Sinking Fund:
A sinking fund is a fund which created for the purpose of repayment of liabilities (redemption of debentures) and replacing fixed assets. Every year a fixed amount either charged against profit or loss account or appropriated out of the profit and loss appropriation account. The same amount is withdraw from business in each year and invested on investments. The interest received on these investments is re-invested again to earn compound interest every year. When the debentures are due for redemption, the investments are sold and debentures are redeemed. Any profit on sale of investment is credited in sinking fund account whereas loss is demented to the same account.
Types of Sinking Fund
There are two types of sinnkng fund. they are:
1. Sinking fund for redeeming liabilities: it is created for the purpose of repayment of liabilities or redemption from its creations is knows as sinking fund for redeeming liabities.
2. Sinking fund for replacing fixed assets: it is created for the purpose of replacing old assets by creating fund of the company at the end life of fixed assets is called sinking fund for replacing fixed assets.
Advantages or Objectives of Sinking Fund
The following advantage or objectives of sinking fund are as follows:
• It provided adequate fund for the redemption of debenture or other loans.
• It provides adequate fund for the redemption of old fixed assets at the end of its useful life for new assets.
• It helps to invest in outside securities which will increase sum of reserve.
• It helps to maintain strong to be distributed to the shareholders.
Disadvantages of Sinking Fund
• It is impossible to collect sufficient fund for replacing old assets for new immediately.
• It reduces the divisible profit to be distributed to the shareholders.