Variance Analysis

Prerequisites

Prior to reading the instructions on variance analysis, it is beneficial to review the below sections to gain foundational information:

  1. Accounting Fundamentals
  2. Chart of Accounts & General Ledger
  3. Financial Statements

Preface

This section discusses what a variance analysis is and how it is used internally at Indiana University. Information presented below will walk through a general understanding of how to use IU’s financial reports to pull a variance analysis along with why a variance analysis is important and how it is conducted throughout the University. Additionally, this section will help users and entities throughout the entire University analyze variances correctly to ensure that management can understand why variances are present within IU’s financial statements.

Introduction

In accounting, a variance is a difference between a budgeted, planned, or standard cost and the actual amounts on the financial statements. While there are multiple types of variances, at Indiana University the most common variances include prior year to current year balances or budgeted to actual amounts. At Indiana University, variance analysis most commonly compares fiscal periods, typically analyzing prior year to current year balances which can help identify various trends. In addition, financial statement users compare current year actuals to budgets amounts. This comparison is a requirement of both the Office of the University Controller (UCO) and University Budget Office (UBO). This analysis is used to identify any large differences in an entity’s actual and budgeted financial activity so issues can be resolved and improved. The more detailed the analysis, the better management can understand why different fluctuations occur within the entity.

The quarterly variance analysis is a tool that is used to explain significant variances in the financial statements of each organization. Performing a variance analysis internally at the account or organization level also helps identify errors and explains any variances that impact IU’s consolidated financial statements and the university budget. Variances that are found within the financial statements must then be investigated by the RC or fiscal officer to get a better understanding of why the variance occurred and if steps need to be put in place to remedy the variance moving forward.

Importance and Impact of Variance Analysis

Variance analysis is an important tool for management and for external audit. By completing the variance analysis by entity, documentation to support some of IU’s largest fluxes are easily accessible and can be provide to auditors upon request.

Variance analysis is used to identify and explain overarching trends on the financial statements which in turn helps identify accounting errors. Determining trends within the financial statements allows campus leaders to provide comprehensive financial information to the VPCFO. This information is used to create consolidated financial statements that helps IU executive leadership make decisions for the future of the university. This allows campus leaders to provide comprehensive financial statements for the unit to VPCFO to create accurate and detailed consolidated financial statements. Additionally, variance analysis of budgeted to actual amounts, helps units to determine areas in which they have over/underspent. This helps management determine how funds should be allocated in the future.

How to Perform a Variance Analysis

Quarterly Variance Analysis Timeline

The Quarterly Variance Analysis is completed by every IU entity. This analysis is performed the month following the end of each fiscal quarter. In order to identify errors and appropriately account for budgeted variances, analysis should be completed prior to period close. Refer to the closing calendar for detailed dates. Any material variances along with specifically required variances by the applicable RC’s should be available upon request on the 10th of every month as part of the monthly closing procedures.

Running the Appropriate Reports

After pulling the income statement and balance sheet, refer to the following list when performing a variance analysis.

  1. A variance analysis should be completed on all three of an entities’ financial statements. However, users should compare each individual financial statement based on the criteria below:

    • Balance Sheet – Analyze variances between prior year and current year financials.
    • Income Statement – Analyze variances between prior year and current year as well as budgeted vs actual financials.
    • Cash Flow Statement – Analyze variances between prior year and current year financials. While the comparative year Cash Flow Statement is not currently available, comparing multiple years of information should be considered a best practice and review information at the highest level – changes in cash flow from operations, investments and financing.  
  2. Variances should be analyzed at different levels for varying financial statements. There are three reporting levels within IU’s financial system consisting of object code, level, and consolidation. While the primary focus is on the level code, units may choose to complete a variance analysis at any or all three levels. Refer to the requirements and best practices section for further detail on IU specific requirements. Variances should be analyzed at different levels for varying financial statements.

