Explain sinking fund depreciation.

Question

Explain sinking fund depreciation.

Banking & FinanceFinance ManagementGrowth & Empowerment

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Sinking fund depreciation is also called as depreciation fund account. Amount generated through sinking fund depreciation is used to replace the asset when it needed. In this amount, charge is credited in sinking fund account, which is shown in liability side in balance sheet and asset value has its original value, and shown in asset side of balance sheet. The amount generated through sinking fund is invested in marketable security at the end of the year.

Formula

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

                    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

(rounded off to 3 decimals)

Money accumulated$\frac{(1+\frac{interest \:rate}{total\:no\:of\:payments\:per\:year})no\:of\:year-total\:no\:of\:payments\:per\:year-1}{{\frac{interest\:rate}{total\:no\:of\:payments\:per\:year}}}*periodic \:sinking\:fund$

Periodic sinking fund=$\frac{{\frac{interest\:rate}{total\:no\:of\:payments\:per\:year}}}{(1+{\frac{interest\:rate}{total\:no\:of\:payments\:per\:year}})no\:of\:year-total\:no\:of\:payments\:per\:year-1}* money accumulated$

Advantages of sinking fund depreciation are −

• Cash needed to replace asset is maintained.
• Improves financial position.
• Less interest rate.

Disadvantages of sinking fund depreciation are −

• P&L account increases as years go on.
• Problems for regular investment.
• Market conditions.

Mandalika

Published on 26-Sep-2020 17:16:28

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