CPA Regulation: Bankruptcy basics — Complete Study Guide

What trips up even the sharpest candidates on REG bankruptcy questions isn't the obvious stuff—it's the exceptions. You might know the 90-day look-back for preferential transfers, but do you know how the "ordinary course of business" exception really works on the exam? It’s a judgment call, and the AICPA loves testing your ability to make it under pressure.

Chapter 7 vs. Chapter 11 vs. Chapter 13: What's the Difference?

The CPA exam expects you to know the fundamental purpose and mechanics of the three most common bankruptcy chapters. Don't just memorize the names; understand who they're for and what they accomplish. This is a common source of easy points if you're prepared.

Here’s a quick-reference table to solidify the differences:

Feature	Chapter 7 (Liquidation)	Chapter 11 (Reorganization)	Chapter 13 (Adjustment of Debts)
Primary Purpose	Liquidate assets for a "fresh start"	Continue business operations while reorganizing debt	Repay debts over 3-5 years from future income
Typical Debtor	Individuals, Partnerships, Corporations	Corporations, Partnerships, High-debt Individuals	Individuals with regular income
Key Process	Trustee appointed to sell non-exempt assets	Debtor (usually) remains in possession, proposes a plan	Debtor proposes a 3-5 year repayment plan
Means Test?	Yes, for individuals	No	No, but must have regular income
Outcome	Most debts are discharged; business ceases	Business continues operating under the plan	Debts are paid down; remaining eligible debts discharged

Myth vs. Reality: The Chapter Trap

• Myth: Bankruptcy is just Chapter 7 for individuals and Chapter 11 for businesses.
• Reality: The lines are more nuanced. Corporations can file Chapter 7 to liquidate. High-debt individuals can use Chapter 11. And Chapter 13 is a critical, testable option for individuals with a steady income who want to repay debts over time, which isn't possible in Chapter 7. Forgetting Chapter 13 is a common mistake.

What is the Automatic Stay in Bankruptcy?

This is a foundational concept you must know. The moment a bankruptcy petition is filed, an automatic stay goes into effect. This is a legal injunction that immediately stops most collection activities by creditors.

Think of it as a legal "time out." The stay prevents creditors from:

• Starting or continuing lawsuits against the debtor.
• Garnishing wages.
• Foreclosing on property.
• Attempting to collect debts in any way.

The purpose is to give the debtor breathing room and to ensure an orderly, fair distribution of assets without a chaotic race by creditors. The exam might test this by presenting a scenario where a creditor continues collection efforts after a bankruptcy filing, which would be a violation of the stay.

How Does the CPA Exam Test Preferential Transfers?

This is a favorite topic for examiners because it’s a pure application of rules, dates, and relationships. A preferential transfer is a payment to a creditor right before filing bankruptcy that allows them to receive more than they would have in a Chapter 7 liquidation. A trustee can "claw back" these payments.

For a transfer to be preferential, it must meet all five conditions:

1. A transfer made to or for the benefit of a creditor.
2. On account of an antecedent (pre-existing) debt.
3. Made while the debtor was insolvent (presumed within 90 days of filing).
4. Made within a specific look-back period:

• 90 days before filing for general creditors.
• One year before filing for insiders (officers, directors, relatives).

1. Enables the creditor to receive more than they would have in a Chapter 7 liquidation.

However, the real test is knowing the exceptions. A payment meeting the above criteria is not preferential if it's:

• A contemporaneous exchange for new value (e.g., paying cash for goods delivered today).
• A payment made in the ordinary course of business (e.g., paying a routine utility bill on its normal due date).
• A payment creating a perfected PMSI within 30 days.
• A payment for domestic support obligations (alimony/child support).
• A payment below a certain threshold:
• For debtors with primarily non-consumer debts, the threshold is $7,575 (for 2026).
• For an individual debtor with primarily consumer debts, the threshold is $725 (for 2026).

These dollar amounts are indexed for inflation and change every three years. The exam will test your knowledge of these specific rules, not just the general concept.

What Debts Can't Be Discharged in Bankruptcy?

