Lesson 5 Amortization and Sinking Fund

AMORTIZATION AND
SINKING FUND
LEARNING OBJECTIVES:
 Discuss Amortization and Amortization Schedule
 Compute for the Outstanding Principal
 Compute for the Amortization using The Prospective and
Retrospective Method
 Discuss Sinking Fund
 Compute Sinking Fund Method for Retiring a Debt
AMORTIZATION
One important application of annuities is the repayment of debts by periodic or
installment payments. This gradual extinction of a debt over a period of time by
means of a sequence of equal payment as to principal and interest due at the end
of equal intervals of time is known as amortization.
Amortization is an accounting technique used to periodically lower the book

value of a loan or an intangible asset over a set period of time. Concerning a loan,
amortization focuses on spreading out loan payments over time.
FORMULA
Present Value Period or Equal Payments
Formula: R Formula: R= A
Where:
A= Present Value
R = Periodic or Equal Payments
n = number of conversion periods
I = interest rate per conversion period
For Example: Equal Payments
A man obtains a loan of 60,000 to be amortized by equal payments at the end of six months for
3 years at 10% interest compounded semi-annually. Find the periodic payment.
Formula: R= A
R=
R = 11,821.05
For Example: Present Value
Mr. Santos is required to pay 5 annual instalments of 25,000 each for a loan at 10%
compounded annually. How much is his loan?
Formula: A= R
A= 25,000 []
A = 94, 769.67
AMORTIZATION SCHEDULE
The table that shows the amount paid to the interest and to the principal, and the
reduction of the outstanding principal after each payment is called an
Amortization Schedule.
The construction of an amortization schedule is important when a debt is

gradually repaid because it gives information to both the lender and the lendee
on how much of each payment goes to the interest and how much is applied to
the reducing principal
STEPS IN AMORTIZATION SCHEDULE
1. Find the interest in the period using the formula Prt
2. Determine the amount repaid to the principal at the end of the period by
subtracting the interest obtained in step 1 from the periodic payment
3. Compute the outstanding principal at the end of the period by subtracting the
amount repaid from the outstanding principal
4. Repeat the procedures above until the end of the term
Note that:
5. The amount of the original loan is equal to the total repayments on the principal
6. The amount of the original loan is the outstanding principal at the beginning of
the term
7. The outstanding principal is equal to zero at the end of the term
8. The interest payments decrease, while the payments on the principal increase
towards the end of the term.
Construction of Amortization Schedule
A man obtains a loan of 60,000 to be amortized by equal payments at the end of six months for 3 years at 10% interest
compounded semi-annually. Find the periodic payment.
R= R = 11,821.05
Period Periodic Payment Interest Amount Repaid Outstanding

to the Principal Principal
0 60,000
1 11,821.05 3,000 8,821.05 51,178.95
2 11,821.05 2558.95 9,262.10 41,916.85
3 11,821.05 2,095.84 9,725.21 32,191.64
4 11,821.05 1,609.58 10,211.47 21,980.17
5 11,821.05 1,099.01 10,722.04 11,258.16
6 11,821.05 562.91 11,258.14 0

Finding the Outstanding Principal
The Prospective Method The Retrospective Method

