Journal of Accountancy

Volume 62 Issue 1 Article 2

7-1936

Sinking-fund Accounting
Malcolm Johnston

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Recommended Citation
Johnston, Malcolm (1936) "Sinking-fund Accounting," Journal of Accountancy: Vol. 62: Iss. 1, Article 2.
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 Sinking-fund Accounting
By Malcolm Johnston

Little has been written on the composition and structure of

sinking-fund accounts, and the subject, therefore, needs to be
somewhat clarified.
As in all legal documents, bond indentures express the vagaries
of the persons who draw them. Although the intent of such in­
struments is primarily to protect bondholders, there are loosely
drawn mortgages that do not afford full security, as well as the
iron-clad kind that do. Often sinking-fund provisions are ob­
scured by legal terminology and ambiguous phrases, and this is
particularly true in mortgages of the former type.
Thus, a sinking-fund provision which stipulates that a sinking
fund of $20,000 per annum shall be created five years from date of
issuance of bonds might be construed to mean that either the pay­
ment on the one hand or the accrual on the other shall commence
at the end of the fifth year. Yet the results would be quite dif­
ferent, and unless the meaning was properly interpreted a serious
error would be made.
If an annual sinking fund equivalent to 3% of the net earnings
of a corporation is to be set aside for the redemption of bonds, the
correct calculation depends upon the meaning intended. Does
it mean that the contribution is to be 3% of net earnings, which
include such contribution, or exclude it? It is reasonable to
believe that the first interpretation is the correct one; but
the language employed does not definitely presuppose this con­
clusion.
In the first case, insertion of the specific date of payment in­
tended and, in the second, a proper qualifying clause would ob­
viate these difficulties, and an attorney experienced in this work
would take such precautions in drawing the mortgages.
As to the accounting involved, the transactions during the life
of a sinking fund are numerous and diversified, and the applica­
tion of correct principles requires more consideration than repeti­
tive and strictly routine matters.
To handle a sinking fund intelligently, from the standpoints of
administration and of accounting, a general knowledge of the
mortgage and a thorough knowledge of the sinking-fund provi-
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 The Journal of Accountancy

sions should be obtained first-hand, and all questionable points

should be settled before any steps are taken.
With respect to grouping, this distinction should be made: (1)
there are sinking funds which are administered by individual
trustees, and (2) there are those that are administered wholly, or
partly, by corporate trustees. As the latter type is more common
they are discussed in this article.
As soon as a sinking fund is created there will be transactions
from time to time of the following nature:
1. Monthly accrual of mortgage requirements.
2. Monthly accrual of income from investments.
3. Satisfaction of requirements upon maturity and adjust­
ment of reserve accounts.
4. Collection of income by trustee on maturity and adjust­
ment of reserve accounts.
5. Investment of fund by trustee and adjustment of reserve
accounts.
6. Sale of investment securities by trustee and adjustment of
reserve accounts.
7. Retirement of bonds by trustee and adjustment of reserve
accounts.
This classification will help the reader understand the following
entries which are made and fully explained.
A simple problem is taken for illustration. Let it be assumed
that on January 1, 1928, The North Company issued $200,000 par
value first mortgage bonds maturing January 1, 1948, to bear 5%
interest payable January 1st and July 1st of each year. The
bonds were sold at 99 and accrued interest. For the purpose of
this discussion it is not necessary to consider underwriting and
incidental expenses. The following entry would be made to
record this transaction:
Cash......................................................................... $198,000.00
Unextinguished discount on bonds......................... 2,000.00
The North Company first mortgage bonds........... $200,000.00
For $200,000 par value of bonds
sold at 99................................... $198,000.00
Discount on bonds........................ 2,000.00

Amount of issue............................ $200,000.00

Commencing in January, 1928, and continuing during the life of

the bonds, or until there was a reduction in the funded debt, the
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 Sinking-fund Accounting

discount of $2,000 would be written off to profit-and-loss by a

monthly entry:
Profit-and-loss......................................................... $ 8.34
Unextinguished discount on bonds......................... $ 8.34
Amount of discount to be written
off in 20 years............................ $ 2,000.00

Monthly proportion—1/240......... $ 8.34

The Western Trust Company was designated trustee of the

mortgage, under the provisions of which an annual sinking fund of
$15,000 was created for a period of ten years, payable out of
income. The first payment was to be made to the trustee Jan­
uary 1, 1933, and annually thereafter on that date. This provi­
sion anticipated the retirement of 75% of the bonds within fifteen
years from date of issue, or five years before maturity.
The mortgage provided further that in the discretion of the
trustee contributions to the sinking fund might be used for invest­
ment in securities of other companies in lieu of the redemption
of outstanding bonds. For the purpose of such investments the
issuing company might deliver to the trustee as live securities
bonds of the outstanding issue which it had reacquired from time
to time with that thought in mind.
Another significant provision is that in case of a deficit from
operations in any year, the trustee will accept from The North
Company a certificate to that effect in place of a cash contribution.
The accounting transactions arising from these features may be
summarized in the following manner:
1. Investments in securities of other companies.
2. Acceptance by trustee as live securities of bonds of the
outstanding issue reacquired by the accounting company.
(a) At par.
(b) At a cost less than the par value.
(c) At a cost above par.
3. Acceptance of deficit certificate by trustee.
4. Redemption and cancellation of outstanding bonds.
Sinking-fund reserve, as used in this article, is the designation
of a primary account which is composed of items of the following
kinds:
1. Unmatured requirements accrued.
2. Unmatured interest accrued on investments held by the
fund.
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 The Journal of Accountancy

3. Cash held in general funds of the company.

4. Cash held by the trustee.
5. Cost of investments held by the fund.
Separate accounts should be used for each of these groups.
Furthermore, when more than one sinking fund is in operation
separate accounts should be provided for each reserve, and the
titles of the accounts should indicate the specific mortgages under
which the bonds were issued as a means of identification. The
titles of the reserve accounts used here are not earmarked in this
way as the discussion is limited to one sinking fund.
Obviously, one-twelfth of the annual requirement must be ac­
crued monthly during the term of the sinking fund, except that
such accruals commenced in January, 1932, in order to take care
of the first payment due one year later. The entry was:
Income applied to sinking fund.............................. $ 1,250.00
Sinking-fund reserve—unmatured requirements
accrued................................................................. $ 1,250.00

