Sinking Fund Method of Depreciation | Example |

Sinking Fund Method of Depreciation-feature image

Sinking Fund Method:

In Sinking Fund Method will provide us with an amount of depreciation as well as provide funds for the replacement of this asset when an asset need replacement like the end of life of an asset. Under this method, we charged depreciation on the value of asset but will not be credited to the asset account instead we will credit to sinking fund account. This account will be shown on the liabilities side of the Balance Sheet(Because it is a funds account) and an asset will be shown on the original value on the assets side of the Balance Sheet. At the end of each accounting year, the total amount of sinking fund credited in a year will be invested in the outside marketable security to provide cash for the replacement of an asset when needed.

It is also called Depreciation fund account.

*Interest received on marketable security will be invested likewise. So we to calculate the amount of depreciation is such way the amount of compound interest will be a sum equal to the cost of the asset less scrap value by the time it becomes useless.

*So, this amount will be calculated with the help of sinking fund table.

The formula of Calculation of Sinking Fund table value :

Depreciation formula of compound interest 2 - Sinking Fund Method of Depreciation | Example |

The following Table shows the Sinking Fund value period wise. 

Period

1%

2%

3%

4%

5%

1  1.000000  1.000000  1.000000  1.000000  1.000000
2  0.497512  0.495050  0.492611  0.490196  0.487805
3  0.330022  0.326755  0.323530  0.320349  0.317209
4  0.246281  0.242624  0.239027  0.235490  0.232012
5  0.196040  0.192158  0.188355  0.184627  0.180975
6  0.162548  0.158526  0.154598  0.150762  0.147017
7  0.138628  0.134512  0.130506  0.126610  0.122820
8  0.120690  0.116510  0.112456  0.108528  0.104722
9  0.106740  0.102515  0.098434  0.094493  0.090690
10  0.095582  0.091327  0.087231  0.083291  0.079505
15  0.062124  0.057825  0.053767  0.049941  0.046342
20  0.045415  0.041157  0.037216  0.033582  0.030243
25  0.035407  0.031220  0.027428  0.024012  0.020952
30  0.028748  0.024650  0.021019  0.017830  0.015051

Journal Entries for Sinking Fund Method:

1st Year: 

1) Asset A/c                                 Dr     ________

To Bank A/c                                                 ________

(Being asset purchased )

2) Depreciation A/c                        Dr     ________

To Sinking Fund A/c                                 ________

(Being dep. charged for the year)

3) Profit/loss A/c                            Dr.    ________

To Depreciation A/c                              ________

(Being dep. of the year transferred to P/L A/c)

4) Sinking Fund Investment A/c    Dr.   ________

To Bank A/c                                         ________

(Being amount of Dep. Invested in SFI A/c)

Subsequent Years: –

1) Bank A/c                                    Dr.    ________

To Sinking fund A/c                 ________

(Being Interest on Sinking fund investment account received for the year)

2) Depreciation A/c                        Dr.  ________

To Sinking Fund A/c                             ________

(Being dep. charged for the year)

3) Profit/loss A/c                            Dr.  ________

To Depreciation A/c                             ________

(Being dep. of the year transferred to P/L A/c)

4) Sinking Fund Investment A/c    Dr.  ________

To Bank A/c                                          ________

(Being amount of Dep. plus interest on Sinking fund investment Invested in SFI A/c)

In Last Year: –

1) Bank A/c                                    Dr.    ________

To Sinking fund A/c                 ________

(Being Interest on Sinking fund investment account received for the year)

2) Depreciation A/c                        Dr.  ________

To Sinking Fund A/c                             ________

(Being dep. charged for the year)

3) Profit/loss A/c                            Dr.  ________

To Depreciation A/c                             ________

(Being dep. of the year transferred to P/L A/c)

4) Sinking Fund Investment A/c    Dr.  ________

To Bank A/c

5) Bank A/c                                         Dr.  ________

To Sinking fund Investment a/c                ________

(Being invest sold at par means no profit no loss)

or 

5) Bank A/c                                         Dr.   ________

Sinking Fund A/c                                Dr.   ________

To Sinking fund Investment a/c                 ________

(Being invest sold at on loss)

or 

5) Bank A/c                                         Dr.  ________

To Sinking fund Investment a/c                ________

To Sinking Fund A/c                                  ________

(Being invest sold at on profit)