- It is used in finding the outstanding principal or -Under this method, the outstanding principal is
remaining liabilities of an obligation when all the determined by finding the difference between the
payments, including the final , are the same accumulated value of the loan and the
accumulated value of all payments
Formula: OP = R[ ]
Formula: OP = A (1+i) - R
Where:
OP = Outstanding Principal
R = Periodic Payment
i = rate of interest per conversion period
n – k = number of unpaid period payments
k = number of paid periodic payments
Problem: Prospective Method
A debt is amortized by equal payments of 3,000 at the end of every 3
months for 20 years at 8% compounded quarterly. Find the following
a. Present value of the Debt
b. Outstanding Principal after 5 years
c. Outstanding Liability just after the 15 payment
d. The Principal to be paid on the 16th payment
Solution: Prospective Method
a. Present value of the Debt
Formula = R
= 3,000
= 119,233.54
b. Outstanding Principal after 5 years
Formula = R
= 3,000
= 104,282.66
Solution: Prospective Method
c. Outstanding Liability just after the 15th payment
Formula = R
= 3,000
= 108,592.40
d. The payment to the principal on the 16th payment
Formula: i= Prt
= 108, 592.40 x (.08/4)
= 2,171.85
P paid on the 16th = R – i
= 3,000 - 2,171.85
= 828.15
Problem: Retrospective Method
A debt of 120,000 is payable by equal amortizations of 4,000 at 10%
interest compounded quarterly and payable at the end of each 3 months
for as long as necessary. Find
a. The outstanding principal at the end of 20th payment
b. The remaining liability at the end of 10 years.
Solution: Retrospective Method
a. The outstanding principal at the end of 20th payment
Formula: OP = A (1+i)ᵏ - R
OP = 120,000 (1+.025)²⁰ - 4,000 []
OP = 196, 633.97 – 102, 178.63
OP = 94.455.34
b. The remaining liability at the end of 10 years.
Formula: OP = A (1+i) ᵏ - R
OP = 120,000 (1+.025)⁴⁰ - 4,000 []
OP = 322, 207.66 – 269, 610.21
OP = 52, 597.45
SINKING FUND
A systematic accumulation of money by making equal periodic deposits
that will result to the desired sum of money at the desires time is known
as Sinking Fund.
Formula: R = S=R
Problem Solving: Sinking Fund
A sum of 200,000 will be needed every end of 3 months to purchase a
lot at the end of 2 years. If money is deposited at 12% compounded
quarterly, find the periodic payment.
Solution: R = R=
R = 22, 491.28
Problem Solving: Sinking Fund
A man makes an equal quarterly periodic investments of 10,000 for 2
years that pays an interest rate at 12%. How much money will he have
after 2 years?
Solution: S = R
S = 10,000
S = 88,923.36
Sinking Fund Schedule
A sinking fund table contains a schedule of gradual accumulation of money deposited
into the fund, interests earned at intervals of time or period and the amount of money
before and after the periodic payments
Steps:
1. Use the first sinking fund deposit as the amount of the fund at the end of the first
period, wherein no interest has been earned yet.
2. Compute for the interest for the 2nd period
3. Determine the amount of the fund at the end of the second period by obtaining
the sum of the fund at the start of the period (R+i)
4. Repeat the procedures to obtain the last payment for the period.
Example: A sum of 200,000 will be needed every end of 3 months to purchase a lot at the end of 2 years. If money is
deposited at 12% compounded quarterly, find the periodic payment.
R = = 22,491.28
Number of Fund At The Interest Earned Amount Of Amount of the

Payment Start Of Period At 3% Periodic Deposit Fund
1 0.00 0.00 22,491.28 22,491.28
2 22,491.28 674.74 22,491.28 45,657.30
3 45,657.30 1,369.72 22,491.28 69, 518.30
4 69, 518.30 2,085,55 22,491.28 94.095.13
5 94,095.13 2,822.85 22,491.28 119,409.26
6 119,409.26 3, 582.28 22,491.28 145,482.82
7 145,482.82 4,364.48 22,491.28 172,338.58
8 172,338.58 5,170.16 22,491.28 200,000.02
Total 20,069.78 179,930.24

SINKING FUND METHOD FOR RETIRING A
DEBT
Sometimes the principal of a loan may be payable in one installment and the
interest payable periodically as due. In this case, one can accumulate a sinking
fund designed to contain an amount of payment of the principal when this falls
due. At the same time, the debtor has to pay the interest periodically. This
method of discharging is called the sinking fund method.
Formula: SF = Ai + Where: A= present value
w = rate per conversion period
n = number of conversion period
Problem Solving: Sinking Fund Method
A loan of 50,000 is contracted with an agreement that interest shall be

paid quarterly at the rate 8%, and the principal shall be paid in one
installment at the end of 1 and a half years. Using the sinking Fund
method, find
a. The quarterly expense of the debt if the debt for investing his fund
at 6% compounded quarterly
b. The book value just after the 3rd deposit in the fund
c. The quarterly expense of the debt if it were to be amortized at 8%
compounded quarterly.
Solution: Sinking Fund Method
a. Ai + = 50,000 (.015) + = 8,776.26
b. BV=A - ( =50,000 –()
= 50,000 – 8,026.26 (3.045225)
= 25,558.23
c. = . = 8,926.29
Any questions and clarifications?

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AMORTIZATION AND

Amortization is an accounting technique used to periodically lower the book

Present Value Period or Equal Payments

The construction of an amortization schedule is important when a debt is

Period Periodic Payment Interest Amount Repaid Outstanding

1 11,821.05 3,000 8,821.05 51,178.95

2 11,821.05 2558.95 9,262.10 41,916.85

3 11,821.05 2,095.84 9,725.21 32,191.64

4 11,821.05 1,609.58 10,211.47 21,980.17

5 11,821.05 1,099.01 10,722.04 11,258.16

6 11,821.05 562.91 11,258.14 0

The Prospective Method The Retrospective Method

Number of Fund At The Interest Earned Amount Of Amount of the

2 22,491.28 674.74 22,491.28 45,657.30

3 45,657.30 1,369.72 22,491.28 69, 518.30

4 69, 518.30 2,085,55 22,491.28 94.095.13

5 94,095.13 2,822.85 22,491.28 119,409.26

6 119,409.26 3, 582.28 22,491.28 145,482.82

7 145,482.82 4,364.48 22,491.28 172,338.58

8 172,338.58 5,170.16 22,491.28 200,000.02

Total 20,069.78 179,930.24

A loan of 50,000 is contracted with an agreement that interest shall be

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