Define: Accretion Of Discount

Q: What is accretion of discount?
A: Accretion of discount refers to the process of gradually increasing the value of a bond or other debt instrument that was issued at a discount to its face value. This increase in value occurs over time as the bond approaches its maturity date.

Q: How does accretion of discount work?
A: When a bond is issued at a discount, it means that its initial price is lower than its face value. Over time, the bond’s value increases, or “accretes,” to its face value. This increase is typically recognized as interest income over the life of the bond.

Q: Why do bonds get issued at a discount?
A: Bonds may be issued at a discount for various reasons, such as market conditions, credit risk, or the issuer’s financial situation. Investors are willing to purchase bonds at a discount because they can earn a higher yield compared to bonds issued at par or a premium.

Q: How is accretion of discount calculated?
A: Accretion of discount is calculated using the effective interest method. This method takes into account the bond’s initial discount, its face value, and the time remaining until maturity. The accretion amount is typically recognized as interest income on the income statement.

Q: What is the effective interest method?
A: The effective interest method is a way to allocate interest income or expense over the life of a bond or debt instrument. It considers the bond’s initial discount or premium, the face value, and the time remaining until maturity to calculate the periodic interest income or expense.

Q: Is accretion of discount taxable?
A: Yes, accretion of discount is generally taxable as interest income. It is treated as ordinary income and is subject to applicable income tax rates.

Q: Can accretion of discount be reversed?
A: No, once a bond is issued at a discount, the accretion process cannot be reversed. The bond will continue to accrete until it reaches its face value at maturity.

Q: What happens if a bond is called or redeemed before maturity?
A: If a bond is called or redeemed before its maturity date, the accretion of discount will stop. The investor will receive the call price, which may be higher or lower than the bond’s accreted value.

Q: Are there any risks associated with accretion of discount?
A: Accretion of discount is a normal process for bonds issued at