Sinking fund method is used when the cost of replacement of an asset is too large. Depreciation is charged every year to the profit and loss A/c. But, it may sometimes happen that the amount is not readily available at the time of purchase of the new asset. Thus, the sinking fund method is used.
Browse more Topics under Concept And Accounting Of Depreciation
- Concept and Meaning of Depreciation
- Cost of Asset for Calculating Depreciation
- Straight Line Method
- Diminishing Balance Method
- Units of Production Method
- Annuity Method
- Profit or Loss on Disposal of Asset
- Change in Method of Depreciation
Sinking Fund Method
Under this method, the amount of depreciation charged every year is transferred to the sinking fund account. This amount is then invested in Government securities. Also, the interest earned on these securities is reinvested.
The amount of depreciation to be charged every year is calculated after considering the element of interest. The interest will be earned on the amount which is invested every year and will remain invested till the useful life of the asset.
At the time of the replacement of the asset, the investment is sold and the new asset is purchased from the sale proceeds. At this time, the book value of the old asset that needs to be replaced is transferred to the Sinking Fund Account.
Also, the sale proceeds of the old asset and any profit or loss from the sale of investments are transferred to the Sinking Fund Account. The balance in the Sinking Fund Account is then transferred to the Profit and Loss A/c or General Reserve.
The annual amount of depreciation to be charged is calculated with the help of Sinking Fund Tables. These tables show that at a given rate of interest and for a certain period how much amount needs to be set aside so that it accumulates to ₹1.
However, this method is a complex method of accounting. As the rates of interest keep fluctuating, therefore, the amount accumulated in the sinking fund may not match the original cost of the asset.
Also, the cost of replacement of the old asset may also change over the period. This method is mostly used by large-scale industries that have long-term assets and for real estate assets and leases.
Journal Entries for Sinking Fund Method
| Date | Particulars | Amount (Dr.) | Amount (Cr.) | |
| 1. For Depreciation | Depreciation A/c | Dr. | xx | |
| To Sinking Fund A/c | xx | |||
| (Being depreciation on the asset transferred to the sinking fund account) | ||||
| 2. For transferring depreciation to P&L A/c | Profit and Loss A/c | Dr. | xx | |
| To Depreciation A/c | xx | |||
| (Being depreciation charged to the profit and loss A/c) | ||||
| 3. For investing the depreciation amount | Sinking Fund Investment A/c | Dr. | xx | |
| To Bank A/c | xx | |||
| (Being amount of depreciation invested) | ||||
| 4. For interest earned | Bank A/c | Dr. | xx | |
| To Interest on Sinking Fund Investment A/c | xx | |||
| (Being interest earned on the sinking fund investments) | ||||
| 5. For transferring interest on investment | Interest on Sinking Fund Investment A/c | Dr. | xx | |
| To Sinking Fund A/c | xx | |||
| (Being interest on Sinking Fund Investment transferred to Sinking Fund A/c) | ||||
| 6. For sale of sinking fund investment | Bank A/c | Dr. | xx | |
| To Sinking Fund Investment A/c | xx | |||
| (Being Sinking Fund Investment sold at the end of the useful life of the asset) | ||||
| 7. For the profit on the sale of investment | Sinking Fund Investment A/c | Dr. | xx | |
| To Sinking Fund A/c | xx | |||
| (Being profit on the sale of investment transferred to sinking fund) | ||||
| 8. For loss on sale of investment | Sinking Fund A/c | Dr. | xx | |
| To Sinking Fund Investment A/c | xx | |||
| (Being loss on sale of investment transferred to sinking fund) | ||||
| 9. For transferring the book value of the asset | Sinking Fund A/c | Dr. | xx | |
| To Asset A/c | xx | |||
| (Being the book value of the asset transferred to the sinking fund) | ||||
| 10. For the transfer of surplus in Sinking fund | Sinking Fund A/c | Dr. | xx | |
| To General Reserve A/c | xx | |||
| (Being surplus in sinking fund transferred to the General Reserve) | ||||
| 11. For transfer of deficit in sinking fund | Profit & Loss A/c | Dr. | xx | |
| To Sinking Fund A/c | xx | |||
| (Being deficit in sinking fund transferred to profit and loss A/c) |
Solved Example onSinking Fund Method
Q. On 1st April 2015, R&P enterprises purchased a lease property for ₹2000000. The lease will expire on 31st March 2018. It was decided to provide depreciation on lease using the Sinking Fund Method. Following transactions took place during the period.Prepare the required accounts.
