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Explain sinking fund depreciation.
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.
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