Depreciation Fund Method Sinking Fund Method of Depreciation Definition, Explanation, Example

As a result, the company has refinanced its debt by paying off the higher-yielding callable bonds with the newly-issued debt at a lower interest rate. The prospectus of the bond issue can provide details of the callable feature including the timing in which the bonds can be called, specific price levels, as well as the number of bonds that are callable. Typically, only a portion of the bonds issued are callable, and the callable bonds are chosen at random using their serial numbers. Sinking funds are beneficial because they encourage financial discipline, reduce dependency on loans, and prepare for future expenses without financial strain.

Sum-of-the-Years-Digits Depreciation Method

First, you need to determine the amount of depreciation to be charged on the asset. Every fixed asset has a specific useful life, after which it needs replacement. With each passing year, the asset’s value keeps on decreasing for various reasons. But the amount is not invested because the investments will be sold at the end of the year and used for the replacement of the old asset.

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BFL shall not be responsible or liable for any loss or shortfall incurred by the investors. There may be other/better alternatives to the investment avenues displayed by BFL. Hence, the final investment decision shall at all times exclusively remain with the investor alone and BFL shall not be liable or responsible for any consequences thereof. A sinking fund is commonly used by organisations and individuals for specific financial goals. For instance, consider a company that issues bonds worth Rs. 50 lakh, maturing in 10 years.

The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed.

1. Basically, there is only a very small difference between a sinking fund and a savings account, as both involve setting aside an amount of money for the future.
2. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable.
3. For instance, if you have a loan of Rs. 500,000, which needs to be paid in 10 years and the interest is 5%, then according to the sinking fund formula, your yearly saving should be Rs. 65,145.
4. A sinking fund is a fund used to set aside money over time for a specific future expense.
5. In such a way, the students do not have to take out extra money from their pockets because, throughout the year, they were already busy depositing money into their sinking fund.

Lower Default Risk

With an annual return of 6%, this will allow them to accumulate the desired $18,000 to replace the server at the end of its useful life. In such a way, the students do not have to take out extra money from their pockets because, throughout the year, they were already busy depositing money into their sinking fund. In short, a sinking fund is proactive because it prepares the individual for a future expense to be paid. These contributions may come from an individual’s income, a company’s revenue, or periodic payments from stakeholders, depending on the purpose, such as debt repayment or planned purchases. Choosing the right place to store your sinking fund is crucial for its growth and accessibility. A sinking fund should be kept in an account or investment vehicle that is safe, liquid, and earns moderate returns.

The company established a sinking fund whereby $4 billion must be paid to the fund each year to be used to pay down debt. By year three, ExxonMobil had paid off $12 billion of the $20 billion in long-term debt. A sinking fund is a fund containing money set aside or saved to pay off a debt or bond. A company that issues debt will need to pay that debt off in the future, and the sinking fund helps to soften the hardship of a large outlay of revenue. A sinking fund is established so the company can contribute to the fund in the years leading up to the bond’s maturity.

In the sum-of-the-years digits depreciation method, the remaining life of an asset is divided by the sum of the years and then multiplied by the depreciating base to determine the depreciation expense. Depreciation expense is used in accounting to allocate the cost of a tangible asset over its useful life. In other words, it is the reduction in the value of an asset that occurs over time due to usage, wear and tear, or obsolescence. The four main depreciation methods mentioned above are explained in detail below.

Also, if interest rates decrease, which would result in higher bond prices, the face value of the bonds would be lower than current market prices. In this case, the bonds could be called by the company that redeems the bonds from investors at face value. The investors would lose some of their interest payments, resulting in less long-term income.

(ii) Determine the annual depreciation cost by the sinking fund method. 5 marks

1. Since there will be funds set aside to pay off the bonds at maturity, there’s less likelihood of default on the money owed at maturity.
2. The server has an expected useful life of 5 years and a salvage value of $2,000 at the end of its useful life.
3. Hence, the final investment decision shall at all times exclusively remain with the investor alone and BFL shall not be liable or responsible for any consequences thereof.
4. A company could set aside cash deposits to be used as a sinking fund to retire preferred stock.

Paying the debt early via a sinking fund saves a company interest expense and prevents the company from being put in financial difficulties in the long term if economic or financial conditions worsen. The company could have opted not to establish a sinking fund, but it would have had to pay out $20 billion from profit, cash, or retained earnings in year five to pay off the debt. The company would have also had to pay five years of interest payments on all of the debt. sinking fund method of depreciation If economic conditions had deteriorated or the price of oil collapsed, Exxon might have had a cash shortfall due to lower revenues and not being able to meet its debt payment. Companies that are capital-intensive usually issue long-term bonds to fund purchases of new plant and equipment.

Sinking funds are typically non-refundable as they are allocated for specific financial obligations or purposes, such as repaying debt or replacing assets. However, unused sinking funds after fulfilling the intended goal may be redirected or withdrawn depending on the entity’s discretion. In managing investments, the Bajaj Finserv Mutual Fund Platform emerges as a key tool.

The main difference is that the former is set up for a particular purpose and to be used at a particular time, while the savings account is set up for any purpose that it may serve. In both cases, the sinking fund provides a structured approach to meeting financial commitments without impacting other cash flow needs. It ensures preparedness for planned expenses, reduces financial stress, and eliminates the need for last-minute borrowing.

This platform offers a diverse selection of over 1000 mutual fund schemes, catering to different investment needs, from beginner individual investors to large institutions planning endowments. It simplifies the investment process, making it more accessible and helps align investors’ financial contributions with their long-term goals in areas like education, research, and innovation. The Bajaj Finserv Platform does more than just manage funds; it provides expert guidance to ensure that investments make significant and lasting impacts. While the sinking fund provides for the purchase of a new asset at the end of the former’s useful life, some firms prefer to instead use their working capital for this purchase.