- 31st March 2016: Depreciation was ₹640000 and this sum was invested.
- 15th November 2016: Investments costing ₹100000 was sold for ₹120000 and the proceeds were re-invested.
- 31st March 2017: Depreciation was ₹640000 and the interest on investments was ₹32000. These sums were re-invested.
- 31st August 2017: Investments costing ₹200000 was sold for ₹225000 and the proceeds were re-invested.
- 31st March 2018: All investments were sold for 950000. Interest earned was 64000. Depreciation was ₹640000.
Ans:In the books of R&P enterprises
Lease A/c
| Date | Particulars | Amount | Date | Particulars | Amount | |
| 2015-16 | 2015-16 | |||||
| 1 Apr | To Bank A/c | 2000000 | 31 Mar | By Balance c/d | 2000000 | |
| 2000000 | 2000000 | |||||
| 2016-17 | 2016-17 | |||||
| 1 Apr | To Balance b/d | 2000000 | 31 Mar | By Balance c/d | 2000000 | |
| 2000000 | 2000000 | |||||
| 2017-18 | 2017-18 | |||||
| 1 Apr | To Balance b/d | 2000000 | 31 Mar | By Sinking Fund A/c | 2000000 | |
| 2000000 | 2000000 |
Sinking Fund A/c
| Date | Particulars | Amount | Date | Particulars | Amount | |
| 2015-16 | 2015-16 | |||||
| 31 Mar | To Balance c/d | 640000 | 31 Mar | By Depreciation A/c | 640000 | |
| 640000 | 640000 | |||||
| 2016-17 | 2016-17 | |||||
| 31 Mar | To Balance c/d | 1332000 | 1 Apr | By Balance b/d | 640000 | |
| 15 Nov | By Sinking Fund Investment A/c | 20000 | ||||
| 31 Mar | By Interest on Sinking Fund Investment A/c | 32000 | ||||
| 31 Mar | By Depreciation A/c | 640000 | ||||
| 1332000 | 1332000 | |||||
| 2017-18 | 2017-18 | |||||
| 31 Mar | To Sinking Fund Investment A/c | 407000 | 1 Apr | By Balance b/d | 1332000 | |
| 31 Mar | To Lease A/c | 2000000 | 31 Aug | By Sinking Fund Investment A/c | 25000 | |
| 31 Mar | By Interest on Sinking Fund Investment A/c | 64000 | ||||
| 31 Mar | By Depreciation A/c | 640000 | ||||
| 31 Mar | By Profit and Loss A/c | 346000 | ||||
| (deficit) | ||||||
| 2407000 | 2407000 |
Sinking Fund Investment A/c
| Date | Particulars | Amount | Date | Particulars | Amount | |
| 2015-16 | 2015-16 | |||||
| 31 Mar | To Bank A/c | 640000 | 31 Mar | By Balance c/d | 640000 | |
| 640000 | 640000 | |||||
| 2016-17 | 2016-17 | |||||
| 1 Apr | To Balance b/d | 640000 | 15 Nov | By Bank A/c (sale) | 120000 | |
| 15 Nov | To Sinking Fund A/c | 20000 | 31 Mar | By Balance c/d | 1332000 | |
| (profit on sale) | ||||||
| 15 Nov | To Bank A/c | 120000 | ||||
| (sale proceeds reinvested) | ||||||
| 31 Mar | To Bank A/c | 672000 | ||||
| (Depreciation and interest amt. reinvested) | ||||||
| 1452000 | 1452000 | |||||
| 2017-18 | 2017-18 | |||||
| 1 Apr | To Balance b/d | 1332000 | 31 Aug | By Bank A/c (sale) | 225000 | |
| 31 Aug | To Sinking Fund A/c | 25000 | 31 Mar | By Bank A/c (sale) | 950000 | |
| (profit on sale) | 31 Mar | By Sinking Fund A/c | 407000 | |||
| 31 Aug | To Bank A/c | 225000 | (loss on sale) | |||
| (sale proceeds reinvested) | ||||||
| 1582000 | 1582000 |
