Concept and Accounting of Depreciation Sinking Fund Method, Formula, and FAQs

This uniform amount is charged until the asset gets reduced to nil or its salvage value at the end of its estimated useful life. The sinking fund method of assets depreciation is ideally suited for plant and machinery, as well as other wasting assets that require replacement. Now, ABC Ltd. plans to repurchase 50 percent of its Rs. 100,000 outstanding bonds in the open market in the current year to lower the principal balance which it will owe at the maturity period. Since the interest rates increase and decrease over time, the price of the bonds might as well increase or decrease. Obviously, ABC Ltd. doesn’t want to purchase the bonds for more than their face value, so the company included a sinking fund provision in the original issuance.

How many types of sinking funds are there?

21 Sinking Fund Categories To Use In Your Budget.

In other words, it literally saves an organized legal entity from ‘sinking’ in debt.How does a housing society use its Sinking Fund? With respect to co-operative housing societies, a sinking fund is to be generated in specific ways and used for a particular purpose. While a housing society is expected to set aside other funds such as Reserve Fund, Repair and Maintenance Fund, Education and Training Fund, a Sinking Fund is to be utilised when structural repairs are needed. When a reconstruction/alteration, heavy repairs or additions need to be carried out , the Sinking Fund kicks in as a go-to fund.

Understanding the Sinking Fund Method

This is because an asset might be in good physical condition after a few years but it may not be used for production purposes. It is the estimated net realizable value of an asset at the end of its useful life. This value is determined as a result of the difference between the sale price and the expenses necessary to dispose of an asset.

Each residence is sold at a different price, higher or lower, depending upon a variety of circumstances. Also, in any given society, there may be 2,3,4 BHK apartments, some buildings may be brand new construction while some wings of the same society may be constructed over an existing structure. Thus the actual cost incurred in making every flat may not be the same in every incident. Therefore it is unfair to charge every resident with a contribution derived from the same fixed rate on different buildings. At times, the builders are also unwilling to give out the actual cost of the construction as they sell the residential unit at a higher price than the original amount it cost to build it. Thus the price a customer pays for flat proportionate land is not always based on the actual.

  • The amount of annual depreciation is invested outside the business every year in good securities bearing interest at a specified rate.
  • The funds available in sinking fund are invested in gilt-edged securities where the amount is convertible in to cash.
  • Thus the price a customer pays for flat proportionate land is not always based on the actual.
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f) Interest on sinking fund investment is credited to

Sinking fund methods are mostly used by large-scale industries such as utilities that require expensive, long-term investments. Furthermore, companies may also use the sinking fund method for depreciation of real estate assets. Depreciation for lease renewals is one of several scenarios that apply to real estate assets.

What is sinking fund and its types?

A sinking fund is a type of savings account established for the accumulation of capital over time so as to repay the principal on an issue of debt. In the corporate world, a sinking fund is a type of bond created to repay the debt by a certain date.

The depreciation amount is fixed and remains the same year after year and is charged to profit and loss account every year through the creation of “depreciation fund” or “sinking fund”. The amount of annual depreciation is invested outside the business every year in good securities bearing interest at a specified rate. The aggregate amount of interest and annual provision is invested every year. When the asset is completely written off or is to be replaced, the securities are sold and money realised by selling securities is used to replace the old asset. Depreciation fund account is closed by transfer of its balance to old asset account. One of the objectives of providing for depreciation is to provide for replacement of the assetat the end of its useful life.

How does a housing society generate a Sinking Fund?

The investment amounts are determined by the depreciation schedule of the asset. Additionally, companies may also use the for real estate assets. Different scenarios may apply to real estate assets, but one of the most common is depreciation for lease renewals. In this situation, a depreciation schedule is based on the lease term and expected interest.

  • When a company uses the sinking fund to buy bonds before maturity, investor losses the interest on that particular time.
  • A man loans P 187,400 from a bank with interest at 5% compounded annually.
  • A sinking fund incorporates funds set aside or borrowed to pay off a loan, debt or any future capital expense at the time of maturity.
  • This method is adopted especially when it is desired not merely to write off an asset but also to provide enough funds to replace an asset at the end of its working life.
  • Long-term investments are typically used, but shorter-term investments can also be reinvested.

