What is 'Accretion'
Accretion is asset and earnings growth due to business expansion, and it can occur through a company's internal growth or by way of mergers and acquisitions. Accretion is also used to account for a capital gain when an investor buys a bond at a discount and holds the bond until maturity.
BREAKING DOWN 'Accretion'
Accretion is a term used in accounting for bonds and accretion is required when a bond is purchased at a discount. Bonds are issued with a face amount (par value) of $1,000, or a multiple of $1,000. The investor receives $1,000 at maturity, and the interest rate on the bond is based on the $1,000 face amount.
In some cases, a bond is issued at a price below the face amount and this occurs when interest rates increase during the time that the bond is being underwritten for sale to the public. To make the bond attractive due to higher interest rates, the bond issue is issued at a discount from the face amount.
Factoring in Bond Accounting
As interest rates increase, the value of existing bonds decline in value, which means that bonds trading in the market decline in price to reflect the interest rate increase. Since all bonds mature at the face amount, the investor recognizes a gain on a bond purchased at a discount, and that gain is recognized using accretion.
How Bond Accretion Works
Assume that an investor purchases a $1,000 face amount bond at $860, and that the bond matures in 10 years. In the duration between the bond's purchase date and maturity date, the investor needs to recognize a capital gain of $140. When the bond is purchased, the $140 is posted to a discount on bond account. Over the next 10 years, a portion of the $140 is reclassified into bond income account each year, and the entire $140 is posted to income by the maturity date.
Examples of Earnings Accretion
The earnings-per-share (EPS) ratio is defined as (earnings available to common shareholders) divided by (average common shares outstanding), and accretion refers to an increase in a firm’s EPS due to an acquisition.
Assume, for example, that a firm generates $2,000,000 in available earnings for common shareholders and that 1,000,000 shares are outstanding, which results in an EPS ratio of $2. The company issues 200,000 shares to purchase a company that generates $600,000 in earnings for common shareholders. The new EPS for the combined companies is ($2,600,000 earnings) divided by (1,200,000 shares), or $2.17. Investment professionals refer to the additional earnings as accretion due to the purchase.