A discharge is the legal release from personal liability for debts. But some obligations are considered too important to society to be erased. You must memorize this list of non-dischargeable debts:

• Willful and malicious injury debts
• Alimony and child support
• Fines and penalties to a government
• Taxes (recent income/property taxes)
• Educational (student) loans (unless undue hardship is proven)
• Debts from fraud, embezzlement, or larceny
• Death or injury debts from a DUI/DWI

A simple mnemonic is WAFTEDD.

Additionally, a court can deny a discharge entirely if the debtor acted in bad faith. This can happen if the debtor, for example, fraudulently transferred or concealed property within one year of filing bankruptcy. It's crucial to note this one-year look-back applies to specific actions like fraudulent transfers; other grounds for denial, like failing to explain a loss of assets, have no time limit.

In some Chapter 7 cases, a debtor may wish to keep certain property secured by a loan (like a car). They can do this by entering into a reaffirmation agreement with the creditor, agreeing to remain legally obligated to pay the debt after bankruptcy.

How Are Creditors Paid? Understanding the Priority Order

When a debtor's assets are liquidated, there's a strict pecking order for who gets paid. Misunderstanding this is a fatal error on a simulation.

First, Secured Creditors: Before anyone else, secured creditors are paid from the proceeds of the sale of their collateral. If a bank has a $20,000 loan secured by a car that sells for $15,000, the bank gets the full $15,000. The remaining $5,000 becomes a general unsecured claim. Next, Priority Claims (in order): After secured creditors are satisfied, the remaining funds are paid to priority claimants in a specific order. You must know this hierarchy:

1. Support obligations (alimony, child support).
2. Administrative expenses (trustee fees, legal fees).
3. Gap claims (involuntary case claims arising in the ordinary course of business after filing but before a trustee is appointed).
4. Wage claims up to $15,175 per employee, earned within 180 days of filing.
5. Employee benefit plan contributions up to $15,175 per employee (less wage claims paid), earned within 180 days of filing.
6. Grain farmers and fishermen claims.
7. Consumer deposits up to $3,350 per person.
8. Tax claims.
9. Injury claims from intoxicated driving.

A good mnemonic is SAG WEG CTI.

Last, General Unsecured Creditors: Whatever is left over is distributed pro-rata among the general unsecured creditors (e.g., credit card companies, trade suppliers). Shareholders are paid last, which in most bankruptcies means they get nothing.

To master these complex rules, you need repetition. You can test your judgment on priority and distribution scenarios with VoraPrep's adaptive question bank.

Worked Example: Applying Bankruptcy Rules to a REG Scenario

Let's walk through a realistic exam-style scenario.

Scenario:

Maplewood Manufacturing, Inc., a small C corporation, has been struggling. On March 1, 2026, Maplewood paid its primary supplier, Timberline LLC, $25,000 for an invoice dated December 15, 2025. On April 15, 2026, Maplewood repaid a $5,000 loan to its CEO, Sarah Chen. On May 15, 2026, Maplewood filed for Chapter 7 bankruptcy while insolvent.

Questions:

1. Is Maplewood eligible for Chapter 7?
2. Are the payments to Timberline and Sarah Chen preferential transfers?

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Step-by-Step Walkthrough: 1. Is Maplewood eligible for Chapter 7?

• Reasoning: Chapter 7 is available to individuals, partnerships, and corporations. As a C corporation, Maplewood is eligible. The "means test" applies only to individuals, not corporations.
• Conclusion: Yes, Maplewood is eligible.

2. Are the payments preferential transfers?

Let's analyze each payment against the five conditions. The first three (to a creditor, for an antecedent debt, while insolvent) are met for both. The key is the look-back period and exceptions.

