What is accretion (short definition)
– Accretion is the gradual increase in value or income that a holder recognizes over time. In markets and accounting, it most commonly describes:
– bond accretion — the recognition of the gain when a fixed‑income instrument is bought below its face (par) value and held to maturity;
– earnings accretion — an increase in earnings per share (EPS) that results when a transaction (for example, an acquisition) raises combined earnings more than the dilution from new shares.
Key terms (defined)
– Face (par) value: the amount the issuer promises to pay at maturity.
– Discount: face value minus the purchase price when a security is bought below par.
– Accreted value: the face (or redemption) amount that the discounted security will reach at maturity.
– Accretion (accounting): systematic reclassification of the discount into interest or income over the life of the instrument.
– Earnings per share (EPS): net earnings available to common shareholders divided by the weighted average common shares outstanding.
– Accretive transaction: a deal that increases EPS for the acquirer after the transaction settles.
How bond accretion works — step by step
1. Buy a bond below par. Example: par = $1,000, purchase price = $860. Discount = $140.
2. Record the purchase at cost and place the discount in a contra‑bond or discount account on the balance sheet (accounting mechanics vary by standard).
3. Over the life of the bond, move (amortize) a portion of the discount into interest income each period so that by maturity the full discount has been recognized as income.
4. At maturity, the bond redeems at par ($1,000); the investor has recognized the purchase yield as interest via accretion.
Simple formula (non‑compounding annual basis, as described in the body text)
– Annual accretion = (Face value − Purchase price) ÷ Number of years to maturity.
Worked numeric example — bond accretion
– You buy a $1,000 bond for $860, maturity in 10 years.
– Discount = $1,000 − $860 = $140.
– Annual accretion (straight‑line, non‑compounding) = $140 ÷ 10 = $14 per year.
– Accounting: each year you reclassify $14 from the discount account into interest income; after 10 years the $140 discount has been fully accreted and the bond redeems at $1,000.
Notes on zero‑coupon bonds (from the provided material)
– Zero‑coupon bonds are sold at a discount and make no periodic interest payments. The increase in value is recognized over the term and paid in a single lump sum at maturity. The accretion process recognizes that implied interest as income over the holding period; the body text notes the interest is not paid periodically and is not compounding in the described approach.
Earnings (EPS) accretion — how to check whether an acquisition is accretive
1. Compute pre‑deal EPS (earnings / shares).
2. Add the acquired company’s earnings to the buyer’s earnings.
3. Add new shares issued to pay for the deal (if any) to the buyer’s shares outstanding.
4. Compute post‑deal EPS = (combined earnings) ÷ (combined shares).
5. If post‑deal EPS > pre‑deal EPS, the acquisition is accretive.
Worked numeric example — EPS accretion
– Company A: earnings = $2,000,000; shares = 1,000,000 → EPS = $2.00.
– Company A issues 200,000 shares to buy Company B, which adds $600,000 in earnings.
– Combined earnings = $2,000,000 + $600,000 = $2,600,000.
– Combined shares = 1,000,000 + 200,000 = 1,200,000.
– New EPS = $2,600,000 ÷ 1,200,000 = $2.1667 (≈ $2.17).
– EPS accretion = $2.17 − $2.00 = $0.17 per share (≈ 8.5% accretive).
Practical checklist — when evaluating accretion
– For bond accretion:
– Confirm purchase price, face value, and time to maturity.
– Decide on the accretion method your accounting or tax rules require (straight‑line vs. effective interest method).
– Record discount in the correct account and amortize consistently until maturity.
– Remember accreted book value can differ from market price between purchase and maturity.
– For EPS/accretion from M&A:
– Calculate pro forma combined earnings and share count.
– Include deal costs, financing interest, and any synergies or integration costs that affect earnings.
– Compare pre‑ and post‑deal EPS; examine whether the accretion is sustainable or one‑time.
– General:
– Check relevant accounting or tax guidance for required treatment.
– Note that long‑term debt may be reclassified as current when the remaining term falls to one year.
Important caveats drawn from the provided material
– The accreted (book) value recognized by accretion is not the same as the security’s market price; market conditions and interest rates can move prices independently.
– The body text describes accretion on a simple, straight‑line basis (discount divided by years). Different accounting frameworks may require different amortization methods (for example, an effective interest method), which change the timing and amount of recognized income.
– Debt classification: a long‑term obligation can become a short‑term one when its remaining maturity falls to within one year.
Relevant sources (for further reading)
– Investopedia — “Accretion” (explainer page)
https://www.investopedia.com/terms/a/accretion.asp
– U.S. Securities and Exchange Commission (SEC) — Investor Bulletin: Bonds
https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_bonds
– U.S. Department of the Treasury — Treasury Securities information (rates, maturities, descriptions)
https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/default.aspx
Educational disclaimer
This explainer is for educational purposes only and does not constitute individual investment, tax, or accounting advice. Consult a licensed professional for guidance tailored to your specific circumstances.