What is Accretion of Discount?
Accretion of Discount refers to the gradual increase in the value of a discount bond as it approaches maturity. It represents the amortization of the difference between the bond’s purchase price and its face (par) value over time.
Definition
Accretion of Discount is the systematic recognition of interest income that arises from the difference between a bond’s purchase price (below par) and its redemption value at maturity.
Key Takeaways
- Applies to discounted bonds and other financial instruments.
- Reflects the unrealized interest income accrued over time.
- Reported as interest income for investors and interest expense for issuers.
- Ensures accurate amortized cost accounting under GAAP and IFRS.
- Often used for zero-coupon bonds and treasury securities.
Understanding Accretion of Discount
When an investor buys a bond below its face value, the discount represents additional yield to be earned by holding the bond to maturity. Over time, the discount is gradually accreted — increasing the bond’s carrying value on the balance sheet and recognizing interest income in the income statement.
This process aligns with the effective interest method, which spreads the discount evenly based on the bond’s yield to maturity (YTM). It ensures that the bond’s book value matches its redemption value at maturity.
Formula (If Applicable)
Accretion Amount = (Face Value − Purchase Price) ÷ Years to Maturity
or using the effective interest method:
Accretion = Carrying Value × Effective Interest Rate − Coupon Interest Received
Example:
An investor buys a $1,000 zero-coupon bond for $900 with a 2-year maturity. The annual accretion is:
($1,000 − $900) ÷ 2 = $50 per year.
Real-World Example
A pension fund purchases $10 million of U.S. Treasury zero-coupon bonds at a discount. Each year, it records accretion income as the bonds’ carrying value increases until they reach par value at maturity. This method is mandated by FASB ASC 835-30 and IFRS 9.
Importance in Business or Economics
Accretion of discount ensures:
- Accurate financial reporting of investment income.
- Matching principle compliance under accrual accounting.
- Transparent valuation of fixed-income securities.
- Realistic yield measurement for investors and institutions.
Economically, it reflects the time value of money and interest rate dynamics in bond markets.
Types or Variations
- Straight-Line Accretion: Equal amounts per period.
- Effective Interest Method: Based on yield and compounding.
- Zero-Coupon Bond Accretion: Entire return realized through discount.
- Tax Accretion: Recognition of imputed income for tax purposes.
Related Terms
- Amortization of Premium
- Effective Interest Rate
- Yield to Maturity (YTM)
- Accretion
- Discount Bond
Sources and Further Reading
- FASB – ASC 835-30: Imputation of Interest.
- IFRS 9 – Financial Instruments.
- Investopedia – Accretion of Discount.
- CFI – Fixed Income Fundamentals.
Quick Reference
- Purpose: Recognize earned interest on discounted bonds.
- Applied To: Zero-coupon and below-par bonds.
- Effect: Increases carrying value over time.
- Method: Effective interest or straight-line.
- Output: Reported as interest income or expense.
Frequently Asked Questions (FAQs)
Is accretion of discount taxable?
Yes, under U.S. tax law, accreted interest on discount bonds is taxable annually.
How does accretion differ from amortization?
Accretion increases value (discount bonds), while amortization reduces value (premium bonds).
What accounting method is used for accretion?
The effective interest method is preferred under IFRS and GAAP.
Does accretion affect cash flow?
No — it’s a non-cash adjustment recognizing earned interest income.
