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3.3 Define and Describe the Initial Steps in the Accounting Cycle

The Accounting Cycle Overview​

The accounting cycle is the process of recording, classifying, and summarizing business transactions to produce financial statements. In Luxembourg, this cycle must follow PCN standards and legal requirements.

The complete accounting cycle includes:

  1. Identify transactions
  2. Record transactions in journal
  3. Post to ledger accounts
  4. Prepare trial balance
  5. Make adjusting entries
  6. Prepare adjusted trial balance
  7. Prepare financial statements
  8. Close temporary accounts
  9. Prepare post-closing trial balance

In this chapter, we focus on steps 1-4. Steps 5-9 are covered in Chapters 4 and 5.

Step 1: Identify Transactions​

Purpose: Determine which economic events should be recorded in the accounting system.

Criteria for Recording:

  • Must be a business transaction (affects the business entity)
  • Must be measurable in monetary terms (euros)
  • Must affect assets, liabilities, or equity

Examples of Transactions to Record:

  • Sales to customers
  • Purchases from suppliers
  • Payment of expenses
  • Receipt of cash
  • Borrowing money
  • Owner investments

Examples of Events NOT Recorded:

  • Hiring an employee (no monetary transaction yet)
  • Receiving a quote (no commitment yet)
  • Market value changes (until realized)

Luxembourg Requirement: All business transactions must be supported by source documents (invoices, receipts, bank statements) and retained for 10 years.

Step 2: Analyze Transactions​

Purpose: Determine which accounts are affected and how (debit or credit).

Process:

  1. Identify accounts affected
  2. Determine account type (asset, liability, equity, revenue, expense)
  3. Determine if account increases or decreases
  4. Apply debit/credit rules
  5. Verify equation balances

Example Analysis:

Transaction: Restaurant sells €500 of food for cash.

Analysis:

  1. Accounts affected: Cash, Sales Revenue
  2. Cash = Asset (increases = debit)
  3. Sales Revenue = Revenue (increases = credit)
  4. Debit Cash €500, Credit Sales Revenue €500
  5. Equation: Assets increase, Equity (via revenue) increases ✓

PCN Accounts:

  • Debit: 510000 Cash (Class 5)
  • Credit: 701000 Sales Revenue (Class 7)

Step 3: Record Transactions in Journal​

Purpose: Record transactions chronologically in a journal (book of original entry).

Journal Format:

  • Date
  • Account names and numbers
  • Debit amounts
  • Credit amounts
  • Description/explanation

Example Journal Entry:

Date: 2024-11-19

Account                          Debit      Credit
─────────────────────────────────────────────────
510000 Cash                       €500
701000 Sales Revenue                         €500
To record cash sale of food

Luxembourg Practice: Journal entries should include PCN account numbers for proper classification and compliance.

Step 4: Post to Ledger Accounts​

Purpose: Transfer journal entries to individual ledger accounts (book of final entry).

Ledger Account Format (T-Account):

Account Name (Account Number)
─────────────────────────────
        Debit        Credit
─────────────────────────────

Posting Process:

  1. Find the account in the ledger
  2. Enter the date
  3. Enter the amount on the appropriate side (debit or credit)
  4. Enter the reference (journal page number)
  5. Calculate new balance

Example Posting:

Journal Entry:

510000 Cash                €500
701000 Sales Revenue                €500

Posted to Ledger:

Cash (510000)
─────────────────────────────
Nov 19  J1    €500    │
─────────────────────────────
Balance  €500
Sales Revenue (701000)
─────────────────────────────
        │  Nov 19  J1    €500
─────────────────────────────
        │  Balance  €500

Luxembourg Compliance Note​

In Luxembourg, businesses must maintain:

  • Journal (Journal): Chronological record of all transactions
  • General Ledger (Grand Livre): All accounts with their balances
  • Subsidiary Ledgers (Sous-Livres): Detailed accounts (e.g., individual customer accounts)

All must follow PCN classifications and be maintained for 10 years.

Think It Through​

Why is it important to record transactions in a journal before posting to ledger accounts? What would happen if transactions were posted directly to the ledger without journal entries?