What is accretion?
Everything that has to do with a company’s improvement, like business expansion, internal growth, or mergers and acquisitions, and the like, will have gradual and incremental asset and earnings growth as it happens. We call it “accretion.” And when we say accretion in finance, we refer to the accumulation of more income an investor can expect to get after buying a discounted bond and holding it until it matures. If we are to name a famous financial accretion, it would have to be a zero-coupon bond. It is also renowned as cumulative preferred stock.
Now, if we say accretion in corporate finance, we refer to making value by using organic growth or transactions. For instance, we have an asset bought at a discount or a lower price than their perceived current market value. Accretion also happens when getting assets with values that seem to grow as soon as the transaction occurs.
We can also encounter accretion in the securities market. For instance, buying bonds cheaper than their face or par value is like buying them with discounts. We also have premiums, and this is the opposite of what we just mentioned. This is when an entity buys at a price higher than the face or par value. Finance accretion will adjust the cost basis from the discounted or purchase amount to the anticipated redemption amount at maturity. Let us say that you bought a bond at 80% of the face amount. The accretion is now 20%.
Let us move on to bond accounting.
An interest rate increase is also like saying a decline in a bond’s existing face value. It means that the price of market traded bonds declines to reflect the rise in the interest rate. We know that bonds mature at the face amount. So, the investor knows that more income on a discounted bond is known with the help of accretion.
Finance and bond accretion
How do we know how fast the accretion is? We can divide the discount by the term’s years. For zero-coupon bonds, it is not a compounding acquired interest. Indeed, the bond’s value goes higher depending on the agreed-upon interest rate. However, it should be held for the term which was agreed upon before being cashed.
Accounting and earnings accretion
Next, let us talk about EPS or earnings per share ratio. It refers to the earnings that are there for common shareholders, and we divide that by the average common shares that are still existing. In this sense, accretion refers to the firm’s EPS increase when an acquisition happens. It is possible that the security’s accredited value is not related to its market value.
Accretion means incremental and gradual asset growth. Saying accretion in finance implies accumulating additional income investors expect to get when they buy discounted bonds and hold until they mature. We can determine an accretion rate if we divide the bond’s discount by how many years it will take in its term until its date of maturity.