The reserve is coming into more general use every year, especially by corporations, whose managers see the necessity of providing for these contingencies. When a machine wears out it must be replaced. If no reserve has been created, the money for its replacement must come from current earnings, or be provided by borrowing money or increasing capital. The better plan is to make provision in advance by creating a reserve. The amount of the reserve should be the value of the asset, and the sum set aside annually should be sufficient to equal the value of the asset at the end of its estimated life. To illustrate, if a machine is estimated to last 10 years, the annual reserve for depreciation should be 10% of its cost. The reserve is carried on the books as a liability and is an off-set to the asset which it is to replace. If we were to prepare a statement of the value of machinery as shown by the books we would state it in this form-- Machinery $20,000 Less reserve for depreciation 2,000 -------- $18,000 This shows the exact amount at which this asset is valued. Taking the illustration referred to--at the end of 10 years the liability _reserve for depreciation_ will equal the asset _machinery_, and the funds which have been reserved from profits during the past 10 years will be available for the purchase of new machinery. =45. Reserve Funds.= A term frequently used to designate a reserve created for a certain purpose is reserve fund. This term is somewhat confusing for when we speak of a _fund_ we are more likely to think of it as an asset than as a liability. When the principle underlying reserves is thoroughly understood, however, it is readily seen that the use of the term _reserve fund_ is merely a question of the use of English and does not affect the principle. A reserve or _reserve fund_ is a nominal liability artificially created to off-set a decrease in value of an asset. On the principle that an increase of liabilities represents a loss, the amount reserved each year represents a loss, but since the liability created is not a real but a nominal liability it does not affect the real assets of the business. =46. Sinking Funds.= A sinking fund is an amount set aside out of profits to meet an anticipated liability, or an obligation which is to fall due at some future date. Sinking funds are set aside for such purposes as the payment of bonds at maturity, mortgages, etc. The sinking fund is the amount which, invested at compound interest, will produce the desired amount at the end of the period. A sinking fund is an asset and may or may not be withdrawn from the business. Frequently a sinking fund is invested in securities, such as government bonds, which are placed in the hands of a trustee, thus insuring against the withdrawal of the funds from actual use in the business.