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Concept And Accounting of Depreciation

Sinking Fund Method

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.

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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.

Sinking Fund Method

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 on Sinking 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.

  1. 31st March 2016: Depreciation was ₹640000 and this sum was invested.
  2. 15th November 2016: Investments costing ₹100000 was sold for ₹120000 and the proceeds were re-invested.
  3. 31st March 2017: Depreciation was ₹640000 and the interest on investments was ₹32000. These sums were re-invested.
  4. 31st August 2017: Investments costing ₹200000 was sold for ₹225000 and the proceeds were re-invested.
  5. 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

 

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