By this entry $15,000 was debited as a deduction from income

in the calendar year ended December 31st, and a corresponding
amount was credited to sinking-fund reserve.
On January 1, 1933, The North Company paid the trustee
$15,000 and recorded the transaction by the following cashbook
entry:
Western Trust Co., trustee sinking fund—cash... $ 15,000.00
Cash......................................................................... $ 15,000.00

At the same time it was necessary to adjust the reserve account

by the following journal entry:
Sinking-fund reserve—unmatured requirements
accrued................................................................. $ 15,000.00
Sinking-fund reserve—cash in hands of trustee... $ 15,000.00

Similar entries would be made annually thereafter until January

1, 1943.
With this sum the trustee on March 1, 1933, purchased $16,000
par value Atlantic and Pacific Railroad Company first mortgage
4% bonds, with interest maturing January 1st and July 1st in
each year. For these it paid 90 and accrued interest for two
months, amounting to $14,506.67, leaving a balance of $493.33 in
the hands of the trustee for further investment.
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 Sinking-fund Accounting

Two entries were necessary: the first, to record the asset value
of the investment, and the second, to adjust the reserve accounts.
These were set up on the books in the following manner:
Western Trust Co., trustee sinking-fund—securities $14,400.00
For cost of $16,000 par value of bonds pur­
chased at 90 for investment.
Interest accrued on securities held by sinking
fund...................................................................... 106.67
For amount of accrued interest paid on above
bonds from January 1 to March 1, 1933, the
date of purchase.
Western Trust Co., trustee sinking fund—cash... $ 14,506.67
Sinking-fund reserve—cash in hands of trustee.. . 14,506.67
Sinking-fund reserve—cost of investment securi­
ties ........................................................................ 14,400.00
For cost of bonds as per contra entry.
Sinking-fund reserve—unmatured interest ac­
crued ................................................................. 106.67
For amount of accrued interest paid as per
contra entry.
Commencing in March, 1933, and monthly thereafter, or during
the period for which the $16,000 par value of bonds were held as a
sinking-fund investment by the trustee, interest was accrued by
the following entry:
Interest accrued on securities held by sinking-fund $ 53.33
Income from sinking-fund...................................... $ 53.33
However, as income from sinking-fund investments can not be
used for the payment of dividends, or for any corporate purpose
other than as an accretion to the reserve fund, the following entry
was made concurrently with the preceding one:
Income applied to sinking fund.............................. $ 53.33
Sinking-fund reserve—unmatured interest ac­
crued ..................................................................... $ 53.33
On July 1, 1933, the trustee collected the interest matured on
the bonds held in the fund and the transaction was recorded on
the books of the accounting company, as follows:
Western Trust Co., trustee sinking-fund—cash... $ 320.00
Interest accrued on securities held by sinking-fund $ 320.00
and a corresponding entry was made to adjust the reserve ac­
counts :
Sinking-fund reserve—unmatured interest ac­
crued ............................................................. ... $ 320.00
Sinking-fund reserve—cash in hands of trustee... $ 320.00
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 The Journal of Accountancy

The interest having been collected by the trustee, the accruals

were no longer necessary at this point, and the debit and credit
balances in the two accrued accounts were cleared by the fore­
going entries.
The trustee now had $813.33 in the fund available for the re­
demption of bonds or for further investment, as was deemed
expedient.
It is customary for corporate trustees to allow interest on un­
invested cash balances in its hands, and assuming 2% was the
prevailing rate on monthly balances, there was an additional
credit of $53.29, making a total amount of $866.62 in the fund as of
July 1, 1933. Again, two entries were necessary to record this
transaction:
Western Trust Co., trustee sinking fund—cash... $ 53.29
Income from sinking fund........................... . ......... $ 53.29

Income applied to sinking fund.............................. 53.29

Sinking-fund reserve—cash in hands of trustee. . . 53.29
On January 1st of the following year further accretions to the
sinking fund, amounting to $15,328.67, representing sinking-fund
contribution, interest on bonds held as investments and interest
on cash balances increased the cash balance available for invest­
ment to $16,195.29.
For reasons explained below, the matured requirements due
January 1st were not paid to the trustee as before but were held
in the general funds of the company. In these circumstances the
adjustment of the reserve accounts was slightly modified by the
following entry:
Sinking-fund reserve—unmatured requirements
accrued................................................................. $ 15,000.00
Sinking-fund reserve—matured requirements in
general funds of company............................... $ 15,000.00
The funds in the hands of the trustee, therefore, were only
$1,195.29. By journal entries similar to those explained above,
the facts were reflected in the appropriate asset and offsetting
reserve accounts.
To illustrate a variation in the accounting procedure as the next
step in the administration of a sinking fund, it may be assumed
that The North Company arranged with the trustee to deliver to
it in satisfaction of the requirements due January 1st, bonds of the
14
 Sinking-fund Accounting

outstanding issue reacquired by the former, to be held by the

latter as live securities — that is to say, they were to continue as
interest bearing bonds and in all respects to be considered in the
same category as securities of other companies purchased for in­
vestment.
Therefore, anticipating this arrangement, bonds of The North
Company had been purchased at intervals during the previous
year at the following prices from general funds of the company
advanced to the sinking fund :
Oct. 1,1933 $9,000 at 102................................... $ 9,180.00
Accrued interest 3 mos.................... 112.50 $ 9,292.50

Nov. 1, $5,000 at 103................................... $ 5,150.00

Accrued interest 4 mos................... 83.33
--------------- 5,233.33
Dec. 1, $1,000 at 104................................... $ 1,040.00
Accrued interest 5 mos................... 20.83 1,060.83

Total $15,000 par value, cost.... $ 15,586.66

Although combined below for the sake of brevity, these trans­

actions were recorded on the respective purchase dates by cash­
book entries in the following manner :
The North Company first mortgage bonds reac­
quired for sinking fund .................................. $ 15,370.00
Oct. 1 $9,000 at 102......................... $9,180.00
Nov. 1 5,000 at 103......................... 5,150.00
Dec. 1 1,000 at 104......................... 1,040.00

