Glossary term
Accretion of Discount
Accretion of discount is the process of increasing a discounted bond's carrying value or tax basis over time toward its maturity value.
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What Is Accretion of Discount?
Accretion of discount is the process of increasing a discounted bond's carrying value, book value, or tax basis over time toward its maturity value. It applies when a debt instrument is issued or purchased below the amount expected to be paid at maturity.
The concept matters because discount is not just a bargain price. In many tax and accounting contexts, the discount is treated as income or yield earned over the life of the bond rather than only at maturity.
Key Takeaways
- Accretion of discount gradually recognizes the discount on a debt instrument over time.
- It commonly applies to zero-coupon bonds, original issue discount instruments, and some market discount bonds.
- Accretion can increase carrying value, tax basis, or recognized interest income.
- The investor may have taxable income before receiving matching cash, depending on the instrument and tax rules.
- The method and tax treatment depend on the bond type, purchase price, issue terms, and applicable rules.
How Discount Accretion Works
A bond is discounted when its price is below the amount due at maturity. Over time, that gap narrows through accretion. For a zero-coupon bond, the investor may receive no periodic interest, but the bond's value moves toward the maturity amount as the implied interest is recognized.
For accounting purposes, accretion can increase the carrying amount of the investment. For tax purposes, original issue discount generally has its own income-recognition rules. Market discount, municipal bond discount, and taxable OID can all have different consequences.
Simple Example
Suppose an investor buys a bond for $900 that will pay $1,000 at maturity. The $100 difference is the discount. Accretion spreads that discount over the holding period rather than treating the full $100 as appearing only on the maturity date.
The investor's reported income, adjusted basis, or book value may rise over time even if no cash coupon is paid. That is why discount bonds can create a mismatch between taxable or accounting income and cash received.
Where It Shows Up
Instrument | How accretion may matter |
|---|---|
Zero-coupon bond | Discount represents much of the investor's economic return. |
Original issue discount bond | OID may be reported over time under tax rules. |
Municipal discount bond | Accretion can affect adjusted basis and tax treatment. |
Accounting carrying value | Book value may rise toward maturity value. |
Tax and Cash-Flow Caution
Discount accretion can create income recognition before cash is received. That surprises investors who expect tax only when money arrives. Brokers may report OID or related amounts on tax forms, but investors should still understand whether the bond's return is cash coupon, accreted discount, or both.
The tax treatment can be technical, especially for municipal bonds, stripped bonds, market discount, and bonds sold before maturity. The glossary-level point is simple: accretion changes basis and income timing.
The Bottom Line
Accretion of discount recognizes the value of a bond discount over time. It helps explain why a discounted bond's basis or carrying value can rise and why investors may report income before receiving cash.