What it means
Some borrowings pay no cash interest at all. Instead they are issued well below the amount repayable at maturity, and the investor's return comes entirely from that gap closing over time.
Accreted value tracks the closing of that gap. It equals the original issue price plus all the interest accrued to date, so on the maturity date the accreted value equals the face value the borrower must repay.
This matters for both sides of the deal. The issuer records rising interest expense and a rising liability even though no cash leaves the business, and the holder records interest income and a rising asset even though no cash arrives.
It also appears in contracts. Redemption prices, conversion terms and covenant tests on discounted bonds are frequently expressed as a percentage of accreted value rather than of face value, so getting the figure right has real money attached to it.
The calculation normally uses the effective interest method, applying the yield at issue to the carrying amount each period. Some simpler arrangements accrete on a straight-line basis, which spreads the discount evenly and is easier but slightly less accurate.
Do not confuse accreted value with market value. Accreted value is a bookkeeping figure driven by the original yield; the market price moves with current interest rates and credit quality and can sit well above or below it.
In practice
Real-world examples.
Example
A property developer issues zero coupon notes to fund a project that will not generate rent for three years. No cash interest is due in the meantime, but the balance sheet liability climbs each quarter as the notes accrete towards face value.
Example
A bond fund holds a deeply discounted instrument and reports interest income equal to the annual accretion. Investors see income in the accounts even though the fund received no coupon payments during the year.
Example
A borrower wants to redeem discounted notes early. The indenture sets the redemption price at 102% of accreted value, so with an accreted value of $751,314 the redemption cost is $766,340 rather than anything based on the $1,000,000 face amount.
Formula
Calculation
The formula is: Accreted value at time t = issue price x (1 + yield)^t, and each period's accretion = opening accreted value x yield.
A logistics group issues a five-year zero coupon note with a face value of $1,000,000 priced to yield 10% a year. The issue price is $1,000,000 / (1.10)^5 = $1,000,000 / 1.61051 = $620,921.
Year 1 accretion = $620,921 x 10% = $62,092, so the accreted value at the end of year 1 is $620,921 + $62,092 = $683,013. Year 2 accretion = $683,013 x 10% = $68,301, giving an accreted value of $751,314 at the end of year 2.
Continuing the same pattern gives roughly $826,446, then $909,090, and finally $1,000,000 at the end of year 5, ignoring small rounding differences. Over the five years the issuer charges $379,079 of interest expense in total without paying a cent of cash interest.Case study
Seen in the real world.
Fenwick Rail Holdings is a fictional infrastructure company used purely for illustration. It financed a depot upgrade with $620,921 of proceeds from zero coupon notes repayable at $1,000,000 after five years, chosen because the depot would produce no revenue for the first two years.
The chief executive initially told the board the financing was "interest free until maturity" because no cash payments were due. The finance director corrected the framing by showing the accretion schedule: roughly $62,000 of interest expense in year one and around $91,000 in year five, all of it real cost even though it never touched the bank account.
Once the board saw the schedule, it modelled the covenant test, which was written against accreted value, and confirmed the ratio would still be met in the final year when the liability was largest. The illustrative point is that non-cash interest is still interest, and it lands hardest at the end.
Watch out
Common mistakes.
- Describing a zero coupon issue as interest free because no cash coupons are paid, when the whole discount is interest recognised over the life of the instrument.
- Using face value in a covenant or redemption calculation when the contract specifies accreted value, which usually produces a materially different number.
- Treating accreted value as the market price, when the two only coincide by chance and diverge whenever rates or credit quality move.
Questions
People also ask.
Is accreted value the same as carrying value?
For a simple discounted instrument they are effectively the same figure, although carrying value is the broader accounting term and may also reflect issue costs.
Does accretion affect taxable income?
In many jurisdictions the holder is taxed on accrued discount each year even without cash receipts, which is why these instruments are often held in tax-sheltered accounts.
Why does accretion grow each year?
Because the yield is applied to a larger opening balance every period, so the same percentage produces a bigger dollar amount as maturity approaches.
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