Interest on The North Company first mortgage

bonds reacquired—accrued but not due. 216.66
Interest paid on above bonds from July 1, 1933,
to dates of reacquirement—
$9,000 for 3 mos............................. $ 112.50
5,000 for 4 mos............................. 83.33
1,000 for 5 mos............................. 20.83

Cash.......................................................................... $ 15,586.66

Under the terms of the mortgage, bonds of the outstanding

issue reacquired for sinking fund are to be treated as having been
sold to the sinking fund at par. Upon acceptance of securities by
trustee, journal entries were required, therefore, for the bonds
15
 The Journal of Accountancy

purchased at 102, 103, and 104, respectively, to adjust the pur­

chase prices to par value:
Profit-and-loss.......................................................... $ 370.00
The North Company first mortgage bonds re­
acquired for sinking fund................................ $ 370.00
For adjustment on $15,000 par value of bonds.
Also, interest was accrued monthly on the foregoing securities
from their respective dates of reacquisition to December 31st:
Interest on The North Company first mortgage
bonds reacquired—accrued but not due......... $ 158.34
Income from securities reacquired.......................... $ 158.34
Int. on $9,000 for 3 mos. (Oct.-Dec.) $112.50
Int. on $5,000 for 2 mos. (Nov.-Dec.) 41.67
Int. on $1,000 for 1 mo. (Dec.)........ 4.17

At December 31st the balance in the account “income from

securities reacquired” would be written off to profit-and-loss.
It must be borne in mind that these bonds were live securities
and that there had been no reduction in the funded debt out­
standing. Therefore, interest charges had to be computed at all
times on the entire issue of $200,000 par value of bonds outstand­
ing until the bonds so purchased had been actually retired.
Each month, commencing January, 1928, liability for the interest
accruing during such month and the corresponding debit against
income account were recorded by journal entry:
Interest on The North Company first mortgage
bonds...................... .......................................... $ 833.34
Unmatured interest accrued on The North Com­
pany first mortgage bonds............................... $ 833.34
$200,000 par value at 5%—monthly proportion.
At December 31st of each year the balance in the account
“interest on The North Company first mortgage bonds” would
be closed out to profit-and-loss.
At December 31st of the current period the credit balance in
the latter account amounted to $5,000, and as this sum became
due and payable on the day following, namely January 1st, the
nature of the liability was more clearly expressed in the account to
which the balance was then transferred:
Unmatured interest accrued on The North Com­
pany first mortgage bonds.............................. $ 5,000.00
Interest matured unpaid on The North Company
first mortgage bonds........................................ $ 5,000.00
Interest on $200,000 par value 5% bonds due and
payable January 1st.
16
 Sinking-fund Accounting

Similar entries would be made January 1st and July 1st of each
year, commencing July, 1928.
Before The North Company delivered to the trustee of the
mortgage the $15,000 par value of bonds reacquired in satisfac­
tion of sinking-fund requirements, it detached the coupons matur­
ing January 1st, the date from which subsequent interest accrued
to the fund. The question arose as to the ownership of the
coupons. As the transactions incidental to the purchases in
question took place prior to the maturity of the sinking-fund
requirement, the trustee could not claim the interim bond interest.
It logically belonged, therefore, to The North Company. The
per contra cashbook entries for the payment and collection of the
interest were the following :
Interest matured unpaid on The North Company
first mortgage bonds................................. $ 375.00
Cash......................................................................... $ 375.00
For payment of interest due January 1, 1934, on
$15,000 par value of The North Company first
mortgage 5% bonds.

Cash......................................................................... $ 375.00
Interest on The North Company first mortgage
bonds reacquired—accrued but not due.. $ 375.00
For collection of above interest.

The interim interest which The North Company in effect paid

to itself was offset in the cash account by these two entries and in
the income account by the preceding third and fourth entries,
respectively.
On January 5th the trustee notified The North Company that
the bonds tendered had been accepted in satisfaction of sinking-
fund requirements and the latter completed the transaction by
the following journal entries:
Western Trust Co., trustee sinking-fund securities $ 15,000.00
The North Company first mortgage bonds re­
acquired for sinking fund......................... $ 15,000.00
For $15,000 par value of above bonds delivered
to trustee.
Sinking-fund reserve—matured requirements in
general funds of company............................... 15,000.00
Sinking-fund reserve—cost of investment securi­
ties.................................................................... 15,000.00
For adjustment of reserve accounts.
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 The Journal of Accountancy

Substitution of bonds of the outstanding issue for securities of

other companies purchased for investment affords certain ad­
vantages to the issuing company and to the sinking fund, and
mortgages should always be drawn with that thought in mind.
The advantages are—
1. A potential profit representing the difference between
(1) the price that would be paid for the bonds as they
approached maturity due to enhanced value or (2) the
redemption price upon call, as stipulated in the mort­
gage, or (3) the redemption at par upon maturity and
the lower market price that would prevail during the
earlier stages of the life of the bonds.
2. No necessity for trustee to replace the investment in an
unfavorable market, as it might be required to do in the
case of investments in bonds of other companies, if the
latter were called for redemption prior to maturity of
the outstanding issue.
3. In this problem, the bonds of the outstanding issue bear a
higher rate of interest than the other investments and
yield a greater return.
The disadvantages are—
1. There is always the question of the relative stability of
the two issues.
2. No reduction of interest on the outstanding issue.
The safeguard against the first disadvantage is that the trustee
would not permit such substitution of investments without fully
considering the past record of the issuing company and the
safety factor of the bonds in question. As to the second disad­
vantage it does not deserve serious consideration when weighed
against the more important fact that a liability has theoretically,
if not actually, been discharged for the principal of so many bonds
outstanding.
As the result of a deficit from operations of The North Com­
pany for the year 1934 there was, of course, no current income
from which to pay the sinking-fund requirement due January 1st
of the next year; nor was the company obligated by the mortgage
to make the payment out of accumulated surplus.
In these circumstances the mortgage provides, however, that in
lieu of making a cash contribution The North Company may file a
deficit certificate with trustee stating the facts. Furthermore, the
sinking-fund requirement is not cumulative, as the mortgage is
not mandatory in requiring that a default in any one year be made
up by appropriations of income in subsequent years.
18
 Sinking-fund Accounting

