Capital Account meaning with example: In the field of international trade and commerce, these two terms – current account and capital accounts – are widely used. Both of them relate to trade and business dealings of a nation with others. Wondering how does a Capital Account work? Let’s consider the following. While capital account deals with the change in ownership of a country’s assets, the current account reflects the change in a country’s net income. These two accounts – capital and current – together form the balance of payments or BoP of a country. When we refer to balance of payments, this refers to the record of all commercial transactions between a country along with the rest of the world. The country, in this context, includes the government, private entities and citizens.
Both the capital account and current account can have deficit or surplus situations. A surplus capital account means that money is flowing into the country, but these inflows reflect changes in the ownership of national assets by way of sale or borrowing.
A deficit situation in the capital account occurs when more money is flowing out of a country to acquire assets and rights abroad. It also means that though the money is going out of the country, it results in the acquisition of assets or rights.
Capital Account Surplus with Example
Here is an interesting example of a capital account transaction. For example, a foreign entity acquires a hotel chain in India. Such a transaction involves the payment of billions of dollars that helps the capital account to become surplus. The country will then receive inflows of billions of dollars but this also means that a domestic entity will lose ownership of the hotel chain.
The surplus account will not be against any goods or services supplied by a domestic entity to a foreign entity that can qualify as income or payment of a fee against delivery of some service.
Capital Account Deficit with Example
For example, an Indian corporate entity acquires a large European steel producer in a deal involving payment of billions of Euros. The transaction may turn the capital account into a deficit situation as the total outflow in the capital account may exceed total inflows because of the size of the deal. It will create a deficit situation in the capital account, but the deal will result in an Indian entity acquiring ownership right of a foreign asset.
How to calculate Capital Account?
Wondering how do you calculate Capital Account? Capital Account is the difference between the change in foreign ownership of domestic assets and change in domestic ownership of foreign assets.
Capital Account Formula:
Capital Account = Change in the foreign ownership of domestic assets – Change in domestic ownership of foreign assets
What goes into the Capital Account?
- Capital Account includes the following:
- Foreign Direct Investment (FDI),
- Foreign Portfolio Investment (FPI),
- Other investments
- Reserve Account
- Difference between Capital Account and Current Account
While capital account represents the change in ownership of assets, both within the country and outside, the current account reflects the net income of a country.