SINKING FUND METHOD OF DEPRECIATION

The sinking fund method of depreciation is used when an organization wants to set aside a sufficient amount of cash to pay for a replacement asset when the current asset reaches the end of its useful life.

As depreciation is incurred, a matching amount of cash is invested, with the interest proceeds being deposited into an asset replacement fund. The interest deposited into this fund is also invested. By the time a replacement asset is needed, the funds needed to make the acquisition have accumulated in the associated fund.

More, The Sinking fund depreciation is also called a depreciation fund account. The amount generated through sinking fund depreciation is used to replace the asset when it needed. In this amount, the charge is credited to the sinking fund account, which is shown in the liability side of the balance sheet and the asset value has its original value and is shown on the asset side of the balance sheet.

The amount generated through the sinking fund is invested in marketable security at the end of the year.

Formula

Sinking fund value = [interest/ {(1+interst) ^period -1}

ADVANTAGES:-

A sinking fund helps the company to pay its liability well in advance.
A company is able to pay the debt in time because a company has already pulled a money well before.
A sinking fund is also used to redeem the bond or any other liability in a mid-way also.
A sinking fund also increases the goodwill of the company by paying the debt in time, and this will increase the faith of investors and attract more investment.

DISADVANTAGES:-

When a company uses the sinking fund to buy bonds before maturity, investor losses the interest on that particular time.
When a company uses this fund to purchase bonds at a discount or par value, so this will lose to the investors.
When a company has sufficient fund to buy back, the investors cannot take advantage of the company and that will make uncertainty to the investors.

Sinking fund table

Year	2%	4%	6%	8%	10%
1	1.00	1.00	1.00	1.00	1.00
5	0.192	0.185	0.177	0.170	0.164
10	0.091	0.083	0.076	0.069	0.063
15	0.058	0.045	0.043	0.037	0.031
20	0.041	0.033	0.027	0.022	0.017
25	0.031	0.024	0.018	0.014	0.01
30	0.025	0.018	0.013	0.009	0.006
35	0.02	0.014	0.009	0.006	0.003
40	0.02	0.01	0.006	0.004	0.002
45	0.014	0.008	0.005	0.002	0.001
50	0.012	0.006	0.003	0.002	0.001