Therefore, as The North Company had made definite appro­

priations of income during the current year and had set up a
corresponding reserve by monthly accruals in anticipation of the
payment which it expected to make, the only adjustments neces­
sary were those cancelling the entries previously made. As this
situation became apparent before the close of the fiscal year, the
certificate was filed by The North Company and accepted by the
trustee in sufficient time for the adjustments to be made in the
accounts of the current year by the following journal entry:
Sinking-fund reserve—unmatured requirements
accrued............................................................. $ 15,000.00
Income applied to sinking fund.............................. $ 15,000.00
If, however, the adjustment had not been made until the sub­
sequent year, the entry would have been:
Sinking-fund reserve—matured requirements in
general funds of company................................ $ 15,000.00
Profit-and-loss.......................................................... $ 15,000.00
At this time funds available for investment in the hands of the
trustee from bond interest and interest on cash balances amounted
to $1,862.51. Of this amount, $1,615.00 was expended by the
trustee on February 1st in purchasing $1,500.00 par value Sea­
board Steel Company first mortgage 4% bonds with interest
maturing March 1st and September 1st in each year. For these
it paid 106 and accrued interest for five months. The journal
entries were identical with those previously outlined recording
similar transactions.
Up to this point three usual methods employed in satisfying
sinking-fund requirements have been considered: (1) by investing
in securities of other companies; (2) by reacquiring bonds of the
outstanding issue and holding them as live securities; (3) by
deficit certificate filed with the trustee in circumstances which
have been explained.
While these temporary expedients are permissible and comply
fully with mortgage provisions, the fact remains that sinking
funds are created and reserves established for the sole purpose of
redeeming bonds issued under their indentures, and that this ob­
jective must ultimately be attained. When bonds are retired
through sinking funds, the reserve is gradually extinguished, but
it is not diminished one cent by sinking-fund investments—the
status of the reserve only is changed.
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 The Journal of Accountancy

Consider, then, that The North Company decided, at the sug­

gestion of the trustee, to redeem bonds upon maturity of the next
sinking-fund contribution. The procedure would be for the
trustee to advertise some time before January 1st, and in the man­
ner prescribed in the mortgage, for tenders for the surrender of as
many bonds at prices to be named by the holders thereof, but not
to be in excess of the redemption price specified in the mortgage,
plus accrued interest (for which the trustee would be reimbursed
by the company) as would exhaust the balance of $16,712.85,
with the usual qualification that the trustee reserved the right to
reject any and all bids not accepted.
From the tenders received it may be assumed that the trustee
accepted bids on the following bonds which it purchased :
Jan. 10 $8,000 at 103............................................ $ 8,240.00
Accrued interest 10 days......................... 11.11 $ 8,251.11

15 $4,000 at 104............. $ 4,160.00

Accrued interest 15 days........ . ............... 8.33 4,168.33

20 $4,000 at 105............................................ $ 4,200.00

Accrued interest 20 days...................... 11.11 4,211.11

Total $16,000 par value, cost.............. $ 16,630.55

These bonds would be delivered to the trustee with coupons

due July 1st and subsequently maturing attached thereto, and
thereupon they would be cancelled.
Three journal entries are required to adjust the asset, liability,
profit-and-loss and surplus accounts:
The North Company first mortgage bonds............. $16,000.00
For $16,000 par value of bonds retired.
Interest on The North Company first mortgage
bonds reacquired—accrued but not due..... 30.55
For amount of interest paid on bonds from Janu­
ary 1st to their respective dates of purchase.
Profit-and-loss........................................................... 600.00
For adjustment to par value of bonds purchased
at costs above par value-
Cost................................................ $16,600.00
Par value....................................... 16,000.00

Western Trust Co., trustee sinking fund—cash........ $16,630.55

For cost of bonds retired out of funds in hands of
trustee.
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 Sinking-fund Accounting

Sinking-fund reserve—cash in hands of trustee........ $16,630.55

Cost of bonds per contra entry.
The North Company first mortgage bonds retired
through sinking fund.................................. $16,600.00
For amount of appropriated income expended in
the discharge of the principal of $16,000 par
value of bonds redeemed and cancelled.
Sinking-fund reserve—unmatured interest accrued.. 30.55
For amount of interest paid on bonds per contra
entry. (Trustee to be reimbursed for this
amount by company.)

Profit-and-loss........................................................... 96.00
Unextinguished discount on bonds.......................... 96.00
For balance of unextinguished discount on $16,000
par value of bonds redeemed and cancelled,
charged off to profit-and-loss:
Discount on $16,000 par value of
bonds for 20 years..................... $ 160.00
Charged to profit-and-loss January
1, 1928, to December 31, 1935—
8 years........................................ 64.00

Unextinguished balance—12 years $ 96.00

As the amount of bonds outstanding is now $184,000, the monthly

proportion of unextinguished discount on bonds to be charged to
profit-and-loss in subsequent months would be reduced to $7.67.
As there would be no further liability for sixteen bonds thus
retired, that portion of the reserve balance which represents the
amount of appropriated income expended in the discharge of the
principal thereof was extinguished and carried to its final resting
place as indicated in the two preceding entries. The disposition
of this item is important, as the tendency might be to include a
large amount in profit-and-loss, making it available for future
distribution, whereas if earmarked in a separate account as ap­
propriated surplus this danger would not exist. On the other
hand, it would not be proper to include in this account amounts
expended from current funds for the retirement of bonds in
excess of sinking-fund requirements.
To show the results of a sale of investment securities held in
the sinking fund it may be assumed that the trustee arranged to
sell on April 1st, $10,000 par value of Atlantic and Pacific Rail­
road first mortgage 4% bonds at 104 and accrued interest, leav­
ing $6,000 par value of such bonds still in the fund.
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 The Journal of Accountancy

