Concept Of Sinking Fund Method Of Providing Depreciation, Its Advantages And Disadvantages

Concept Of Sinking Fund Method Of Depreciation

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. 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.

Under this method, a fixed amount is debited every year to depreciation amount and credited to depreciation fund account instead of asset account. The asset is shown at its original cost, in the books, in every year. The amount which is credited in the sinking fund, is invested in gilt-edged securities. The interest on such investment is also invested in similar securities. The securities are readily convertible into cash. Investments are purchased every year. When the assets become useless, the inestments are sold away and thus new assets can be purchased without disturbing the financial position of the firm. The sinking fund method is adopted specially when it is desired not merely to write off an asset but also to provide enough funds to replace the asset at the end of its working life. The amount set aside as depreciation is such that this, with compound interests, will be sufficient to meet the cost of new asset, less scrap value, if any, for replacement. The depreciation under this method can be calculated with the help of sinking fund table for a particular period at a given rate of interest.

Advantages Of Sinking Fund Method Of Depreciation

i. Sinking fund method makes available a sum of money for the replacement of asset by maintaining separate provision.

ii. Sinking fund method helps to strengthen financial position of a concern.

Disadvantages Of Sinking Fund Method Of Depreciation

i. The burden on profit and loss account goes on increasing as years pass by since the amount of depreciation every year remains same but the amount spent on repairs goes on increasing as the asset become old.

ii. Sinking fund method creates complication due to frequent investment.

iii. Prices of securities may fall at the time when they are to be realized as a result of which loss may have to be suffered.