Accretion refers to the progressive and cumulative growth of assets and profits at the expense of branching out processes, an enterprise’s inner growth, or a merger and acquisition.
In the financial industry, accretion also means building up the additional income that an investor strives to obtain after bond purchasing at a reduced cost and holding it to maturity.
Essence of the term
The concept of accretion implies adding value due to the organic growth, or conducting financial operations. For instance, new assets are purchased at a reduced price, or lower than their current market value. Accretion also takes place by assets’ acquisition that are expected to increase in cost after the transaction.
Considering the securities market, a bonds’ purchase lower their par value is regarded as an acquisition at a discount. At the same time, buying above the notional worth anticipates a premium purchase. So that accretion makes adjustments to the baseline estimate from the acquisition amount to the expected repayment amount at maturity. In case the face value of a bond is 85%, the accretion would be 15%.
Receivable based financing in bond accounting
Due to increased competition in product and service markets, lots of suppliers are forced to provide deferred or installment payments to their customers, thus acting as creditors and undertaking credit, currency and interest rate risks.This leads to a diversion of suppliers' working capital, affecting their financial statements.
So, with increase of interest rates there is a depreciation of bonds. In other words, it means that these financial instruments traded on the market decline in value, indicating a growth of interest rates. As long as all bonds mature at the notional principal amount, the investor admits supplementary income on a bond acquired at a reduced price. Such income is received with an accretion method.
Accretion of corporate stocks
A pace of accretion is specified by apportioning a reduced price by the number of years. In the context of zero coupon bonds, accumulated interest isn’t charged. Although, there exists a connection between the bond and the interest rate, it’s still necessary to keep it during the agreed period before encashing.
Actually, the earnings-per-share coefficient means a profit for common stockholders segregated by average equity shares in circulation. Accretion, in turn, is defined as a markup in the enterprise's EPS as a result of purchase.
Note: the market value of a security isn’t related to its accreted value.
Real life examples
Let’s suppose that a company gets $3,000,000 of obtainable profits for ordinary stockholders, while 1,000,000 shares are in circulation. Thus, the EPS coefficient amounts to $3. The enterprise issues 100,000 stocks to acquire a firm that brings $800,000 of profit for ordinary shareholders. The emergent coefficient for integrated companies is calculated by apportioning its $3,800,000 gains by 1,100,000 stocks. So that the result will be $3,45. That figure is called accretion via a purchase.
Nevertheless, in certain cases, long-term debt instruments including auto loans, turn into short-period financial facilities, especially when the liability is anticipated to be fulfilled over the course of a year. In case of taking a six-year auto loan, the obligation converts into a short-term tool after the fifth year.