The first entry to be made would dispose of the asset value of

the bonds carried at cost, set up the accrued interest collected and
account for the profit realized from the sale, thus:
Western Trust Co., trustee sinking fund—cash........ $10,500.00
For proceeds from sale by trustee of $10,000 par
value of A. & P. R. R. Co. 4% bonds at 104 and
accrued interest to March 31st.
Western Trust Co., trustee sinking fund—securities $ 9,000.00
For book value of bonds.
Interest accrued on securities held by sinking fund.. 100.00
For interest accrued at 4% from January 1st to
March 31st, collected by trustee.
Profit-and-loss........................................................... 1,400.00
For profit realized—
Sale of $10,000 par value of bonds
at 104..................................... $10,400.00
Cost at 90 ...................................... 9,000.00

As the reserve would be increased by the profit of $1,400, the

amount should be dealt with as surplus applied to sinking fund.
The entry to be made adjusting reserve and surplus accounts
would be:
Sinking-fund reserve—cash in hands of trustee........ $10,500.00
Sinking-fund reserve—cost of investment securities $9,000.00
Sinking-fund reserve—unmatured interest accrued 100.00
All as per contra entry.
Surplus applied to sinking fund............................... 1,400.00
For appropriation of profit realized from sale of
bonds per contra entry.
Conversely, when securities are sold below cost, the reserve is
decreased by the amount of the loss. In such cases the difference
between the cost of the securities and the amount received for
them should be credited to “surplus applied to sinking fund.”
At this point (April 1, 1936), the sinking fund would have been
in operation for four years and three months. At the end of
this article the debits and credits for that period to the various
ledger accounts, explained above, are shown. Following is an
analysis of the sinking-fund accounts.
Appropriations of income and surplus
Income appropriated................................................. $51,835.35
Surplus appropriated................................................ 1,400.00

Total.................................................................. $53,235.35

22
 Sinking-fund Accounting

Disposition of Appropriations
Bonds redeemed and cancelled:
$16,000 par value, cost...................................... $ 16,600.00
Balance of reserves:
Cost of investment securities......... $21,990.00
Cash in hands of trustee............... 10,612.30
Unmatured interest accrued............ 283.05
Unmatured requirements accrued... 3,750.00 36,635.35
Total................................................................... $53,235.35
Sinking-fund assets
Cash in hands of trustee........................................... $10,612.30
Investment securities with trustee:
$6,000 par value A. & P. R. R. Co. 4% bonds....... $ 5,400.00
$15,000 par value The North Co. 5% bonds......... 15,000.00
$1,500 par value Seaboard Steel Co. 4% bonds... 1,590.00 21,990.00
Unmatured interest accrued:
$6,000 A. & P. R. R. Co. bonds—3 mos.............. $ 60.00
$15,000 The North Co. bonds—3 mos.................... 187.50
$1,500 Seaboard Steel Co. bonds—1 mo................. 5.00
$16,000 North Co. bonds—amount paid on bonds
retired............................................................ 30.55 283.05
Total.............................................................. $32,885.35

There are also certain inferences that may be drawn from the
accounts which will prove the correctness of the accounting.
Of course, the first significant fact is that any statement showing
the disposition of appropriations must agree with the total ap­
propriations of income and surplus. Next, the difference between
the balance of reserves (credits) and sinking-fund assets (debits)
must equal the amount of accrued contributions. The latter sum
has been absorbed as a charge against income account for the cur­
rent period. The above tabulations meet both these conditions.
And finally, the difference between the income appropriated for
sinking funds (debits) and income from sinking funds (credits)
must be equivalent to the sum of matured and accrued sinking-
fund contributions, when considering these accounts for the entire
period during which the sinking fund has been in operation, thus:
Appropriations of income.......................................... $51,835.35
Less: Income from sinking fund............................... 3,085.35
Difference represents—
Matured contributions for three years (one year
satisfied by deficit certificate) at $15,000 per
annum............................................................. $45,000.00
Accrued contributions for 3 mos............................... 3,750.00 $48,750.00
23
 The Journal of Accountancy

In developing this problem thirty basic entries have been used

and they are sufficient to cover the majority of cases in sinking-
fund accounting. New conditions that may arise from time to
time will be merely the outgrowth or expansion of the principles
already discussed, and additional entries can be framed easily,
or those prescribed here may be slightly modified to meet the
situation.
As an illustration, if the sinking-fund requirements of $15,000
were satisfied by the redemption of an equal amount of bonds
purchased by the issuing company, which cost, say $12,050,
including accrued interest, and the mortgage by specific provision
did not make it mandatory to redeem bonds above such require­
ments, nor in excess of the purchase price, the difference of $2,950
should properly be credited to income or profit-and-loss account,
depending upon circumstances, and the adjusting entries would
be similar to those outlined for requirements satisfied by deficit
certificates.
Again, if the requirements of $15,040, representing a contribu­
tion equal to 3% of net earnings, were satisfied in full by the
redemption of bonds equivalent to the nearest multiple thereof,
or $15,000 par value, and were purchased at or below par, the
adjustments would be made in the same manner.
Conditions are apt to change during the life of a bond issue,
so that the financial position of an organization and the compara­
tive market value of securities are important elements to be
considered in administering sinking funds efficiently. What is a
wise course to pursue at one time may be inadvisable at another.
Those factors that are favorable in a holding company may pre­
sent different aspects in certain subsidiaries. If there are many
bond issues outstanding, as would probably be the case in large
corporate entities, the accounting becomes more complex than
it would be for a single issue, as each sinking fund must be han­
dled independently. There is also more detail, as separate ac­
counts should be set up for each fund.
Nevertheless, the accounting procedure can be greatly simpli­
fied with an adequate accounting structure. The method pre­
scribed in this discussion breaks down the primary asset and
reserve accounts into component secondary accounts that indi­
cate the nature of the balance in each of such ledger accounts; it
reflects the true status in the appropriated and free surplus ac­
counts; it prevents the common tendency to short-cut methods
24
 Sinking-fund Accounting

that give impetus to the work for the time being but retard it to
the point of exasperation when information is required on the
spur of the moment or when accounts are finally analyzed for
results. The advantages of a proper control over sinking-fund
transactions will be appreciated by anyone who has sought in
meaningless accounts for rays of enlightenment and revealed the
errors of faulty accounting.
In conclusion, it is not too much to say that this scheme of ac­
counting can be reduced to the simplest routine. I found it
convenient to prepare for the guidance of the general bookkeeper
a complete chart of skeleton entries with a standard explanation
for each transaction and instructions when each one was to be
used. By grouping the entries under the categorical headings
listed at the beginning of this article it was an easy matter for
the bookkeeper to copy the appropriate data in journal form,
fill in the figures and other details applicable to the particular
transaction and complete the entry. Much time and effort can
be saved and frequent searching through an irrelevant mass of
details can be avoided by abstracting the essential data from the
mortgages for ready reference.
The debits and credits to the ledger accounts follow:
Western Trust Co., trustee sinking fund—cash
Debit Credit

