SINKING FUND AND AMORTIZATION

Sinking fund and amortization are two common applications of annuities.

Sinking funds are accounts used to set aside equal amounts of money at the end of each period, at
compound interest, for the purpose of saving for a future obligation.

Amortization is the opposite of a sinking fund. It is a financial arrangement whereby a lump sum
obligation measured at present value is incurred and is paid off or liquidated by a series of equal
periodic payments for a specified amount of time at compound interest

Sinking fund payment formula is exactly the same as finding the annuity payment of an ordinary
annuity, where annuity payment is termed as sinking fund payment and future value is termed as future
value of the sinking fund.

Sinking Fund Payment = Future Value of the Sinking Fund

Table factor

= Future Value of the Sinking Fund

( 1 + i )n - 1
i

Sinking Fund Schedule

Example :
A P40,000 debt is to be repaid at the end of 1 ½ years. Interest charged is 15 %
payable at the end of every 3 months. The debtor established a sinking fund that earns 12 %
interest compounded quarterly.
a. Find the interest payment on the debt for each 3 – month period.
b. Construct a sinking fund schedule.

Solution :

a. The quarterly interest payment for the debt is computed using I = Prt.
I = Prt = 40,000 x 15 % x ¼ = P1,500.00

b. Sinking Fund Schedule :

Sinking Fund Payment = Future Value of the Sinking Fund

Future Value Table Factor
= __40,000___
6.468410
= P6,183.90

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 SINKING FUND SCHEDULE

1 2 3 4 5 6

At the End of Interest Periodic Periodic Sinking Fund Book Value

Each Period Income on Deposit in Increase in Accumulated P40,000 – ( 5 )
Sinking Fund Fund Fund or ( 6 ) - ( 4 )
( 3 – month ( 4 ) + ( 5 )*
interval ) 3% x (5) (2) + (3)

(n)

1 ….. 6,183.90 6,183.90 6,183.90 33,816.10

2 185.52 6,183.90 6,369.42 12,553.32 27,446.68

3 376.60 6,183.90 6,560.50 19,113.82 20,886.18

4 573.41 6,183.90 6,757.31 25,871.13 14,128.87

5 776.13 6,183.90 6,960.03 32,831.16 7,168.84

6 984.93 6,183.91*** 7,168.84 40,000.00 0.00

Total 2,896.59 37,103.41 40,000.00

* of the previous period

*** correction for P0.01 discrepancy

Note : Column 5 are the future values of the sinking fund.

Column 2 period 1 has no interest yet because the deposit is made at the end of the period.
Example : The 4th period:
FV = payment x ( 1 + i ) n - 1
i
= 6,183.90 x ( 1.03 )4 - 1
0.03
FV = P 25,871.13

AMORTIZATION

Amortization method broadly refers to the discharging of a debt by means of a set of regular or
irregular and equal or unequal payments. In this example only a debt discharged by a sequence of equal
payments at equal intervals of time is considered. In order to discharge a debt, each payment must be
greater than the periodic interest, so that a part of the payment applies to the interest and the
remainder applies to the principal until the principal becomes zero.

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Formula of amortization payment is exactly the same as ordinary annuity payment, present value.

Formula :
Amortization Payment = Original Amount of Obligation
Present Value Table Factor
= Original Amount of Obligation
1 – ( 1 + i )-n
i

Example :
A debt of P40,000 is to be amortized by equal payments at the end of every quarter for
1 ½ years. If the interest charged is 12 % compounded quarterly, find the outstanding
principal after each payment is made.

Amortization Payment = Original Amount of Obligation

Present Value Table Factor
= Original Amount of Obligation
1 – ( 1 + i )-n
i
= ____40,000____
1 - ( 1.03 )-6
0.03
= ___40,000___
5.417191
= P7,383.90

AMORTIZATION SCHEDULE

1 2 3 4 5

Period Outstanding Interest Due at the Equal Payment at Portion of

Principal at the End of Each Period the End of Each Principal Reduced
( 3 – month Beginning of Each Period by Each Payment
interval ) Period (2) x 3%
(4) -(3)
**
(2) -(5)

1 40,000 1,200.00 7,383.90 6,183.90

2 33,816.10 1,014.48 7,383.90 6,369.42

3 27,446.68 823.40 7,383.90 6,560.50

4 20,886.18 626.59 7,383.90 6,757.31

5 14,128.87 423.87 7,383.90 6,960.03

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 6 7,168.84 215.07 7,383.90 7,168.84

4,303.41 44303.41 40,000.00

** of the previous period

* correction for P0.01 discrepancy

Note : Column 2 are the present values. The ( n ) must be the remaining time. For example
the loan is paid at the end of the second quarter or 6 months, the ( n ) to be used for the
computation should be the remaining 4 quarters. This means that the interest for the 4 quarters
are discounted. If we want to find the present value at the end of the 4th quarter, the n should
be the remaining 2 quarters.

