SINKING-FUND METHOD OF RETIRING A DEBT

A common method of paying off long-term loan is to pay the interest on the loan at the end of each interest period and create a sinking-fund to accumulate the principle at the end of the term of the loan. Usually, the deposit into the sinking fund are made at the same times as the interest payments on the debt are made to the lender. The sum of the interest payment and the sinking-fund payment, is called the periodic expense or cost of the debt. It should be noted that the sinking fund remains under the control of the borrower. At the end of the term of the loan, the borrower returns the whole principal as a lump-sum payment by transferring the
accumulated value of the sinking fund to the lender, When the sinking fund method is used, we detain the book value of the borrower's debt at any time as the original principal, minus the amount in sinking-fund. The book value of the debt, may be considered as the outstanding balance of the loan.