1-1-33 Sinking-fund req. 1932 $15,000.00 3- 1-33 $16,000 A. &. P. 4’s &
7-1-33 Int. $16,000 A. &P. 4’s. 320.00 int. purchased.... $14,506.67
7-1-33 Int. on cash bal....... *53.29 3- 1-35 $1,500 S. S. 4’s & int.
1-1-34 Int. $16,000 A. &P. 4’s. 320.00 purchased........
1,615.00
1-1-34 Int. on cash bal....... *8.67 1-10-36 $8,000 North Co. 5’s
7-1-34 Int. $16,000 A. &P. 4’s. 320.00 &int. purchased... 8,251.11
7-1-34 Int. on cash bal....... *11.95 1-15-36 $4,000 North Co. 5's
1-1-35 Int. $16,000 A. & P. 4’s. 320.00 & int. purchased... 4,168.33
1-1-35 Int. on cash bal....... *15.27 1-20-36 $4,000 North Co. 5’s
3-1-35 Int. $1,500 S. S. 4’s.... 30.00 & int. purchased... 4,211.11
7-1-35 Int. $16,000 A. & P. 4’s. 320.00
7-1-35 Int. $15,000 North Co.
5’8.................. 375.00
7-1-35 Int. on cash bal....... *5.36
9-1-35 Int. $1,500 S. S. 4’s.... 30.00
1-1-36 Int. on cash bal........ *9.98
1-1-36 Sinking-fund req. 1935 15,000.00
1-1-36 Int. $16,000 A. &P. 4’s. 320.00
1-1-36 Int. $15,000 North Co.
5’8.................. 375.00
3-1-36 Int.$1,500S. S.4’s.... 30.00
4-1-36 Sale $10,000 A. & P.’s &
int.................. 10,500.00 4- 1-36 10,612.30
Balance.............

$43,364.52 $43,364.52
* 2% on monthly balances.

25
 The Journal of Accountancy

Sinking-fund reserve—cash in hands of trustee

See credits to account—“W. T. See debits to account—“W. T.

Co., trustee sinking fund— Co., trustee sinking fund—
cash”....................... $32,752.22 cash"...................... $43,364.52
4-1-36 Balance............... 10,612.30

$43,364.52 $43,364.52

Western Trust Co., trustee sinking fund—securities

3-1-33 $16,000 A. & P. 4’s @ 90 $14,400.00 4-1-36 $10,000 A. & P.’s @ 90. $ 9,000.00
1-5-34 $15,000 North Co. 5’s.. 15,000.00
2-1-35 $1,500 S. S. 4’s @ 106 .. 1,590.00 4-1-36 Balance.............. 21,990.00

$30,990.00 $30,990.00

Sinking-fund reserve—cost of investment securities

See credits to account—“W. T. See debits to account—“W. T.

Co., trustee sinking fund—se­ Co., trustee sinking fund—se­
curities" ..................... $ 9,000.00 curities”.................... $30,990.00
4-1-36 Balance............... 21,990.00

$30,990.00 $30,990.00

Interest accrued on securities held by sinking fund

Interest collected:
3- 1-33 $16,000 A. & P.—1-1 to
3-1................. $106.67 7-1-33 $16,000 A. & P......... $320.00
3-1 to 1-1-34 $16,000 A. &P......... 320.00
6-30-33 $16,000 A. & P.—4 mos. 213.33 7-1-34 $16,000 A. &P......... 320.00
7-1 to 1-1-35 $16,000 A. &P......... 320.00
12-31-33 $16,000 A. & P.—6 mos. 320.00 3-1-35 $1,500 S.S.............. 30.00
1-1 to 7-1-35 $16,000 A. & P.......... 320.00
6-30-34 $16,000 A. & P.—6 mos. 320.00 7-1-35 $15,000 North Co...... 375.00
7-1 to 9-1-35 $1,500 S. S............. 30.00
12-31-34 $16,000 A. & P.—6 mos. 320.00 1-1-36 $16,000 A. &P......... 320.00
1-31-35 $16,000 A. & P.—1 mo. 53.33 1-1-36 $15,000 North Co...... 375.00
$15,000 North Co.—1 3-1-26 $1,500 S.S............. 30.00
mo.................. 62.50 4-1-36 Accrued 1-1 to 3-31—
2- 1-35 $1,500 S. S.—9-1-34 to $10,000 A. & P.’s sold
1-31-35 ............ 25.00 by trustee............ 100.00
2-1 to
6-30-35 $16,000 A. & P.—5 mos. 266.67
$15,000 North Co.—5
mos............... 312.50
$1,500 S. S.—5 mos.... 25.00
7-1 to
12-31-35 Int. on above bonds—6
mos... 725.00
1-1 to
3-31-36 Int. on above bonds—3
mos................. 362.50 4-1-36 Balance................ 252.50

$3,112.50 $3,112.50

Sinking-fund reserve—unmatured interest accrued

See credits to account—“Interest See debits to account—“Interest

accrued on securities held by accrued on securities held by
sinking fund ”............... $2,860.00 sinkingfund ”................
$3,112.50
4-1-36 Balance................ 283.05 Interest paid on bonds retired... 30.55

