ACCA Financial Management (F9) Certification Practice Exam

What is the creditor hierarchy?

1. A ranking of creditors by loan amount

2. A method for distributing dividends

3. A structured order of claims against a company's assets in bankruptcy

4. A system for managing cash flow

The correct answer is: A structured order of claims against a company's assets in bankruptcy

The creditor hierarchy refers to the structured order of claims against a company's assets in the event of bankruptcy or liquidation. This hierarchy dictates the priority of payments to creditors based on their legal rights and the terms of their debt agreements. In a bankruptcy scenario, creditors are classified into various categories, such as secured creditors, unsecured creditors, and equity holders. Secured creditors, who have a legal claim over specific assets that serve as collateral for their loans, are typically paid first. Unsecured creditors, who do not have any collateral backing their claims, come next, followed by subordinated debt holders and finally the equity holders, who receive payment only if there are remaining funds after all higher-ranking claims have been settled. Understanding this hierarchy is critical for both the company facing bankruptcy and the creditors involved, as it affects the likelihood and extent of recovery for different types of debts owed by the insolvent entity. Other choices offered, such as ranking creditors by loan amount, distributing dividends, or managing cash flow, do not accurately capture the essence of creditor hierarchy or its implications in a bankruptcy context. Such tasks may be related to financial management but do not define the structured approach to addressing claims in insolvency scenarios.