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Companies record liabilities at their discounted value in the first year. As time passes, they recognize an interest charge on the screen while increasing the obligation. This process liability on the balance sheet reflects the actual amount paid by the company. Companies use accretion expenses to achieve that.
What is Accretion Expense?
Accretion expense, or the “accretion of discount,” is a fundamental accounting concept used to gradually recognize increases in the carrying value of certain liabilities or financial instruments. This incremental recognition aligns the recorded value with the future payment obligations associated with these instruments. The primary application of accretion expense is prominent in bonds or debt instruments issued at a discount.
When a company issues such instruments, the initial difference between the face value of the bond and the proceeds received from investors constitutes a discount. Over the bond lifecycle, this discount is systematically accreted, with each period’s portion recognized as an interest expense on the income statement. This process ensures that the bond’s carrying value equals its face value by its maturity date.
How does Accretion Expense work?
Accretion is an essential accounting process that facilitates the gradual recognition of increases in the carrying value of specific liabilities or financial instruments over time. It aligns the recorded value with future payment obligations or face values, providing a more accurate depiction of a company’s financial position and performance. This process applies to two primary scenarios: bonds or debt instruments issued at a discount and asset retirement obligations (ARO).
In the case of bonds or debt instruments, accretion works by calculating a periodic accretion amount based on the remaining discount and the total remaining periods until maturity. This amount then gets recognized as interest on the income statement. Simultaneously, the liability’s carrying value on the balance sheet increases by accretion amount, ensuring the instrument’s value gradually converges with its face value near maturity.
What is the accounting for Accretion Expense?
Accretion expense gets distinct treatment depending on its application. In the context of bonds or debt instruments issued at a discount, accretion starts with recording the discount as a liability and creating a contra-liability account called “discount on bonds payable.” Over time, accretion is systematically calculated and recognized as interest expense on the income statement, representing the cost of carrying the bond at its original discount.
Simultaneously, the bond’s carrying value on the balance sheet increases by the accretion amount, gradually aligning it with its face value by maturity. For asset retirement obligations (ARO), accretion follows a similar pattern. The initial obligation’s present value gets recorded as a liability on the balance sheet. Periodically, accretion expense gets calculated to recognize the increase in the ARO’s present value due to the passage of time.
What is the journal entry for Accretion Expense?
The journal entry for accretion expense increases expenses in the income statement. Simultaneously, it also increases the related liability in the balance sheet. Consequently, the journal entry for accretion expense is as below.
| Dr | Accretion expense |
| Cr | Asset retirement obligation |
The above journal entry only applies to asset retirement obligations. It follows the same approach for bonds and liabilities. For the latter, the journal entry will be as follows.
| Dr | Accretion expense |
| Cr | Discount on bonds payable |
Conclusion
Accretion expense refers to the gradual increase of the carrying value of liabilities while increasing expenses. It applies to certain obligations, including asset retirement obligations and bonds payable. Accretion expenses impact the income statement and balance sheet simultaneously. However, the accounting treatment may differ based on the application.
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