What is a bond sinking fund? - Universal CPA Review (2024)

FAQs

What is a bond sinking fund? - Universal CPA Review? ›

A bond sinking fund is similar to restricted cash in the sense that the company must put aside to buy back bonds that the company had issued. A separate trustee would hold the cash for the company, which is why it is labeled as restricted cash.

A sinking fund is an account containing money set aside to pay off a debt or bond. Sinking funds may help pay off the debt at maturity or assist in buying back bonds on the open market. Callable bonds with sinking funds may be called back early removing future interest payments from the investor.

A corporation's bond sinking fund appears in the first noncurrent asset section of the corporation's balance sheet. This section is likely to have the heading Investments. The bond sinking fund is a noncurrent (or long-term) asset even if the fund contains only cash.

Disadvantages of a Sinking Fund

Here are some more disadvantages: Opportunity Cost: The funds set aside in a sinking fund could earn a higher return if invested elsewhere. Over-funding: There's a risk of setting aside more money than necessary, which might affect the cash flow.

The corporation is required to make regular deposits into the bond sinking fund, which is likely managed by an independent trustee.

A sinking fund is formed by periodically putting money aside to eventually pay back a debt or replace an asset that has depreciated. The purchase fund can be an advantage to investors if the fund is trading below par value because the company must pay par to repurchase the bonds.

The company would classify the bond sinking fund as a non-current asset on its balance sheet. Basically, its just cash set aside by the company to cover any bond payments it would need to make to holders of the bonds.

Basically, the sinking fund is created to make paying off a debt easier and to ensure that a default won't happen because there is a sufficient amount of money available to repay the debt.

Explanation: A bond sinking fund would be categorized as an investment on the balance sheet. These are long-term assets. The bond sinking fund is a restricted cash account where cash is put aside to pay off bonds payable when they become due.

A bond sinking fund provision serves a crucial purpose in the world of finance and investment. Its primary function is to ensure that a company or issuer of bonds can meet its future debt obligations and provide a level of security to bondholders.

How do you calculate bond sinking fund? ›

The sinking fund formula is typically calculated as S= (P * i) / (1 - (1 + i)^-n). This formula helps businesses determine the amount of money they need to set aside periodically to cover the total amount due at the maturity of their debt. Why do they call it a sinking fund?

A sinking fund is a very low-risk way of saving money.

A sinking fund is a savings method that helps fund a specific purchase or expense by a certain date. The term “sinking fund” was first used in 18^th century England to refer to funding public debts,¹ but the meaning has changed over the years.

The 10-year rule

This allows the body corporate 10 years to identify, plan and save for these future expenses. As sinking funds are generally reviewed every 5 years, a quantity surveyor will prepare a 15-year plan to cover 5 annual budgets with a 10-year future projection.

A sinking fund is maintained by companies for bond issues, and is money set aside or saved to pay off a debt or bond. Bonds issued with sinking funds are lower risk since they are backed by the collateral in the fund, and therefore carry lower yields.

- Reinvestment risk: Bonds with sinking funds also face reinvestment risk, which is the risk that the bondholder will not be able to reinvest the periodic principal repayments at the same or higher rate as the original bond.

Annuities and sinking fund, are different from one another. When the fund credit happens for a specific reason, then it is called a sinking fund. Furthermore, an annuity is paying or receiving money, generally a fixed amount for a specific time period.

Wondering “what are sinking funds in budgeting?” Sinking funds are funds you set aside to save toward a significant, pre-planned goal. You save money over time instead of dipping into your checking account for a considerable chunk of cash to cover a particular purchase or event.

Sinking funds are money you set aside each month for specific savings goals. They allow you to save for infrequent expenses and plan for large expenses over time. Having sinking funds can help prevent you from withdrawing money from your emergency fund or going into debt to pay for things.

To determine the amount to keep in a sinking fund, identify and list the anticipated expenses and their estimated costs. “Then, divide each expense by the number of months until it's due,” Rose said. “For example, if a $300 expense is six months away, allocate $50 per month to your sinking fund.

What are the benefits of a sinking fund? ›

The purpose of a bond sinking fund is to: repay bonds early either through purchases or calls. The primary purpose of bond covenants is to: protect the bondholders.