  3. Instructions on how to pull the three reports can be found in the Financial Statement Report Instructions.

How to Use the Reports and Complete Variance Analysis

Variances are automatically identified within the financial statement report based on specified thresholds and are highlighted for the user to identify. Specified thresholds are as follows:

Balance Sheet (Excluding Fund Balance) – Balances that have not changed since the prior year or are negative, with the exception of the below object codes:

Object Code Names Object Code Numbers
Accumulated Depreciation 8901, 8904, 8905 & 8910
Allowance for Uncollectable 8900
Allowance for Doubtful Accounts 8950
Allowance for Inventory Shrinkage 8955
Capital Assets Multiple Accounts from 8601 - 8665
Cash Revolving Funds 8001

RC and campuses may require more detailed analysis – refer to your local campus or unit fiscal officer for further detail. The minimum university threshold for all balance sheet amounts is any variance greater than $1,000,000 and a minimum 10% change or fluctuation greater than $250,000 in the object code balance.

Income Statement – Object Level variances to budget and/or prior year greater than or equal to the materiality for the organization will require detailed explanations. Materiality thresholds will automatically calculate and appear at the bottom of the Income Statement if the users selects the “display materiality” parameter. The Income Statement calculates materiality by taking actual year-to-date Total Revenue and multiplying it by 10%. The minimum university threshold for all income statement analysis is any variance greater than $1,000,000 and a minimum 10% change or fluctuation greater than $250,000 in the object code balance.

Appropriate Variance Explanations

The variance explanations should be as detailed as possible. Suitable explanations will provide details of WHY the variance occurred.

  • If the variance is mainly related to a specific transaction(s), indicate the relevant amount(s), and other details specific to the transaction.
  • If the variance is related to a change in business conditions/operations, then please note the change and if possible quantify the effect.
  • If the variance was due to an accounting error, please provide detail for the related transaction(s) and KFS documents that explain why the variance occurred. Provide documentation that focuses on the cause of the variance, not just ending balances or general ledger transactions.

Examples of Appropriate Variance Analysis Explanations

As a general note, explanations provided should explain a majority (in this case, at minimum 2/3) of the total variance. Multiple explanations may be needed to fully explain the cause of a variance. This section will present several good examples of variances on the balance sheet and income statement with explanations and the documents provided to explain the variance. For specific information regarding appropriate documentation for substantiation of variances refer to the Balance Sheet or Income Statement Substantiation sections.

Accounts Receivable

Actual Prior Year Variance
$400,000 $325,000 ($75,000)

Explanation: In the fiscal year, we began doing business with ABC Company. On 06/30, this company had a $63,500 invoice #124562 outstanding.

Documentation Provided: Invoice dated 5/21 directed to ABC Company for consulting work provided by IU totaling $63,500 and payable by 7/15. In addition, an email is included noting that the invoice had been received by ABC company who plans to make full payment on 7/2.

Accounts Payable

Actual Prior Year Variance
$250,000 $500,000 ($250,000)

Explanation – We purchased a $200,000 fax machine in May 20XX, the invoice for which was not paid until 20X1.

Documentation Provided: Purchase order from BUY.IU for a new fax machine purchased through Brothers USA totaling $200,000 which was approved by the department head and IU’s purchasing department.

NB* Variance analysis explanations are expected to explain at least 1/3 of the total variance

Tuition and Fees

Actual Prior Year Variance
$15,000,000 $20,000,000 ($5,000,000)

Explanation: IU experienced a 25% decrease in enrolled students in comparison to prior year due to an economic recession.

Documentation Provided: Student roster for current and prior year and bursar documents showing tuition revenue in both years.

Sales and Services

Actual Prior Year Variance
$50,000 $40,000 $10,000

Explanation: 10% increase in occupancy across campus in room & board. Therefore, dorm room rate * 10% = $XXX.

Documentation Provided: A detailed bursar bill sent to students in addition to a document or screenshot showing the published occupancy rates and student roster showing total headcount for students that purchased on campus housing.

Supplies and Expense

Actual Prior Year Variance
$2,500,000 $3,000,000 ($500,000)

Explanation: A grant used for the purchase of supplies ended in FY20X1. As the grant was nearing its end, spending was reduced to the remaining amounts ($500,000) to avoid overspending.

Documentation Provided: A copy of the grant showing the start and end dates along with the total cost-reimbursable amount awarded. In addition, the financial statements for the prior year showing the ending balance on the grant and calculation of remaining grant amount for 20X1.


Examples of Inappropriate Variance Explanations

Inappropriate and/or incomplete examples of explanations to support variances on the financial statements include:

Sales Revenue:

Actual Prior Year Variance
$1,500,000 $1,000,000 $500,000

Explanation: In the fiscal year, sales decreased by 33%.

