance of Payment
Balance of Payments Statement
The balance of payment statement records all types of international
transactions that a country consummates over a certain period of
time.
It is divided into three sections:
I.
The Current Account
II. The Capital Account
III. The Official Reserve Account.
Balance of Payment
Debit and Credit Entries
The Balance of Payment of a country is classified into
three well-defined categories –
1. The Current Account,
2. The Capital Account
3. The Official Reserves Account.
The rules for recording a transaction as debit and credit in the current account
are:
Debit (Outflow)
Credit (Inflow)
Goods
Buy
Sell
Services
Buy
Sell
Investment Income
Pay
Receive
Unilateral transfers
Give
Receive
Cont….
The rules for doubly entry recording here are as follow:
Debit (Outflow)
Portfolio
(short-term)
Receiving a payment from a foreigner
Buying a short-term asset
Buying back a short-term domestic
asset from its foreign owner
Portfolio
(long-term)
Buying a long-term foreign asset (not
for purpose of control
Buying back a long-term domestic
asset from its foreign owner (not for
purpose of control)
Foreign direct investment
Buying a foreign asset for purpose of
control
Buying back from its foreign owner a
domestic asset previously acquired for
purposes of control
Credit (Inflow)
Making a payment to a foreigner
Selling a domestic short-term asset
to a foreigner
Selling a short-term foreign asset
acquired previously
Selling a domestic long-term asset
to a foreigner (not for purpose of
control)
Selling a long-term foreign asset
acquired
previously
(not
for
purposes of control)
Selling a long-term foreign asset
acquired
previously
(not
for
purposes of control)
Selling a foreign asset previously
acquired for purposes of control
Balance of Payment : Illustrations
1. Merchandise Trade : An Indian company sells Rs 4,00, 000
worth of machinery to a U S company. The U.S. company
pays for the machinery in 30 days.
Entries:
Particulars
Debit
Liquid Short Term capital
Rs 4,00,000
Exports
Credit
Rs 4,00,000
Balance of Payment : Illustrations
2. Services : Services represents non-merchandise transactions
such as tourist expenditures. Consider, a person visits U.K.
and cashes Rs 300000 worth of his Indian Traveller’s cheque
at a U.K. hotel. Before coming back to India, entire amount
of Rs 3,00,000 in U.K.
Entries:
Particulars
Debit
Tourist Expenditure
Rs 3,00,000
Liquid Short term capital
Credit
Rs 3,00,000
Balance of Payment : Illustrations
3. Unilateral Transfer : This account covers gift by domestic
residents to foreign residents or gift by domestic government
to foreign government or vice versa. Assume that the US Red
cross sends $ 10,000 worth of flood relief goods to India.
Entries: ( In the US Balance of Payment)
Particulars
Debit
Transfer Payments
$ 10,000
Exports
Credit
$10,000
Balance of Payment : Illustrations
4. Long-Term capital : This account shows inflow and outflow of
capital commitments whose maturity is longer than one
year. It covers investments in financial assets without
significant control of the real assets. Assume that , Indian
company purchases Rs 6 crores worth of U.K. bond.
Entries: ( In the India Balance of Payment)
Particulars
Debit
Portfolio investment
Rs 600,00,000
Liquid Short-term capital
Credit
Rs 600,00,000
Balance of Payment : Illustrations
5. Non-liquid Short-term capital : These are the flows of funds
that are not normally sold. Bank loans represents non-liquid
short term liabilities. Suppose U. S. bank lends $30,000 to an
Indian company
Entries: ( In the U.S. Balance of Payment)
Particulars
Debit
Non-liquid short term capital
$ 30,000
Liquid Short-term capital
Credit
$ 30,000
Balance of Payment : Illustrations
Record the following transactions and prepare the Balance of
Payments statement.
a. A US firm export $ 1,000 worth of goods to be paid in six
months.
b. A US resident visits London and spends $ 400 on hotel, meal
and so on.
c. US Government gives a US bank balance of $200 to the
government of a developing nation as part of the US aid
programme.
d. A US resident purchases foreign stock for $800 and pays for it
by increasing the foreign bank balance in the U.S.
e. A foreign investor purchase $600 of United states treasury
bills and pays by drawing down his bank balance in the
United states by an equal amounts.
Balance of Payment : Illustrations
Particulars
Debit
Short term capital Outflow
1000
Merchandise exports
Travel Sevices purchased from foreigners
1000
400
Short term capital inflow
Unilateral Transfer
400
200
Short term capital inflow
Long term capital outflow
200
800
Short term capital inflow
Short term capital outflow
Short term capital inflow
Credit
800
600
600
Balance of Payment : Illustrations
Particulars
Debit
Merchandise
1000
Services
400
Unilateral Transfers
200
Long term capital
800
Short term capital, Net
Total
Credit
400
1400
1400