$3,143.05 $3,143.05

26
 Sinking-fund Accounting

Income applied to sinking fund

12-31-32 Sinking-fund req. 1932 12-31-34 To cancel debit en­

$1,250 per mo...... *$15,000.00 try (deficit certifi­
3-1 to cate filed with
6-30-33 $16,000 A. & P.—int. trustee).........
$15,000.00
4 mos............. 213.33
7- 1-33 Int. on cash balances
with trustee...... 53.29
7-1 to
12-31-33 $16,000 A. & P—int.
6 mos............. 320.00
12-31-33 Sinking-fund req. 1933 *15,000.00
1- 1-34 Int. on cash balances. 8.67
1-1 to
6-30-34 $16,000 A. & P.—int.
6 mos............. 320.00
7- 1-34 Int. on cash balances. 11.95
7-1 to
12-31-34 $16,000 A. & P—int.
6 mos............. 320.00
12-31-34 Sinking-fund req. 1934 *15,000.00
1- 1-35 Int. on cash balances. 15.27
1-31-35 $16,000 A. & P.—int.
1 mo............. 53.33
$15,000 North Co.—
int. 1 mo......... 62.50
2-1 to
6-30-35 $16,000 A. & P—int.
5 mos............. 266.67
$15,000 North Co.—
int. 5 mos...... 312.50
$1,500 S. S.—int. 5
mos............... 25.00
7- 1-35 Int. on cash balances. 5.36
7-1 to
12-31-35 Accrued int. on above
bonds—6 mos.... 725.00
12-31-35 Sinking-fund req. 1935 *15,000.00
1- 1-36 Int. on cash balances. 9.98
1-1 to
3-31-36 Accrued int. on above
bonds—3 mos..... 362.50
1-1 to
3-31-36 3 mos. accrued sink­
ing-fund req.... *3,750.00 4- 1-36 51,835.35
Balance...........

$66,835.35 $66,835.35

* See credits to account "sinking-fund reserve—unmatured requirements accrued.”

Income from sinking fund

See debits to account—"In­

come applied to sinkingfund ”:
Accrued int. items.......... $ 2,980.83
4- 1-36 Balance. $ 3,085.35 Int. on cash balance items.. .. 104.52

$ 3,085.35 $ 3,085.35

27
 The Journal of Accountancy

Sinking-fund reserve—unmatured requirements accrued

1- 1-33 Trf’d to “sinking- See debits to account—“ Income

fund res.—cash in applied to sinking fund (en­
hands of trustee".. $15,000.00 tries designated) .......... $63,750.00
1- 1-34 Trf’d to “sinking-
fund res.—matured
req. in general funds
of company"..... 15,000.00
12-31-34 Debit per contra ac­
count “income ap­
plied to sinking
fund "cancellingac­
cruals ............ 15,000.00
1- 1-36 Trf’d to “sinking-fund
res.—cash in hands
of trustee".......
15,000.00
4- 1-36 Balance............. 3,750.00

$63,750.00 $63,750.00

Sinking-fund reserve—matured requirements in general funds of company

1- 5-34 $15,000 North Co. 1- 1-34 Trf’d from "sinking-

bonds delivered to fund reserve—un­
trustee.$15,000.00 matured req. ac­
crued”. $15,000.00

Surplus applied to sinking fund

4- 1-36 Profit on sale $10,000

A. & P. 4's @ 104
(cost 90)......... $ 1,400.00 4- 1-36 Balance............. $ 1,400.00

The North Company first mortgage bonds reacquired for sinking fund

10- 1-33 $9,000 @ 102....... $ 9,180.00 1- 5-34 Delivery $15,000 bonds

11-1-33 $5,000 @103 ....... 5,150.00 to trustee......... $15,000.00
12-1-33 $1,000 @104....... 1,040.00 1- 5-34 Adj. to par $15,000
bonds. 370.00

$15,370.00 $15,370.00

The North Company first mortgage bonds retired through sinking fund

1-10-36 $8,000 @103....... $ 8,240.00

1-15-36 $4,000 @104....... 4,160.00
4-1-36 Balance............. $16,600.00 1-20-36 $4,000 @ 105 ....... 4,200.00

$16,600.00 $16,600.00

The North Company first mortgage bonds

1-10-36 $8,000 redeemed and 1- 1-28 Bonds issued $200,000.00

cancelled........ $ 8,000.00
1-15-36 $4,000 redeemed and
cancelled......... 4,000.00
1-20-36 $4,000 redeemed and
cancelled ......... 4,000.00
4- 1-36 Balance............. 184,000.00

$200,000.00 $200,000.00

28
 Sinking-fund Accounting

Interest on The North Company first mortgage bonds

1-1 to 12-31-28 Trf’d to profit-and-

12-31-28 $200,000—5%...... . $10,000.00 loss...........
$10,000.00
" " . 10,000.00 Trf’d to profit-and-
1929 1929
" "
1930 10,000.00 loss............
10,000.00
" " 10,000.00 Trf’d to profit-and-
1931 1930
" " 10,000.00 loss............
10,000.00
1932
" " 10,000.00 Trf’d to profit-and-
1933 1931
1-1 to loss............
10,000.00
" " 5,000.00 Trf’d to profit-and-
6-30-34 1932
7-1 to loss............
10,000.00
12-31-34
" " 5,000.00 1933 Trf’d to profit-and-
1-1 to loss...........
10,000.00
12-31-35 " " 10,000.00 Trf’d to profit-and-
1934
1-1 to loss........... 10,000.00
3-31-36 $184,000 “ (in­ 1935 Trf’d to profit-and-
cluding $30.55 paid on loss........... 10,000.00
bonds retired)............. 2,330.55 4— 1-36 Balance........... 2,330.55

$82,330.55 $82,330.55

Unmatured interest accrued on The North Company first mortgage bonds

Trf’d to account—“ Interest See debits to account—“In­

matured unpaid on The North terest on The North Co.
Co. first mortgage bonds"— first mortgage bonds".. $82,330.55
July 1,1928-Dec.31,1935,inc. $80,000.00
4-1-36 Balance.............. 2,330.55

$82,330.55 $82,330.55

Interest matured unpaid on The North Company first mortgage bonds

See credits to account—"Cash” $80,000.00 7-1-28 Int. $200,000—5%.. $ 5,000.00

1-1-29 5,000.00
7-1-29 5,000.00
1-1-30 5,000.00
7-1-30 5,000.00
1-1-31 5,000.00
7-1-31 5,000.00
1-1-32 5,000.00
7-1-32 5,000.00
1-1-33 5,000.00
7-1-33 5,000.00
375.00
4,625.00
7-1-34 5,000.00
1-1-35 5,000.00
7-1-35 5,000.00
1-1-36 5,000.00

