Accretion

Article byVikram Shakti
Edited byAnkush Jain
Reviewed byDheeraj Vaidya, CFA, FRM

Accretion Meaning

Accretion primarily means gradual or incremental growth. However, concerning finance, it refers to the growth of a company due to business expansion, merger & acquisition, or internal growth. It can also refer to the additional bonus an investor expects on the purchase of bond on a discount and holding until maturity.

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In simple terms, accretion finance refers to the growth in the value of a company through organic means or through a particular transaction. Purchasing an asset at a discount or purchasing an asset and its value having potential to grow after the transaction is also closely linked to this concept.

Key Takeaways

  • Accretion carries a technical meaning in finance, representing steady growth or additional increase. 
  • In the bond market context, it refers to the change in bond price when purchased at a discount to its par value or the capital gains realized by a bondholder upon buying or selling the bond. 
  • In mergers and acquisitions, accretion refers to the post-transaction increase in a company’s earnings. 
  • When dealing with zero-coupon bonds that lack periodic coupon payments, Compound Accreted Value (CAV) comes into play. CAV is determined by adding all the interest earned over time to the original bond price, reflecting the accumulated value.

Accretion Explained

Accretion refers to the growth in value for an investor or a company through organic means or through a transaction. This concept is closely looked and analyzed in the bond market and with relation to mergers and acquisitions.

In the context of M&A, accretion is the increase in the company’s earnings after the transaction. For example, if the company has an EPS of 1$. After acquiring the EPS rose to 1.30$, the acquisition would be referred to as 30% accretive. In accounting terms, accretion expense creates when the Present Value (PV) of financial instrumentsFinancial InstrumentsFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes.read more is updated. Accretion in corporate finance is the actual value created in a particular transaction. The deal will always be accretive if the acquirer’s PE ratioPE RatioThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read more is greater than the PE ratio of the target, including the acquisition premiumAcquisition PremiumAcquisition premium is the excess amount paid by the acquirer over the actual value of the target firm to close the deal during a corporate takeover. It is the difference between the purchase consideration and the target company's pre-merger value.read more.

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Accretion in Bond Market

Accretion refers to the change in the price of a bond bought at a discount price to the bond’s par value or the capital gains a bondholder receives when the buy/sell of the bond happens, the gain/loss. In other terms, it can describe as the amortization of the bondAmortization Of The BondWhen a company issues bonds to investors with a coupon rate that is higher than the market rate of interest, the investors may bid higher than the face value of the bond. The excess premium received is amortized by the company over the bond term, and the concept is known as Amortization of Bond Premium .read more. Amortization is the depreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. read more of any intangible assetIntangible AssetIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more. Therefore, the increase or decrease in bond price during a transaction is also called amortization.

Accretion in Mergers and Acquisitions

Accretive deals can occur if the assets are acquired at a discount to their previous market value. In general, accretive investments refer to any security purchased at a discount.

Accretion and dilution are used to test the impact of an acquisitionAcquisitionAcquisition refers to the strategic move of one company buying another company by acquiring major stakes of the firm. Usually, companies acquire an existing business to share its customer base, operations and market presence. It is one of the popular ways of business expansion.read more or g entities equal in size, operations, and customers deciding to amalgamate to form a new entity, expand its reach into new territories, lower operational costs, increase revenues, and earn greater control over market share” merger[/wsm-tooltip] on the acquirer firm’s Earning Per Share (EPS). It helps the buyer firm study the effect of the union on the firm in terms of profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more consequences comprising all factors and complexities. The synergy of the merger can depict by doing such an analysis.

  • Post deal EPS > Buyer EPS —>Accretion
  • Post deal EPS < Buyer EPS —>Dilution
  • Post deal EPS = Buyer EPS —>Breakeven

After the merger, the consensus EPS obtains to determine the accretion or dilution. This analysis is thus helpful in understanding the consequences of the merger. Usually, a merger precedes by thorough due diligence of the target firm. In some cases, the target firm will also conduct due diligence on the buyer firm. Then, during the same period before finalizing the merger, the accretion dilution analysis is performed to study the consequences.

If the merger results in dilution, the buyer firm will think twice about going ahead with a merger or other means to compensate for the decrease in overall EPS in the future.

It is crucial when a buyer plans on a merger or accounting terms while factoring in the tax amount. It also helps to determine the rationale behind combining two companies if the dilution is too high. Then, the acquirer will probably not go ahead with the transaction, or if the accretion is too high, the buyer may go one step forward or increase the bid to close the deal and benefit from the synergy of a mergerSynergy Of A MergerSynergy in M&A is the approach of business units that if they combine their businesses by forming one single unit and then working together to achieve a common goal, the total earnings of the business can be greater than the sum of the earnings of both businesses earned separately, and the cost of the merger can be reduced.read more.

Examples

Let us understand the concept of accretion finance with the help of a couple of examples.

Example #1

Accretion Amount = Purchase Basis * (YTM / Accrual Period per Year) – Coupon Interest

The negative value is dilution, while the positive value determines the accretion.

When an investor purchases a bond at a discount, the discount must accrete over the full life of the bond till maturity. It comprises adjusting the cost basisCost BasisCost basis is the valuation of assets at their original or at-cost price inclusive of incidental expenses determined after making relevant adjustments for dividends, stock splits and distribution of return on capital. It facilitates the taxation of assets.read more (paid the price) at par for each year the bond is held. It, in turn, increased both the cost and reported net income of the bond.

Consider an investor who has bought a bond at 80$, whose maturity is 10 years and par is 100$. The investor’s accretion, in this case, would be (20/10=2) 2$. His reported net income would be 5$(interest) +2$ (accretion) = 7$.

Example #2

In April 2023, Bakkt, a digital asset platform declared their settlements with Apex Crypto LLC as a part of their merger and acquisition plan. As a part of this deal Bakkt would pay $55 million cash and $145 million in stocks to Apex Crypto. As a result,

Bakkt would get access to the 5.8 million active crypto users and their B2B2C model has been a go-to choice for investors and companies in the crypto space.

Accretion Vs Amortization

Accretion finance and amortization have been common terminologies when it comes to recording gains or profits. However, there are fundamental differences in both concepts.

While there is a decrease in cost and decrease in income with amortization, there is an increase in price and increase in income through accretion of the asset that is being purchased. The asset could be a bond or an acquisition of a company.

Frequently Asked Questions (FAQs)

1. What is the difference between accretion and accrual?

Accretion and accrual are accounting terms with different meanings. Accretion refers to the gradual increase in the value of an asset over time, typically through the recognition of additional value or interest. Accrual, conversely, is the recognition of revenue or expenses in the accounting period in which they are earned or incurred, regardless of when the associated cash transactions occur.

2. Is accretion a cash expense?

No, accretion is not a cash expense. Instead, accretion represents an increase in the value of an asset, often related to the passage of time or the accumulation of additional value, such as in the case of accretion of interest on a bond or the growth of an investment’s value.

3. Is accretion expense a debit or credit?

The specific account affected by an accretion expense would depend on the context and the type of transaction involved. Generally, an accretion expense would be recorded as a debit to an expense account and a credit to the corresponding liability or asset account that is increasing in value.

This article is a guide to Accretion meaning. Here, we explain its presence in the bond market, merger & acquisition, examples, and compared it to amortization. You can learn more about investment banking from the following articles: –