Article on Sinking Fund Method - Accounting for Fixed Assets and Depreciation

8/13/2019 Article on Sinking Fund Method - Accounting for Fixed Assets and Depreciation

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Sinking Fund MethodAccounting for Fixed Assets

And

Depreciation


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A sinking fund formed by the usual investment of a fixed amount togather the amount of money required to replace an asset to set date inthe future. This technique is based on idea of present values.

The sinking fund method not only considers depreciation into account

however also makes provision for replacement of the asset. Under thismethod, a fund is formed by giving debit to depreciation account andgiving credit to Sinking Fund Account.


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Depreciation account is finally shifted to Profit and Loss Account. An amountcounterpart to depreciation charged is invested outside the business in gilt-

edged or other securities and are allowed to gather at compound interest soas to create the requisite amount to reinstate the asset after a specifiedphase of time.

The main benefit of this method is that it keeps away from strain on workingcapital, if considerable money is withdrawn from the business to reinstatethe asset at the end of its life. However, during inflation, the depreciable costof an asset is likely to be less than the replacement cost of the asset.


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The asset is placed in the balance sheet each year at its actual value. Sinkingfund is placed on the liabilities side and sinking fund investment is placed in

the assets side of the balance sheet..

At the end of the useful life of the asset all investments are sold away. Theprofits are utilized for purchasing the new asset. The asset account is closed

by setting it off against the sinking fund account. It must be noted that profitand loss on sale of investment is also shifted to the sinking fund account. Theequal amount of cash to be invested every year is determined from thesinking fund table.


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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. Aspiring to replace themachine on the expiry of its life, the company establishes a sinking fund.

Investments are expected to realize 5% interest. On 30th June 2013, themachine was sold off as scrap for $9,000 and the investments were realizedat 5% less than the book value. On 1st July 2013, a new machine is installed ata cost of $62,500. Sinking fund tables show that $0.2320 invested every yearwill make $1 at the end of 4 years at 5%. Show the required ledger

accounts in the books of A Ltd for all the years.


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Amount Required = $55,500 + 3,000

8,000 = $50,000; Therefore, AnnualContribution = $50,000 x 0.232 = $11,600.


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An adjustment has been made in the depreciation charged in 2012-2013.


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Article on Sinking Fund Method - Accounting for Fixed Assets and Depreciation