Some of the well known methods of depreciation accountinle briefly explained in the discussion that follows. Depreciation fund method is also know as sinking fund method or amortization fund method. How do you calculate sinking fund depreciation answers. Under this method, the amount of depreciation charged every year is transferred to the sinking fund account.
Depreciation is charged every year to the profit and loss ac. Annuity method of depreciation is also another method of depreciation apart from other methods like the straightline method, written down value method, etc. Sinking fund formula in a very simple language, sinking fund is a type of fund which is set up for repayment of debt. However, the annual amount is not set aside to a separate fund account in annuity method.
This video explains the sinking fund method of depreciation. The annuity and sinking fund depreciation methods include, as part of the depreciation expense, a return on the asset being depreciated. Depreciation is the accounting process of converting the original costs of fixed assets such as plant and machinery, equipment, etc into the expense. It decides to write off depreciation on the annuity method. As depreciation is incurred, a matching amount of cash is invested, with the interest proceeds being deposited into an asset replacement fund. Each year the profit and loss account is debited and the fund account credited with a sum, which is so calculated that the annual sum credited to the fund account and accumulating throughout the life of the asset may be equal to the amount which would be required to replace the old asset. The depreciation rate will be same for the life of machine. Depreciation fund method of calculating depreciation. In this method the depreciation fund and the actual loss in value of machine are equal.
Depreciation fund sinking fund method under depreciation fund method, funds are made available for the replacement of asset at the end of its useful life. Under this method a fixed amount is debited every year to depreciation account or profit and loss account and is credited to depreciation fund account, instead of asset account. Each year the profit and loss account is debited and the fund account credited with a sum, which is so calculated that the annual sum credited to the fund account and accumulating throughout the. Sinking fund method of depreciation accountingtools. However, in annuity method, as the interest is added to the cost of the asset, the total depreciation is more than the depreciable cost of the asset. Sinking fund method is used when the cost of replacement of an asset is too large.
In the annuity method, along with the value of the asset, interest lost over its life is also written off. Sinking fund method of depreciation what the heck is it. A method of depreciation centered around cost recovery and a constant rate of return upon any asset that is being depreciated. It decided to provide cash for the replacement of the lease at the end of the 4th year by setting up a sinking fund. Suppose that the account has an annual interest rate of compounded times per year, so that is the interest rate per compounding period. The wednesday\naverage rose to 946 mln dlrs from 148 mln a week earlier. Get a close knowledge of concept of annuity and sinking fund method described best by sachin kushwaha for ca foundation. Sinking fund is a fund into which a company sets aside its revenue over a period of time, in order to fund a future capital expense or used to replace the asset at the end of its useful life or for gradual repayment of companys longterm debt. A sinking fund method is a technique for depreciating an asset in bookkeeping records while generating money to purchase a replacement for the asset when it reaches the end of. This method of depreciation considers the cost of the asset and also the amount of interest lost on the capital expenditure. It refers to the decline in the value of fixed assets due to their usage, passage of time or obsolescence. The annuity method of depreciation is a process used to calculate depreciation on an asset by calculating its rate of return as if it was an investment.
The asset is shown at its original cost, in the books, in every year. This method of depreciation is suitable for costly but wasting assets. Annuities and sinking funds sinking fund a sinking fund is an account earning compound interest into which you make periodic deposits. It can be said that it is a method of allocating the cost of the asset over its useful life. The amount of depreciation to be charged every year is calculated after considering the element of interest. This account will be shown on the liabilities side of the balance sheetbecause it is a funds account and an asset will be shown on the original value on the assets side of the balance sheet. The depreciation amount is fixed and remains the same year after year and is charged to profit and loss account every year through the creation of depreciation fund or sinking fund. Under this method, we charged depreciation on the value of the asset but will not be credited to the asset account instead we will credit to sinking fund account.
The depreciation, under this method, can be calculated with the help of a sinking fund table for a particular period at a given rate of interest. Money market shortage forecast at 250 mln stg, body. Depreciation by annuity method a five year lease worth rs 30,000 is to be depreciated by annuity system, the unwritten balance of the asset bearing interest at 5%. My intention here is only to explain the concept and not to make you do the practical question.
Sinking fund method is a method of depreciation if a large sum of money is required for replacement of an asset at the end of its effective life it may not be advisable to leave in the amount of. Concept and meaning of annuity method of depreciation, its. This is a method of depreciation which also takes into account the element of interest on capital outlay and seeks to write of the value of the asset as well as the interest lost over the life of the asset. The methods discussed in the previous posts do not help in accumulating the amount of depreciation which can be readily available for the replacement of the asset when it is completely unusable. This amount is then invested in government securities. Present value of an annuity interest factors can be used to solve a loan amortisation problem, where the objective is to determine the payments necessary to pay off or amortise a loan. Example of the sinking fund method of depreciation. The party who sets up this kind of fund usually sets asides a certain amount of money on a regular basis and which is then used to repay the debt amount.