6) Sinking Fund A/c                              Dr.   ________

To Asset a/c                                            ________

(Being balance of asset account transferred to Sinking fund account)

7) Sinking Fund A/c                              Dr.   ________

To Profit/Loss a/c                                            ________

(Being balance of Sinking fund account transferred to Profit and loss account –  if profit)

Or

7) Profit/Loss A/c                              Dr.   ________

To Sinking Fund a/c                                            ________

(Being balance of Sinking fund account transferred to Profit and loss account –  if Loss)

Example of sinking fund method of depreciation:

A and B Pvt. Ltd. purchase a machine on 01/04/2012 on lease for 4 years for Rs 10,00,000/-. It decided to provide cash for the replacement of the lease at the end of the 4th year by setting up a sinking fund. It is expected that investment will fetch interest @ 5%. The Sinking fund table shows that an annual payment of Re. 1 at 5% compound interest in 4 years is equal to 0.232012. Investment is made to the nearest rupee. At the end of the 4th year investment sold for Rs.7,50,000/-.

Solution :

Working Note: – 

*(it will be shown at the end of the sum in the exam. We have written it here because this is the first step in solving sinking fund method-related questions.)

Calculate the amount of Depreciation or Investment.  

The total cost of an asset     X    value of rupee after four years @ 5% (we got this value from sinking fund table)

10,00,000 X 0.232012 = Rs 2,32,012  (this amount will be amount of depreciation and annual investment amount.)

Calculation of amount of interest and the total amount of investment for each year end.

Year  Opeing Investment  Interest @ 5% Investment at the end of Year Total Investment of the Year  Closing Investment
1 2 3 4 5 = 3+4 6 = 5+2
2012-13 2,32,012 2,32,012 2,32,012
2013-14 2,32,012 11,601 2,32,012 2,43,613 4,75,625
2014-15 4,75,625 23,781 2,32,012 2,55,793 7,31,418
2015-16 7,31,418 36,571 7,31,418

Calculate Profit of Loss on Sinking Fund Investment:

Profit of Loss on SFI = Sale Price of SFI – Book value of SFI

Now, we will post all the journal entries year by year is shown as following according to Sinking Fund Method of Depreciation: – 

First Year 2012-13

Date

Particulars

L.F.

 Debit

 Credit

2012-13
01-Apr Lease (Land) A/c Dr.  10,00,000
To Bank A/c  10,00,000
(Being land purchased on lease )
31-Mar Depreciation A/c Dr.         2,32,012
To Sinking Fund A/c         2,32,012
(Being Depreciation on asset charged)
31-Mar Profit or loss A/c Dr.         2,32,012
To Depreciation A/c         2,32,012
(Being Depreciation transfer to P&L A/c)
31-Mar Sinking Fund Investment A/c Dr.    2,32,012
To Bank A/c         2,32,012
(Being amount of Sinking fund invested)

Second Year – 2013-14

Date 

Particulars

L.F.

 Debit 

 Credit 

2013-14
31-Mar Bank A/c  Dr.        11,601
To Sinking Fund A/c       11,601
(Being Interest received on SFI)
31-Mar Depreciation A/c  Dr.          2,32,012
To Sinking Fund A/c         2,32,012
(Being Depreciation on asset charged)
31-Mar Profit or loss A/c Dr.          2,32,012
To Depreciation A/c          2,32,012
(Being Depreciation transfer to P&L A/c)
31-Mar Sinking Fund Investment A/c Dr.     2,43,613
To Bank A/c         2,43,613
(Being amount of Sinking fund and interest invested)

 
Third Year – 2014-15

Date 

Particulars 

L.F.

 Debit 

 Credit 

2014-15
31-Mar Bank A/c  Dr.        23,781
To Sinking Fund A/c       23,781
(Being Interest received on SFI)
31-Mar Depreciation A/c  Dr.          2,32,012
To Sinking Fund A/c         2,32,012
(Being Depreciation on asset charged)
31-Mar Profit or loss A/c Dr.          2,32,012
To Depreciation A/c          2,32,012
(Being Depreciation transfer to P&L A/c)
31-Mar Sinking Fund Investment A/c Dr.     2,55,793
To Bank A/c         2,55,793
(Being amount of Sinking fund and interest invested)

Fourth Year – 2015-16

Date 

Particulars 

L.F.

