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Sinking Fund Method of Depreciation – Example

Sinking Fund Method of Depreciation Feature image
Sinking Fund Method of Depreciation Feature image

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Sinking Fund Method:

The 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 needs replacement like the end of life of an asset. Under this method, we charged depreciation on the value of the asset but will not be credited to the asset account instead we will credit it to the 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.

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It is also called the Depreciation fund account.

*Interest received on marketable security will be invested likewise. So we calculate the amount of depreciation in such a 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 the sinking fund table.

The formula of Calculation of Sinking Fund table value :

Sinking Fund Method formula of depreciation

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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                                 ________

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(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                                         ________

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(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                             ________

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(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                                          ________

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

In the 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                             ________

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(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

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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.   ________

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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                                  ________

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(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                                            ________

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(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 the 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/-.

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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.)

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

Year Opening Investment Interest @ 5%Investment at the end of YearTotal Investment of the Year Closing Investment
12345 = 3+46 = 5+2
2012-132,32,0122,32,0122,32,012
2013-142,32,01211,6012,32,0122,43,6134,75,625
2014-154,75,62523,7812,32,0122,55,7937,31,418
2015-167,31,41836,5717,31,418

Calculate Profit or Loss on Sinking Fund Investment:

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

The Journal entries under the Sinking Fund Method of Depreciation: –

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

First Year 2012-13

Date

Particulars

L.F.

 Debit

 Credit

2012-13      
01-AprLease (Land) A/cDr.  10,00,000 
  To Bank A/c    10,00,000
 (Being land purchased on lease )   
 
31-MarDepreciation A/cDr.         2,32,012 
  To Sinking Fund A/c           2,32,012
 (Being Depreciation on asset charged)   
 
31-MarProfit or loss A/cDr.         2,32,012 
  To Depreciation A/c           2,32,012
 (Being Depreciation transfer to P&L A/c)   
 
31-MarSinking Fund Investment A/cDr.    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-MarBank A/c Dr.        11,601 
  To Sinking Fund A/c         11,601
 (Being Interest received on SFI)   
 
31-MarDepreciation A/c Dr.          2,32,012 
  To Sinking Fund A/c           2,32,012
 (Being Depreciation on asset charged)   
 
31-MarProfit or loss A/cDr.          2,32,012 
  To Depreciation A/c            2,32,012
 (Being Depreciation transfer to P&L A/c)   
 
31-MarSinking Fund Investment A/cDr.     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-MarBank A/c Dr.        23,781 
  To Sinking Fund A/c         23,781
 (Being Interest received on SFI)   
 
31-MarDepreciation A/c Dr.          2,32,012 
  To Sinking Fund A/c           2,32,012
 (Being Depreciation on asset charged)   
 
31-MarProfit or loss A/cDr.          2,32,012 
  To Depreciation A/c            2,32,012
 (Being Depreciation transfer to P&L A/c)   
 
31-MarSinking Fund Investment A/cDr.     2,55,793 
  To Bank A/c           2,55,793
 (Being amount of Sinking fund and interest invested)   

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Fourth Year – 2015-16

Date 

Particulars 

L.F.

 Debit 

 Credit 

2015-16      
31-MarBank A/c Dr.        36,571 
  To Sinking Fund A/c         36,571
 (Being Interest received on SFI)   
 
31-MarDepreciation A/c Dr.          2,32,012 
  To Sinking Fund A/c           2,32,012
 (Being Depreciation on asset charged)   
 
31-MarProfit or loss A/cDr.          2,32,012 
  To Depreciation A/c            2,32,012
 (Being Depreciation transfer to P&L A/c)   
 
31-MarBank 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 the profit of Rs 18,582/-)   
       
31-MarSinking Fund A/cDr.       10,00,000 
  To Lease (Land) A/c         10,00,000
 (Being Amount of Lease written off by transferring fund to asset account)   
 
31-MarSinking Fund A/cDr.             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)

The Asset account under the Sinking Fund Method of Depreciation: 

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

Lease (Land) Account

Date

Particulars

 Amount 

Date

Particulars

 Amount 

01-04-13To Bank A/c10,00,000   
   31-03-14By Balance C/d10,00,000
  10,00,000  10,00,000
 
01-04-14To Balance B/d10,00,000   
   31-03-15By Balance C/d10,00,000
  10,00,000  10,00,000
 
01-04-15To Balance B/d10,00,000   
   31-03-16By Balance C/d10,00,000
  10,00,000  10,00,000
 
01-04-16To Balance B/d10,00,00031-03-17By Sinking Fund A/c10,00,000
   31-03-17By Balance C/d
  10,00,000  10,00,000

 

Sinking Fund Account

Date

Particulars

 Amount 

Date

Particulars

 Amount 

   31-03-14By Depreciation A/c2,32,012
31-03-14To Balance C/d2,32,012   
  2,32,012  2,32,012
 
   –31-03-15By Balance B/d2,32,012
      –31-03-15By Bank A/c (Interest)11,601
31-03-15To Balance C/d4,75,62531-03-15By Depreciation A/c2,32,012
  4,75,625  4,75,625
 
  31-03-16By Balance B/d4,75,625
      –31-03-16By Bank A/c (Interest)23,781
31-03-16To Balance C/d7,31,41831-03-16By Depreciation A/c2,32,012
    7,31,418  7,31,418
 
31-03-17To Lease(Land) A/c10,00,00031-03-17By Balance B/d7,31,418
31-03-17To Profit/Loss A/c18,58331-03-17By Bank A/c (Interest)36,571
  31-03-17By Bank A/c (Profit)8,582
31-03-17To Balance C/d              –31-03-17By Depreciation A/c2,32,012
  10,18,583  10,18,583

 

Depreciation Account

Date

Particulars

 Amount 

Date

Particulars

 Amount 

31-03-14To Profit/Loss A/c2,32,01231-03-14By Depreciation A/c2,32,012
  2,32,012  2,32,012
 
31-03-15To Profit/Loss A/c2,32,01231-03-15By Depreciation A/c2,32,012
  2,32,012  2,32,012
 
31-03-16To Profit/Loss A/c2,32,01231-03-16By Depreciation A/c2,32,012
  2,32,012  2,32,012
 
31-03-17To Profit/Loss A/c2,32,01231-03-17By Depreciation A/c2,32,012
  2,32,012  2,32,012

 

Sinking Fund Investment Account

Date

Particulars

 Amount 

Date

Particulars

 Amount 

31-03-14To Bank A/c2,32,012   
   31-03-14By Balance C/d2,32,012
  2,32,012  2,32,012
 
31-03-15To Balance B/d2,32,012   
31-03-15To Bank A/c2,43,61331-03-15By Balance C/d4,75,625
  4,75,625  4,75,625
 
31-03-16To Balance B/d4,75,625   
31-03-16To Bank A/c2,55,79331-03-16By Balance C/d7,31,418
  7,31,418  7,31,418
      
31-03-17To Balance B/d7,31,41831-03-17By Bank A/c7,31,418
   31-03-17By Balance C/d
  7,31,418  7,31,418

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