Thus, it spread the principal payments over a period of time to nullify the effect of a large principal payment on the date of maturity. Sinking fund method is a method of calculating depreciation for an asset in which apart from calculating depreciation, it also keeps aside a fund for replacing the asset at the end of its useful life. Prevent Unauthorized Transactions in your demat / trading account Update your Mobile Number/ email Id with your stock broker / Depository Participant. When you are handed your society maintenance bill every month, you may have noticed an item which usually makes up around one-third of the total charges and is known as Sinking Fund.

Assets are expensed by companies over time, not just during the period when they are purchased. As a consequence, depreciation involves spreading the cost of an asset across many different accounting periods, allowing companies to benefit from the asset without deducting the full cost from net income . Sinking funds typically invest in government-backed securities, such as Treasury notes, bills, and bonds. Long-term investments are typically used, but shorter-term investments can also be reinvested. Investment amounts are determined by the asset’s depreciation schedule. Under depreciation fund method, funds are made available for the replacement of asset at the end of its useful life.

practical question 3 !! Related: Concept and Accounting of Depreciation (P… moreart – ?

Interest is received annually and reinvested every year along with the amount of annual depreciation. On the expiry of the life of the asset, the investments are sold and the sale proceeds are used for the replacement of the asset. The company makes provisions of fixed amount every year to the credit of depreciation account instead of asset account. The asset account continues with its original cost in the books of the company. The funds available in sinking fund are invested in gilt-edged securities where the amount is convertible in to cash.

Under the sinking fund method, the amount of the money is to be added to the asset-replacement fund each year. After this, the calculation is done to determine the cost which is to be replaced by the asset. A sinking fund is accounted as a non-current asset or long term asset in a company’s balance sheet and is also often included in the list of long-term investments or other investments. Most often seen with capital intensive companies, long term debts and bonds are issued to fund the purchases of new plants and equipment. In general parlance, a Sinking Fund is money set aside in a separate account to pay off a debt, a way to generate funds for a depreciating asset, to pay off a future expense or repay long-term debt. It is a financial technique of ensuring that a monetary lack does not arise causing any hardships in case of insufficient funds.


The research, personal finance and market tutorial sections are widely followed by students, academia, corporates and investors among others. On 1st July 2009, A Ltd purchased a machine for $55,500 and spent $3,000on its installation. The expected life of the machine is 4 years at the end ofwhich the estimated scrap value will be $8,000.

There are other reasons why sinking fund methods are not appropriate in addition to the extra complexity. The sinking fund method is a technique, where an asset is depreciated while generating enough money to replace it at the end of its own useful life. As depreciation charges are incurred to reflect the asset’s value, the same matching amount of cash is also to be reinvested. We will chalk the details further to know about the sinking fund method in detail.

Depreciation fund method

ClearTax can also help you in getting your business registered for Goods & Services Tax Law. Net income is also known as net profit, which is a single number, that represents a specific type of profit. This how to use gann square in tradingview certificate demonstrates that IIFL as an organization has defined and put in place best-practice information security processes. A sinking is used to pay the liability of a company that will come in future.

The experts may do so by factoring all components including rate per sq feet, valuation of shops, common premises, etc. The amount to be collected from members for the Sinking Fund should be revised every five years by following the same valuation procedure. About MyGateMyGate is India’s largest housing society software, benefiting thousands of housing societies, developers, society facility managers, and millions of homeowners in every Indian city. In most cases, sinking funds invest in government-backed securities, such as Treasury notes, billsand bonds. Investments matching the duration of the asset’s life are usually used, but shorter-term investments can be reinvested.

sinking fund method of depreciation

Think of it as an investment that you are making every month in insuring your residence will be taken care of in the long term when the need arises to rebuild or construct it due to damage and dilapidation. Let’s understand the why, the how and the how much of a Sinking Fund in detail. As depreciation is incurred, a matching amount of cash is invested, usually in government-backed securities. As the name describes a callable bond sinking fund means a sinking fund in which a company has a specific call price.

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