$80,000.00 $80,000.00

29
 The Journal of Accountancy

Unextinguished discount on bonds

1- 1-28 Discount on $200,000 Jan. 1 to Dec. 31—

bonds sold @ 99. $ 2,000.00 1928—Proportion chg’d off $ 100.00
1929— “ “ “ 100.00
1930— “ “ “ 100.00
1931— “ “ " 100.00
1932— “ " " 100.00
1933— “ " “ 100.00
1934— “ " “ 100.00
1935— " “ “ 100.00
Adj. on bonds redeemed and
cancelled:
1-10-36 $8,000—12yrs. .. 48.00
1-15-36 $4,000—“ “ .. 24.00
1-20-36 $4,000—“ “ .. 24.00
Proportion chg’d off on
$184,000 bonds outstand­
ing:
1-31-36.................... 7.67
2-29-36.................... 7.66
3-31-36.................... 7.67
4- 1-36 Balance......... 1,081.00

$ 2,000.00 $ 2,000.00

Interest on The North Company first mortgage bonds reacquired—

accrued but not due

10- 1-33 $ 9,000— 7-1 to 10- 1 $112.50 1- 1-34 Collection interest $ 375.00
10-31-33 $ 9,000-10-1 to 10-31 37.50
11- 1-33 $ 5,000— 7-1 to 11- 1 83.33
11-30-33 $14,000-11-1 to 11-30 58.34
12- 1-33 $ 1,000— 7-1 to 12- 1 20.83
12-31-33 $15,000-12-1 to 12-31 62.50 4- 1-36 Balance.......... 30.55
1-10-36 $ 8,000— 1-1 to 1-10 11.11
1-15-36 $ 4,000— 1-1 to 1-15 8.33
1-20-36 $ 4,000— 1-1 to 1-20 11.11

$ 405.55 $ 405.55

Income from securities reacquired

12-31-33 Trf’d to profit-and- 10-31-33 $ 9,000 North Co. $ 37.50

loss....................... $ 158.34 11-30-33 $14,000 “ " 58.34
12-31-33 $15,000 “ “ 62.50

$ 158.34 $ 158.34

30
 Sinking-fund Accounting

Cash
Payment interest:
1-1-28 Sale of $200,000 bonds 7-1-28 $200,000 bonds.... $ 5,000.00
@99.............. $198,000.00 1-1-29 “ " 5,000.00
" "
1-1-34 Collection of interest 7-1-29 5,000.00
375.00 1-1-30 “ " 5,000.00
per contra entry...
44 44
7-1-30 5,000.00
44 44
1-1-31 5,000.00
7-1-31 5,000.00
1-1-32 5,000.00
44 44
7-1-32 5,000.00
44 44
1-1-33 5,000.00
1-1-33 Sinking-fund paym’t
to trustee......... 15,000.00
7-1-33 Paym’t interest
$200,000 bonds. . 5,000.00
10-1-33 Purchase of $9,000
North Co. bonds
reacquired & ac­
crued interest... 9,292.50
11-1-33 Purchase of $5,000
bonds........... 5,233.33
12-1-33 Purchase of $1,000
bonds........... 1,060.83
Payment interest:
1-1-34 $15,000 North Co.
bonds reacquired.. 375.00
1-1-34 $185,000 bonds... . 4,625.00
7-1-34 $200,000 “ .... 5,000.00
" "
1-1-35 5,000.00
44 44
7-1-35 5,000.00
44 44
1-1-36 5,000.00
1-1-36 Sinking-fund paym’t
to trustee....... 15,000.00
4-1-36 Balance........... 72,788.34

$198,375.00 $198,375.00

31
 The Journal of Accountancy

Profit-and-loss

Debits per contra account—“In­ 12-31-33 Int. on securities re­

terest on The North Co. first acquired........ $ 158.34
mortgage bonds" 1-1-28 to
12-31-35................... $80,000.00
Unextinguished discount on
$200,000 bonds 1928-1935, inc. 800.00
Adj. discount on $16,000 bonds 4- 1-36 Profit on $10,000
redeemed and cancelled ... 96.00 A. & P.’s sold @
1- 1-34 Adj. to par $15,000 104 (cost 90)..... 1,400.00
bonds reacquired...370.00 4- 1-36 Balance............ 80,330.66
1-10-36 Adj. to par $8,000
bonds @ 103 re­
deemed and can­
celled . 240.00
1-15-36 Adj. to par $4,000
bonds @ 104. 160.00
1-20-36 Adj. to par $4,000
bonds @ 105. 200.00
Unextinguished discount on
$184,000 bonds 1-1 to 3-31-36. 23.00

$81,889.00 $81,889.00

Trial balance—April 1, 1936

Debit Credit
Western Trust Co., trustee sinking fund—cash................... $ 10,612.30
Sinking-fund reserve—cash in hands of trustee................... $ 10,612.30
Western Trust Co., sinking fund—securities...................... 21,990.00
Sinking-fund reserve—cost of investment securities................ 21,990.00
Interest accrued on securities held by sinking fund................. 252.50
Sinking-fund reserve—unmatured interest accrued................ 283.05
Income applied to sinking fund................................... 51,835.35
Income from sinking fund........................................ 3,085.35
Sinking-fund reserve—unmatured requirements accrued.......... 3,750.00
Sinking-fund reserve—matured requirements in general funds of
company.....................................................
Surplus applied to sinking fund................................... 1,400.00
The North Company first mortgage bonds reacquired for sinking
fund..........................................................
The North Company first mortgage bonds retired through sinking
fund.......................................................... 16,600.00
The North Company first mortgage bonds......................... 184,000.00
Interest on North Company first mortgage bonds.................. 2,330.55
Unmatured interest accrued on North Company first mortgage
bonds........................................................ 2,330.55
Interest matured unpaid on North Company first mortgage bonds...
Unextinguished discount on bonds................................ 1,081.00
Interest on North Company first mortgage bonds reacquired —
accrued but not due..........................................
Income from securities reacquired................................. 30.55
Cash.............................................................. 72,788.34
Profit-and-loss.................................................... 80,330.66

$242,651.25 $242,651.25

32