| Course | ACC 545 Financial Reporting (ACC/545) |
|---|---|
| Week | 5 |
| Paper type | Troubled debt and deferred tax paper |
| Length | about 1,176 words, 4 double-spaced pages plus title page and references |
| Format | APA 7 student paper |
| School | University of Phoenix |
| Program | MS in Accounting |
| Updated | September 2026 |
Free sample paper for ACC 545 Week 5
A Restaurant Chain in Trouble: Recording a Troubled Debt Restructuring as the Debtor and Deciding How Much of $8 Million in Deferred Tax Assets Can Stay on the Balance Sheet
[Student Name]
University of Phoenix
ACC/545: Financial Reporting
Week 5 Assignment
[Instructor Name]
[Date]
The restaurant chain, its lender and all figures are composites written for a model paper; standards and research findings come from the sources listed.
A composite fast-casual restaurant chain operates 38 locations in four states. Rising food and labor costs and a failed expansion into airport locations produced pretax losses in each of the last three years, a cumulative $31 million. At year end it owed its bank $24.0 million on a term loan plus $1.2 million of accrued interest it had not paid. The chain closed six restaurants, replaced its chief executive and negotiated new terms with the bank. Distress changes the accounting twice: it lets a borrower report a gain on debt it cannot fully repay, and it forces the borrower to doubt tax benefits it has been counting on. This paper addresses both.
Is the Modification Troubled?
A restructuring is troubled when the debtor is experiencing financial difficulty and the creditor, for economic or legal reasons related to that difficulty, grants a concession it would not otherwise consider (Financial Accounting Standards Board, 1977). The chain had defaulted on its covenants, was behind on interest and could not borrow elsewhere on normal terms. The bank agreed to forgive the $1.2 million of accrued interest, reduce principal to $20.0 million, cut the rate from 8% to 4% and extend maturity by three years to five years from now. Those terms are concessions. The modification is a troubled debt restructuring.
The Debtor's Test
For a modification of terms, the debtor compares the total future undiscounted cash payments under the new terms with the carrying amount of the debt. The carrying amount is $25.2 million, principal plus accrued interest. Future payments are $20.0 million of principal plus interest of 4% on $20.0 million for five years, $4.0 million, a total of $24.0 million. Because future payments are less than the carrying amount, the chain recognizes a gain on restructuring of $1.2 million and reduces the carrying amount of the debt to $24.0 million.
After the restructuring, no interest expense is recognized. Every future payment, whether labeled interest or principal, reduces the carrying amount, which reaches zero with the final payment. Had future payments exceeded the carrying amount, no gain would be recognized, and a new effective interest rate would be computed to spread the difference over the remaining term.
The Lender's Side Has Changed
The bank does not mirror this accounting. Since the 2022 update, creditors no longer apply separate troubled debt restructuring recognition and measurement rules; they evaluate modifications under the general loan guidance and disclose modifications made to borrowers experiencing financial difficulty (Financial Accounting Standards Board, 2022). The debtor's model, however, remains in place, so the two parties now account for the same event differently.
The Tax Side of the Forgiveness
For tax purposes, forgiven principal is generally cancellation of debt income unless an exclusion applies, such as insolvency. The chain's liabilities exceeded the fair value of its assets by more than the forgiven amount immediately before the restructuring, so it expects to exclude the income under the insolvency exception and reduce its tax attributes, including net operating losses, by the excluded amount. The forgiven accrued interest was never deducted, so its forgiveness produces no taxable income.
The Deferred Tax Position
Before the valuation allowance analysis, the chain's deferred tax assets include about $6.8 million for federal and state net operating loss carryforwards, after reduction for the excluded cancellation of debt income, $0.9 million for accrued lease obligations and $0.5 million for other accruals, about $8.2 million in total. Its deferred tax liabilities, mainly accelerated depreciation on restaurant equipment and leasehold improvements, are about $2.3 million.
Weighing the Evidence
The chain must reduce its deferred tax assets by an allowance for any portion it probably will never use, judged on all the evidence for and against (Financial Accounting Standards Board, 1992). Cumulative losses in recent years are significant negative evidence that is difficult to overcome. The chain has a three-year cumulative loss of $31 million. Positive evidence includes the closure of the six least profitable restaurants, the lower interest cost and a budget showing a small profit next year. But projections of future income, especially from a company with recent losses, are not objectively verifiable, and the budget depends on a turnaround that has not yet occurred.
The most reliable source of future taxable income is the reversal of existing taxable temporary differences. The depreciation difference of $2.3 million will reverse in future years and can support realization of deferred tax assets of a similar amount, subject to the rule capping post-2017 loss deductions at 80% of a year's taxable income. The chain concludes that about $1.8 million of deferred tax assets is supported by reversing liabilities and records a valuation allowance of about $6.4 million.
Other Distress Questions
Distress raises further accounting questions the chain addressed at the same time. The six closed restaurants had leases with years remaining; their right-of-use assets were tested for impairment and written down, and the lease liabilities remain until the leases are settled or subleased. Equipment at those locations was written down to its expected sale value. The auditors also evaluated whether substantial doubt existed about the chain's ability to continue as a going concern; the restructured loan, lower interest cost and closure of losing locations were sufficient to alleviate that doubt, but management disclosed the conditions and its plans.
Effect on the Statements
The gain of $1.2 million improves this year's pretax result, but the $6.4 million valuation allowance increases income tax expense sharply, producing an effective tax rate that bears little relation to the statutory rate. The notes explain both, including the carryforward amounts and expiration dates of state losses. If the chain returns to sustained profitability, it will release the allowance, reducing tax expense in that year.
