Sinking Fund Method

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DEFINITION of 'Sinking Fund Method'

A technique for depreciating an asset in bookkeeping records while also generating money to purchase a replacement for the asset when it reaches the end of its useful life. Under the sinking fund method, the business sets aside an amount of money to invest annually so that the principal plus the interest earned in the fund will be enough to replace the asset.

INVESTOPEDIA EXPLAINS 'Sinking Fund Method'

The amount of money that needs to be added to the asset-replacement fund each year is calculated by determining how much it will cost to replace the asset, how many years the asset is expected to last and what rate of interest can be earned as well as how much can be earned through the effects of compound interest. The sinking fund method is not common, and is not desirable when interest rates cannot reasonably be predicted.

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