What is the meaning of annuity method of depreciation. Annuity method of depreciation definition, explanation. Under this method, a fund know as depreciation fund or sinking fund is created. The bank of england said it forecast a\nshortage of around 250 mln stg in the money market. Interest methods a annuity method b sinking fund method 5. It requires the depreciation on the asset to be provided through a depreciation or sinking fund brought into being by accumulating thereon the amount of depreciation at a flat rate charged to the profit. A sinking fund method is a technique for depreciating an asset in bookkeeping records while generating money to purchase a. Sinking fund method and insurance policy method are used for systematic writingoff of an asset or redemption of bonds and other longterm debt instruments.
I have just been asked to look into the above depreciation method. Sinking fund formula how to calculate sinking fund. We purchased an asset on lease on 01042016 for five years at a cost of rs. Annuity method is regarded as most exact and precise from the point of view of calculations. Depreciation by depreciation fund method without scrap value. The annual amount to be written off as shown by the annuity table is rs 6,929. The sinking fund method of depreciation is used when an organization wants to set aside a sufficient amount of cash to pay for a replacement asset when the current asset reaches the end of its useful life. This method assumes that certain depreciation occurs according to the straight line law and, therefore, in this method a constant depreciation charge is made every year on the basis of total depreciation initial cost scrap or salvage value and useful life of the equipmentproperty. The annual depreciation cost by sinking fund method at 4% interest is p791. Sinking fund refers to a fund that is set up by the particular bond issuer in order to repurchase a definite portion of the bond issue or for the replenishment of a major asset or any other similar capital expenditure. Concept of sinking fund method of providing depreciation. Distinction between sinking fund and annuity methods of depreciation i under sinking fund method, the annual amount is set aside to a separate fund account. Sinking fund method of assets depreciation play accounting. Accounting students can take help from video lectures, handouts, helping materials, assignments solution, online quizzes, gdb, past papers, books and solved problems.
Sinking fund method is designed in such a way that it incorporates the advantages of depreciating the assets as well as accumulating the necessary amount for its replacement. Depreciation is a method in which the cost of the physical asset is allocated in its lifetime. This method is known by different names such as redemption fund method, amortization fund method, sinking fund method of assets depreciation. Thus, it is based on the assumption that if the amount that is spent on the purchase of the asset was invested elsewhere, it would have earned a certain amount. Also see formula of gross margin ratio method with financial analysis, balance sheet and income statement analysis tutorials for free download on.
Depreciation can be calculated under the annuity method shown below. Depreciation methods methods for providing depreciation. Under this method, a certain amount is written off as depreciation every year and placed to the credit of sinking fund account. Depreciation fund method or sinking fund method of. It requires the depreciation on the asset to be provided through a depreciation or sinking fund brought into being by accumulating thereon the amount of depreciation at a flat rate charged to the profit and loss account every year investing the amount of. You can use the annuity or sinking fund depreciation starter workbook, shown in figure 154, to construct depreciation schedules with the annuity or sinking fund depreciation methods. I have found online that it is a method where they basically save a certain amount each year, based on estimated interest rates, to replace the machine at the end of its useful life. Other methods a revaluation method b group or composite method c discounted cash flow method d replacement method. Understanding the annuity or sinking fund depreciation. All the physical assets such as machinery, building losses their value over time because of usage.
The following are the disadvantages of the annuity method. But, it may sometimes happen that the amount is not readily available at the time of purchase of the new asset. As such, the bond issuer is required to contribute a certain amount of money to the sinking fund each period and the formula to calculate the. Depreciation is the decrease in the value of assets.
Also, the interest earned on these securities is reinvested. Furthermore, depreciation is a non cash expense as it does not involve any outflow of. The annuity and sinking fund depreciation methods are mechanically identical, so this book supplies the same starter workbook for both. It requires the depreciation on the asset to be provided through a depreciation or sinking fund brought into being by accumulating thereon the amount of depreciation at a flat rate charged to the profit and loss account every year investing the. Both of these methods expense less of the cost of an asset in the early periods of an assets life than in the later periods, so they are roughly the opposite of the declining balance and sumoftheyears. An equipment costs p10,000 with a salvage value of p500 at the end of 10 years. Depreciation fund method or sinking fund method under this method, funds are mad available for the replacement of asset at the end of its useful life.
1659 274 1076 209 1478 648 1056 1582 1122 1257 161 1405 1357 649 335 1168 41 526 135 691 710 609 1306 212 1351 96 1288 758 878 325 563 784 551 853 1458 650 209 80 909 1278 685 433