 Debit 

 Credit 

2015-16
31-Mar Bank A/c  Dr.        36,571
To Sinking Fund A/c       36,571
(Being Interest received on SFI)
31-Mar Depreciation A/c  Dr.          2,32,012
To Sinking Fund A/c         2,32,012
(Being Depreciation on asset charged)
31-Mar Profit or loss A/c Dr.          2,32,012
To Depreciation A/c          2,32,012
(Being Depreciation transfer to P&L A/c)
31-Mar Bank A/c  Dr.     7,50,000
To Sinking Fund Investment A/c         7,31,418
To Sinking Fund A/c            18,582
(Being Sinking fund investment sold on profit of Rs 18,582/-)
31-Mar Sinking Fund A/c Dr.       10,00,000
To Lease (Land) A/c       10,00,000
(Being Amount of Lease written off by transferring fund to asset account)
31-Mar Sinking Fund A/c Dr.             18,583
To Profit or loss A/c            18,583
(Being balance amount of sinking fund account transfer to P&L account)
* Total of Sinking Fund A/c – Transfer to Lease A/c (1018583 – 1000000 = 18583)

Now, we will post all these transactions in ledger according to Sinking Fund Method of Depreciation: –

Lease (Land) Account

Date

Particulars

 Amount 

Date

Particulars

 Amount 

01-04-13 To Bank A/c 10,00,000
31-03-14 By Balance C/d 10,00,000
10,00,000 10,00,000
01-04-14 To Balance B/d 10,00,000
31-03-15 By Balance C/d 10,00,000
10,00,000 10,00,000
01-04-15 To Balance B/d 10,00,000
31-03-16 By Balance C/d 10,00,000
10,00,000 10,00,000
01-04-16 To Balance B/d 10,00,000 31-03-17 By Sinking Fund A/c 10,00,000
31-03-17 By Balance C/d
10,00,000 10,00,000

 

Sinking Fund Account

Date

Particulars

 Amount 

Date

Particulars

 Amount 

31-03-14 By Depreciation A/c 2,32,012
31-03-14 To Balance C/d 2,32,012
2,32,012 2,32,012
 – 31-03-15 By Balance B/d 2,32,012
    – 31-03-15 By Bank A/c (Interest) 11,601
31-03-15 To Balance C/d 4,75,625 31-03-15 By Depreciation A/c 2,32,012
4,75,625 4,75,625
31-03-16 By Balance B/d 4,75,625
    – 31-03-16 By Bank A/c (Interest) 23,781
31-03-16 To Balance C/d 7,31,418 31-03-16 By Depreciation A/c 2,32,012
  7,31,418 7,31,418
31-03-17 To Lease(Land) A/c 10,00,000 31-03-17 By Balance B/d 7,31,418
31-03-17 To Profit/Loss A/c 18,583 31-03-17 By Bank A/c (Interest) 36,571
31-03-17 By Bank A/c (Profit) 8,582
31-03-17 To Balance C/d               – 31-03-17 By Depreciation A/c 2,32,012
10,18,583 10,18,583

 

Depreciation Account

Date

Particulars

 Amount 

Date

Particulars

 Amount 

31-03-14 To Profit/Loss A/c 2,32,012 31-03-14 By Depreciation A/c 2,32,012
2,32,012 2,32,012
31-03-15 To Profit/Loss A/c 2,32,012 31-03-15 By Depreciation A/c 2,32,012
2,32,012 2,32,012
31-03-16 To Profit/Loss A/c 2,32,012 31-03-16 By Depreciation A/c 2,32,012
2,32,012 2,32,012
31-03-17 To Profit/Loss A/c 2,32,012 31-03-17 By Depreciation A/c 2,32,012
2,32,012 2,32,012

 

Sinking Fund Investment Account

Date

Particulars

 Amount 

Date

Particulars

 Amount 

31-03-14 To Bank A/c 2,32,012
31-03-14 By Balance C/d 2,32,012
2,32,012 2,32,012
31-03-15 To Balance B/d 2,32,012
31-03-15 To Bank A/c 2,43,613 31-03-15 By Balance C/d 4,75,625
4,75,625 4,75,625
31-03-16 To Balance B/d 4,75,625
31-03-16 To Bank A/c 2,55,793 31-03-16 By Balance C/d 7,31,418
7,31,418 7,31,418
31-03-17 To Balance B/d 7,31,418 31-03-17 By Bank A/c 7,31,418
31-03-17 By Balance C/d
7,31,418 7,31,418

 

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