Answer:
To calculate the annual amounts of sinking fund depreciation, you need to know the income-producing life of the machine, as well as the total amount of income (estimated to be) produced by the machine over that period. The actual economic depreciation in the income-producing value over one year is that value which would be necessary for one to put aside in a bank account, compounding interest, in order for the income to be replaced in the first year in which the machine no longer produces income (and subsequent years). If a machine will produce income for five years at a rate of $1000 per year, the income in the sixth year out (and subsequent years) will need to be replaced with interest generated on a theoretical present value deposited in an interest bearing account today. Assuming that the applicable Fed interest rate is 10%, you discount the $1000 sixth year payment to year one by that rate, and this principal (or present value) amount can be considered the sinking fund depreciation for that year. In years two through five, the depreciation will be calculated as this original present value increases with interest compounding. The principal, which is considered the depreciation, increases with each year due to the fact with each passing year, more money must be invested in order re replace lost sixth year income. In addition, the original present value used above is added to the increasing present value, to account for lost income needing to be replaced in years seven and onward. These calculations take place alongside other normal depreciation deductions on the value of the machine asset itself, and theoretically, income tax deductions should be allowed on the sinking fund depreciation as well as the ACRS schedule for the value of the machine.