• Payment to Timberline LLC ($25,000):
• Look-back: Payment on March 1, filing on May 15. That's 75 days, which is within the 90-day period for a general creditor.
• The "Aha" Moment (Ordinary Course Exception): The invoice was from Dec. 15, paid 75 days later. Is this "ordinary course of business"? This is where candidates get stuck.
• Tempting Wrong Answer: "It's a payment to a primary supplier, so it must be ordinary course."
• How an Examiner Thinks: The "ordinary course" exception requires payment on terms that are common for that business or industry. A 75-day payment on what might be Net 30 terms is likely not ordinary. Insolvency is a prerequisite for a preference; it doesn't prove the payment was not ordinary. On the exam, unless the facts explicitly state "payment was made on normal terms" or "Maplewood routinely paid suppliers in 75 days," you should assume a significantly late payment is not in the ordinary course.
• Conclusion (Timberline): Yes, it is a preferential transfer. It meets all five criteria, and there are no facts to support an exception.
• Payment to Sarah Chen, CEO ($5,000):
• Look-back: Payment on April 15, filing on May 15. That's 30 days.
• Insider Status: Sarah is the CEO, an insider. The look-back period for insiders is one year. The 30-day payment falls squarely within this period.
• Conclusion (Sarah Chen): This is a textbook preferential transfer to an insider.

For a broader look at how these topics fit into the entire REG section, our CPA Taxation and Regulation Cheat Sheet (2026) is an excellent high-level review.

How to Study Bankruptcy for the CPA REG Exam

1. Focus on Application, Not Just Rules: Know why the rules exist. The means test prevents abuse. Preferential transfer rules ensure fairness. This context helps you apply rules to unfamiliar scenarios.
2. Drill the Differences: Use the comparison table in this guide. Constantly ask yourself: "Is this a Chapter 7, 11, or 13 issue? Does the means test apply? Is the goal liquidation or reorganization?"
3. Master Preferential Transfers: This is a high-yield topic. Create flashcards for the five elements and the key exceptions. Do practice questions that force you to calculate dates and apply the insider rule.
4. Use Mnemonics for Priority: The order of claims is pure memorization. Use mnemonics like SAG WEG CTI for priority claims and WAFTEDD for non-dischargeable debts.
5. Connect to Other REG Topics: Bankruptcy doesn't exist in a vacuum. It connects to business structures (who can file?) and secured transactions (who gets paid first?). Understanding these links deepens your knowledge. Our guide on CPA Regulation: AICPA SSTS can help you see how different professional standards interrelate.

Remember, the CPA exam isn't just about what you know, but how you think. VoraPrep's AI tutor (Vory) is available 24/7 to help you reason through tough concepts, ensuring you're not just memorizing, but truly understanding.

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Frequently Asked Questions

How many questions on Bankruptcy basics appear on the CPA exam?

The AICPA does not provide a specific breakdown for individual sub-topics like "Bankruptcy basics." However, bankruptcy falls under the "Business Law" content area within REG, which typically makes up 10-20% of the REG exam. You can expect several MCQs and potentially a TBS with bankruptcy elements.

What's the best way to study Bankruptcy basics?

The best way to study Bankruptcy basics is to focus on understanding the differences between Chapter 7, 11, and 13, mastering the elements and exceptions of preferential transfers, and memorizing the list of non-dischargeable debts. Use comparative charts and practice scenarios to apply the rules.

Is Bankruptcy basics tested in simulations/TBS or only MCQ?

Bankruptcy basics can be tested in both MCQs and Task-Based Simulations (TBS). MCQs will test specific rules, definitions, and applications. TBSs might involve analyzing a debtor's financial situation, identifying preferential transfers, or determining the priority of claims in a more comprehensive scenario.

How long should I spend studying Bankruptcy basics?

Allocate sufficient time to truly understand the core concepts. For most candidates, this might mean 5-10 hours of dedicated study time, including reviewing material and practicing questions. Focus on active recall and application, not just passively reading.

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Official Resources and References

• AICPA Uniform CPA Examination Homepage
• NASBA CPA Exam Candidate Handbook
• U.S. Courts Bankruptcy Basics
• U.S. Code, Title 11 - Bankruptcy

Official resources and references

• AICPA — Uniform CPA Examination
• NASBA — CPA Exam
• U.S. Bureau of Labor Statistics — Occupational Outlook