What is Sinking Fund?

Sinking fund is also known as depreciation fund.  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 company’s long-term debt.

How the sinking funds method of depreciation works?

 The company makes provisions of fixed amount (under straight line depreciation method) every year to the credit of depreciation account instead of asset account. The asset account continues with its original cost in the books of the company. The funds available in sinking fund (depreciation funds) are invested in gilt-edged securities where the amount is convertible in to cash.  Some companies keep this in the bank in the form of long term cumulative deposits that may be sufficient to buy new assets when the existing asset becomes unusable. This is mainly because the 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 and the amount realized may not be adequate to buy the new assets.