What Does It Mean When a Bond Has a Sinking Fund?

A sinking fund is a type of fund that is created and set up purposely for repaying debt. The owner of the account sets aside a certain amount of money regularly and uses it only for a specific purpose. Often, it is used by corporations for bonds and deposits money to buy back issued bonds or parts of bonds before the maturity date arrives.

In short, a sinking fund is proactive because it prepares the individual for a future expense to be paid. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.

1. Further, if there is any loss or profit on the sale of investments that will be debited and credited to the fund.
2. If the bonds issued are callable, it means the company can retire or pay off a portion of the bonds early using the sinking fund when it makes financial sense.
3. Finance Strategists has an advertising relationship with some of the companies included on this website.
4. A sinking fund is generally placed under the control of a trustee or agent who is independent of the entity that established the fund.

The corporation will report the bond sinking fund balance in the investments section of its balance sheet. Potential investors are requiring that ABC establish a bond sinking fund into which ABC will make annual deposits of $500,000. An independent trustee will invest the corporation’s annual deposits with the goal of the sinking fund balance sinking fund in balance sheet growing to approximately $20 million by the time the bonds come due in 20 years. The sinking fund is shown under the investment section on the balance sheet of the issuing corporation. The accounting procedure regarding interest expense recognition and other aspects of bonds is not affected by the existence of a bond sinking fund.

Understanding a Bond Sinking Fund

Since the money in the sinking fund is restricted for a long-term purpose, it cannot be used to pay its short-term liabilities. Therefore, the sinking fund is not a current asset nor is it part of the corporation’s working capital. Similar in concept to a sinking fund for a corporation that issues and repays bonds, a sinking fund for household finances involves setting aside a certain amount of money each month to help pay off debts or to finance large purchases in the future. The idea is that by consistently saving relatively small amounts of money, there will eventually be enough stored up to spend toward something more significant. To lessen its risk of being short on cash 10 years from now, the company may create a sinking fund, which is a pool of money set aside for repurchasing a portion of the existing bonds every year. By paying off a portion of its debt each year with the sinking fund, the company will face a much smaller final bill at the end of the 10-year period.

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What Is a Sinking Fund?

This mechanism may sound very similar to a callable bond, but there are a few important differences investors should be aware of. First, there is a limit to how much of the bond issue the company may repurchase at the sinking fund price (whereas call provisions generally allow the company to repurchase the entire issue at its discretion). Let’s say for example that ExxonMobil Corp. (XOM) issued $20 billion in long-term debt in the form of bonds.

Eventually, the principal amount owed will be lower, depending on how much was bought back. However, it is important to remember that there is a certain limit to how many bonds can be bought back before the maturity date. Further, if there is any loss or profit on the sale of investments that will be debited and credited to the fund. It is an accumulation of earnings, in which an amount is added either as a fixed percentage of outstanding debt or a fixed percentage of profit. The term ‘sinking‘ is used to mean the dropping level of debt, left out as it gets paid off, whereas the term ‘fund‘ represents the amount invested in outside securities.

The bonds would likely pay interest payments (called coupon payments) to their owners each year. In the bond issue’s final year, CTC would need to pay the final round of coupon payments and also repay the entire $1,000 principal amount of each bond outstanding. A sinking fund is generally placed under the control of a trustee or agent who is independent of the entity that established the fund. The amount, which represents a part of the capital raised by a corporation through the sale of various securities to investors, is known as the issue price. To ensure the repayment of the principal, some bond agreements require that the issuing corporation create and maintain a sinking fund. These include repayment of the bond at maturity, early extinguishment of the debt before maturity, and conversion of the bond into common stock.