Bond Sinking Fund: Basics, Accounting, and Financial Impact

Compared to such bonds as callable bonds, convertible bonds, serial bonds and term bonds, sinking fund bonds seem to be the most beneficial corporate borrowing choice of the 1990s. A small business operating as a corporation may issue bonds to investors to raise money for its operations. An agreement takes place between the company and investor to repay the principal and interest at the maturity date. A sinking fund requires the small business to repay a specific number of bonds at a certain time or retire a portion of a bond every year until the debt is completely repaid. Bond sinking funds are established to ensure that a company can repay its bondholders at maturity.

Accounting for Retirement of Bonds

The issuer should monitor the performance of the sinking fund investments and assess the impact on the sinking fund balance. The issuer should compare the actual return on the investments with the expected return based on the sinking fund agreement and the market conditions. The issuer should interest expense also consider the effect of any capital gains or losses on the fair value of the investments.

Business Accounting of Sinking Funds

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Purpose

Coca-Cola also benefited from the bond sinking fund provision, as it improved its credit rating and lowered its borrowing costs. Apple issued $17 billion worth of bonds in 2013, the largest corporate bond offering at the time, to fund its share buyback and dividend program. The bonds had various maturities ranging from 3 to 30 years, and some of them had a bond sinking fund provision.

Corporate Sinking Funds

• By establishing a sinking fund, one can ensure that they are adequately prepared to meet their financial obligations while taking advantage of opportunities for growth and investment.
• Additionally, if the oil prices collapsed or the company could not arrange the necessary funds, they would not have been able to fulfil their debt obligation, which could have led to a default in payment.
• It provides a structured approach to ensure the timely retirement of the bond and mitigates the risk of default.
• By designating a sinking fund for employee-benefit programs, companies can ensure they have the necessary funds to fulfil their obligations to employees when they retire or leave the company.
• It allows the company to contribute towards the funds until the bond’s maturity date.
• Oil and gas companies are capital intensive because they require a significant amount of capital or money to fund long-term operations such as oil rigs and drilling equipment.

A small business with control over its debt is less likely to default on contra entry its bond obligations.Also, sometime, investors might have to reinvest their money elsewhere at a lower rate. Consider a food retail company A, which is doing well in its business and to expand its business operations, they want to raise money through debt route. So that is why they have issued $50,000 worth of bonds, which mature in 10 years and has a sinking fund provision. The Internal Revenue Service allows companies to deduct interest payments made to creditors. While the sinking fund helps companies ensure they have enough funds set aside to pay off their debt, in some cases, they may also use the funds to repurchase preferred shares or outstanding bonds. In general parlance, a Sinking Fund is money set aside in a separate account to pay off a debt, a way to generate funds for a depreciating asset, to pay off a future expense or repay long-term debt.

• For example, some companies set equipment sinking funds, which are used to fund the replacement or upgrade of equipment.
• Tools like Microsoft Excel offer built-in functions such as PMT (payment) that can be used to calculate the periodic contributions to a sinking fund.
• In this section, we delve into the concept of a bond sinking fund and its significance in the realm of bond issuances.
• The business creates a $20 million sinking fund and a call schedule for the next 20 years.
• The money can be utilized to repurchase maturing bonds; alternatively, the money can be used when an option on a callable bond is exercised.

What is your risk tolerance?

In some cases, the company need not deposit any money in the fund for several years. In August 2023, Newfoundland Inc. announced the closing of their $90 million bond sinking fund at 5.122 percent which is due in August 2053. The net proceeds from the private placement of this fund will be used towards repaying short-term borrowings that the company incurred to fund its capital expenditures and general corporate practices. A bond sinking fund is an Escrow Account maintained by the company for the exclusive purpose of retiring the bond issued, and the company places cash in the same at specified periods.

When a bond is purchased between interest dates, the investor generally pays to the issuer the amount of interest that has accrued since the last interest payment. The purchaser of the bond, in effect, “buys” the amount of interest that has accrued since the last payment. The investor’s equity in the difference between the acquisition date fair value and the carrying amount of each identifiable asset or liability of the investee.