This method is different from all the methods stated above in so far as this method provides for necessary cash to replace the asset at the end of its useful life. It would be found from the computation of other methods that only the reduction in the book value is considered and no provision is made for the replacement of the asset. The modus operandi of this method is that it requires the calculation of a basic sum of money which. If set aside each year, would together with interest earned accumulate to an amount equal to the cost of the asset. The amount to be set aside every year by way of depreciation is calculated by using Sinking-Fund Tables. The following procedure is generally adopted for recording purposes:

(i)    Asset stands at its original cost.

(ii)    At the end of the first accounting period following entries are recorded:

(a)    The amount of depreciation as found from the sinking fund tables is debited to depreciation account and credited to sinking (depreciation) fund account i.e.,

Depreciation Account                    Dr.
    To Sinking (Depreciation) Fund Account

(b) The amount of depreciation transferred to Sinking Fund Account is invested in outside securities, i.e.,

    Sinking Fund Investments Accounts            Dr.
        To Bank Account

(iii)    In the second and subsequent years except last year

(a)    On receiving interest on investments
Bank Account                        Dr.
    To Sinking Fund Account

(b)    On setting aside the annual amount [as in (ii) (a)].
Depreciation Account                    Dr.
    To Sinking Fund Account

(c)    On investing the amount set aside together with interest
The same entry as (ii) (b) with the difference that amount to be invested would include the amount set aside plus amount of interest received on previous investments.

Last year
(i)    On sale of investments
    Bank Account                    Dr.
        To Sinking Fund Investment Account

(ii)    The investment may be realized either at their nominal value, or at less than or more than nominal values. If there is a profit on sale of investments:
Sinking Fund Investments Account            Dr.
    To Sinking Fund Account
The entry would be reversed in the event of loss.

(iii)    On sale of old asset
    Bank Account                    Dr.
        To Asset Account

(iv)    The balance in the Sinking Fund Account is transferred to the old asset account and if there is still any balance left, it would be transferred to profit and loss account or income statement.
It may be added that cash realized on the sale of old asset and sale of sinking fund investments is utilized for purchasing the new asset.

For more help in Sinking Fund Method click the button below to submit your homework assignment