What Would Release the Allowance
The allowance is not permanent. Management and the auditors agreed on the evidence that would support releasing it: two consecutive years of pretax profit after the restructuring, a return to positive same-store sales and removal of the cumulative loss position over the most recent three years. Until then, the chain will reassess each quarter and disclose its conclusion.
Research on These Judgments
Graham et al. (2012) reviewed research showing that valuation allowances involve considerable discretion and have been used to manage earnings, which is why auditors examine the evidence closely. Gilson et al. (1990) studied private restructurings of firms in default and found that about half succeeded in avoiding bankruptcy, with success more likely when debt was owed mainly to banks. The chain's bank-only debt structure fits that pattern.
Conclusion
The chain's loan modification was a troubled debt restructuring. Because future undiscounted payments of $24.0 million were less than the $25.2 million carrying amount, it recognized a $1.2 million gain and will record no further interest expense. The same losses that forced the restructuring cast doubt on its deferred tax assets; weighing cumulative losses against reversing temporary differences, it recorded a valuation allowance of about $6.4 million.
References
Financial Accounting Standards Board. (1977). Accounting by debtors and creditors for troubled debt restructurings (Statement of Financial Accounting Standards No. 15).
Financial Accounting Standards Board. (1992). Accounting for income taxes (Statement of Financial Accounting Standards No. 109).
Financial Accounting Standards Board. (2022). Financial instruments, credit losses (Topic 326): Troubled debt restructurings and vintage disclosures (Accounting Standards Update No. 2022-02).
Gilson, S. C., John, K., & Lang, L. H. P. (1990). Troubled debt restructurings: An empirical study of private reorganization of firms in default. Journal of Financial Economics, 27(2), 315-353. https://doi.org/10.1016/0304-405X(90)90059-9
Graham, J. R., Raedy, J. S., & Shackelford, D. A. (2012). Research in accounting for income taxes. Journal of Accounting and Economics, 53(1-2), 412-434. https://doi.org/10.1016/j.jacceco.2011.11.006
What the ACC 545 Week 5 instructions ask
ACC 545 Week 5 typically asks graduate students to account for income taxes, including deferred tax assets and liabilities and valuation allowances, and for debt in distress, including troubled debt restructurings by debtors and related disclosures. Typical requirements include identifying a troubled debt restructuring, applying the debtor's recognition and measurement rules for modifications and settlements, computing any gain, recognizing deferred taxes on temporary differences and carryforwards and evaluating the need for a valuation allowance using positive and negative evidence. Many prompts combine the topics in a distressed company and ask for entries and disclosure. Answers should show the entries, explain each judgment and rest on the Codification and research, referenced in APA form; examiners also look for the tax treatment of any forgiven debt.
How this ACC 545 Week 5 example is built
A restaurant chain that has lost money for three years and renegotiated its bank loan brings both topics together, since the same losses that forced the restructuring created the tax loss carryforwards. The paper first establishes that the modification is troubled, then applies the debtor's test comparing total future cash payments with the carrying amount, which produces a gain and no future interest expense. It notes the tax effect of the forgiven amount, which differs from the book gain. The deferred tax section lists the chain's temporary differences and carryforwards, weighs the evidence required by the standard and explains why cumulative losses dominate. The allowance is computed, and the paper closes with research on how managers use these judgments.
ACC 545 Week 5 grading rubric: where the points go
Instructors look for two things above all: a correctly identified and recorded troubled debt restructuring and a valuation allowance supported by weighed evidence. Faculty check that the restructuring meets both conditions, financial difficulty and a concession, that the debtor compares total future undiscounted cash payments with the carrying amount, recognizes a gain only if payments are less, and reduces the carrying amount with each later payment, and that the valuation allowance weighs objectively verifiable evidence, giving cumulative losses significant weight. Correct deferred tax computations, attention to tax effects of forgiven debt, clear disclosure and cited guidance complete the grade.
ACC 545 Week 5 help: mistakes to avoid
One recurring ACC 545 Week 5 error is discounting the restructured payments when testing for a gain under the debtor model. The test uses undiscounted payments, and when they are less than the carrying amount, no interest expense is recognized afterward. Another is applying the old creditor model; lenders now account for modifications under the general loan guidance. For deferred taxes, students often keep all deferred tax assets because management expects a turnaround. Cumulative losses are hard to overcome with projections. Identify reversing taxable temporary differences as a source of income. Explain the tax treatment of forgiven debt. Finally, disclose the judgments clearly, since readers cannot otherwise see them.
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ACC 545 Week 5 questions, answered
What does ACC/545 Week 5 usually cover?
It usually covers accounting for income taxes, including deferred tax assets and valuation allowances, and troubled debt restructurings, especially the debtor's accounting.
Where can I find a free ACC 545 Week 5 sample paper?
A restaurant chain's troubled debt restructuring and valuation allowance appear in full on this page with a note beside each judgment. For a distressed company in your own assignment, we will write the first draft free.
What makes a debt restructuring troubled?
The debtor is experiencing financial difficulty and the creditor grants a concession it would not otherwise consider, such as a lower rate, a longer term or principal forgiveness.
How does a debtor record a troubled debt modification?
It compares total future undiscounted cash payments under the new terms with the carrying amount; if payments are less, it recognizes a gain and reduces the carrying amount to the total payments, with no future interest expense.
When is a valuation allowance required?
When the evidence suggests, on a better-than-even basis, that part of the tax benefit will never be used; recent cumulative losses weigh heavily against keeping the full asset.
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