Accretion of discount is an accounting process that refers to the increase in value of a financial instrument purchased at a discounted rate, as the security approaches its date of maturity. Securities such as bonds or other debt instruments may be bought at par, premium, or discount. At the time of security’s maturity, the value of the security reverts to par value. For discounts, the value of the instrument rises steadily in the interim until maturity is reached, and this increase in value is accounted for by the process of accretion of discount.

When a discounted financial instrument is issued, the holder of the security records the difference between the face value of the security and the amount paid as a note receivable, or an asset. At each period-end, a journal entry is made that consists of a credit to the note receivable and a debit to Interest Income. The amount of the note receivable is adjusted each accounting period and is based on the original discount, the interest rate and the length of time the security is outstanding.

Although accretion of discount only impacts the balance sheet, it does affect other financial ratios, such as the return on equity (ROE), return on assets (ROA), and earnings per share (EPS). This happens because the income statement is affected as interest income is recognized over the life of the security, as opposed to in a lump sum when the security is issued.

Overall, accretion of discount is a valuable accounting process that helps to ensure that all securities, regardless of face value or purchase price, are represented accurately. It allows investors to accurately analyze the value of their security compared to its original purchase price, as well as their overall return on equity, return on assets, and overall profitability.