Why the response isn’t sufficient: It doesn’t explain WHY sales went down. By including additional information like which line of sales revenue decreased and explain what caused the decrease will strengthen this explanation.

Appropriate Explanation: In the current fiscal year, the sale of IU merchandise such as T-shirts and banners decreased by roughly $450,000 due to a limit on production of these items as a result of factories closing for a majority of the fiscal year.

Tuition Revenue:

Actual Prior Year Variance ($)
$11,000,000 $10,000,000 $1,000,000

Explanation: $11,000 x 1,000 = 11,000,000.

Why the response isn’t sufficient: This explanation doesn’t provide any context. Typically, math alone as an explanation is not sufficient.

Appropriate Explanation: Tuition revenue increased by $1,000,000 from prior year due to the annual tuition increase of $1,000 per student. Student enrollment stayed constant from prior year at 1,000 students.

In conjunction with the balance sheet and income statement substantiation, users should provide physical support (i.e. copies of invoices, inventory counts, spreadsheets and contracts) to corroborate an explanation. Examples of inappropriate documents to provide as explanations include the following, but not this list is not exhaustive.

KFS General Ledger Entry or Balance screenshots Any documents that do not apply to the balance being explained
Post-it Notes/scrap paper notes Controller Toolkit Reports
IUIE Reports Repetitive documents (i.e. excel documents with calculation for the ending balance)

Requirements & Best Practices

This section outlines general requirements and best practices related to performing a variance analysis. Following the requirements and best practices outlined below will allow users to gain a better understanding of their entity’s financial health and help identify errors, mistakes, and pitfalls before they create larger issues.

Requirements

  1. Complete a variance analysis for all operating accounts on a quarterly basis for the income statement and balance sheet prior to closing date.
  2. Run the three Financial Statements (income statement, balance sheet and cash flow statement) and perform a variance analysis review quarterly. Please refer to the Financial Statement Report Instructions for more information on how to pull these financial reports.
  3. Provide detailed explanations of variances, detailing WHY the variance occurred. An internal investigation will allow the entity to better explain why the variance occurred and if any additional steps should be taken to avoid future variances. The Accounting and Reporting team can be consulted if needed at uars@iu.edu.
  4. Ensure documentation/substantiation is available upon request for variances.
  5. Ensure any identified errors have been corrected prior to closing.

Best Practices

  1. Complete a variance analysis for all operating accounts on a quarterly basis for the Statement of Cash Flows prior to closing date. The Statement of Cash Flows reports individual transactions, making the object code level the best option for variance analysis.
  2. The RC fiscal officer is responsible for reviewing and analyzing the documentation and working papers of the RC/organization. Analyzing the quarterly variance analysis allows the fiscal officer to determine if the there are problems with the entity’s financial reports or if entity operations need to be improved. The questions that need to be asked will vary depending on the needs; however, the following questions are some common examples:
    • Were there unusually or a-typical transfers during the period being analyzed? In some instances, transfers may have been booked in error to wrong object codes or in the incorrect period.
    • Is the unit meeting budgeted targets? By knowing if the unit is meeting budgeted targets, explanations may be easier for variance analysis.
    • Has the unit searched for transactions that were erroneously recorded to the wrong accounts, object codes, org codes, etc? By ensuring financial transactions are being properly recorded, it eliminates potential variances and better aligns to budgeted amounts for the period. It also ensures proper recording of financial transactions at the unit and consolidation levels.
    • Has the unit performed any sort of trend analysis or forecasting for the fiscal period? Performing trend analysis or forecasting can help units identify areas expected to be higher or lower than budgeted and/or prior year balances. It allows units to better track transactions and explain current and future variances.
    • Has the unit considered using lower materiality levels to ensure accuracy based on their fiscal transactions? While UCO has specified a minimum materiality level to conduct variance analysis, a unit may require a lower materiality based on its overall transactions (i.e. a unit’s total revenue may be below the UCO threshold). The unit has the best understanding of the volume and amounts of transactions and proper review ensures correct recording all the way through consolidation.
  3. Complete a high level variance analysis at the object level on all reports on a monthly basis.
  4. Follow up internally (employees/students) and externally (vendors/contractors) for any unexplained variances.