Example : The loan is paid at the end of the 4th quarter.

Present Value = payment x present value table factor

= payment x 1 - ( 1 + i )-n
i
= 7,383.90 x 1 - ( 1.03 )-2
0.03
= 7,383.90 x 1.913469695
= P14,128.86888
= P14,128.87

Example of an amortization schedule wherein all periodic payments are equal except the final
payment. Take note that adjustment is usually done on the final payment ( except for discrepancies on
the computation ).

A debt of P60,000 is to be discharged by payments of P10,000 at the end of every

month. Interest charged is 12 % compounded monthly. Find the :
a.) number of payments
b.) outstanding principal after each payment is made
c.) interest included in each payment
d.) principal included in each payment
e.) size of the final payment and the total payments

AMORTIZATION SCHEDULE

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 1 2 3 4 5

Period Outstanding Interest Due at the Equal Payment at Portion of

Principal at the End of Each Period the End of Each Principal Reduced
( 1 – month Beginning of Each Period by Each Payment
interval ) Period (2) x 1%
(4) -(3)
**
(2) -(5)

1 60,000.00 600.00 10,000.00 9,400.00

2 50,600.00 506.00 10,000.00 9,494.00

3 41,106.00 411.06 10,000.00 9,588.94

4 31,517.06 315.17 10,000.00 9,684.83

5 21,832.23 218.32 10,000.00 9,781.68

6 12,050.55 120.51 10,000.00 9,879.49

7 2,171.06 21.71 2,192.77 2,171.06

P62,192.77 P60,000.00

ACTIVITY : SINKING FUND and AMORTIZATION

1. A P150,000.00 debt is to be repaid at the end of 1 year and 3 months. The debtor establishes a
sinking fund that earns 8 % compounded quarterly. Construct a sinking fund schedule and answer
the questions that follow.

SINKING FUND SCHEDULE

1 2 3 4 5 6

Period ( n ) Interest Periodic Periodic Sinking Fund Book Value

Income on Deposit in Increase in Accumulated
Sinking Fund Fund Fund

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Find the :
a. interest income at the end of 9 months
b. sinking fund accumulated at the end of 1 year
c. book value at the end of 6 months
d. periodic increase in fund on the 12th month
e. periodic deposit
f. total amount of interest income
g. sinking fund accumulated at the end of 1 year and 3 months

2. A debt of P250,000.00 is to be amortized with P75,000.00 being paid at the end of every 6 months.
The interest rate is 5 % compounded semi-annually. Construct an amortization schedule and answer
the questions that follow.

AMORTIZATION SCHEDULE

1 2 3 4 5

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 Period ( n ) Outstanding Interest Due at the Payments at the Portion of
Principal at the End of Each Period End of Each Period Principal Reduced
Beginning of Each by Each Payment
Period

Find the :
a. interest rate per period
b. outstanding principal after the 2nd payment
c. interest due at the end of 1 year and 6 months
d. amount to be deducted from the principal after the 3rd payment
e. total amount of interest due
f. amount of the last payment
g. total number of payments

3. Construct an amortization schedule for a 5 – year loan of P500,000.00 at 7 % interest compounded

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 annually, which is to be repaid in annual instalments within 5 years. Answer the questions that
follow.

AMORTIZATION SCHEDULE

1 2 3 4 5

Period ( n ) Outstanding Interest Due at the Equal Payments at Portion of

Principal at the End of Each Period the End of Each Principal Reduced
Beginning of Each Period by Each Payment
Period

Find the :
a. interest due at the end of 4 years
b. outstanding principal after the 5th payment
c. interest due at the end of 2 years
d. amount to be deducted from the principal after the 2nd payment
e. annual amortization
f. outstanding principal after the 4th payment