Chapter 11, Problem 26P

a

To determine

Prepare income statement of University O and University D.

Explanation of Solution

Income statement:

Income statement is the financial statement of a company which shows all the revenues earned and expenses incurred by the company over a period of time.

Given information:

University O pays the instructor $4,600 per course and $230 per student for each enrolment in the class by University D. Both the universities charges $400 as tuition fee per course attended.

The formula to calculate the net income:

$\text{Net income}=\text{Revenue}-\text{Cost}$

Prepare income statement of University K and University D:

Note: Assume that 20 students attend the courses

The cost of University K is fixed at $4,600 and University D is variable at $\left(20\times \$250=\$5,000\right)$

University	O		D
Tuition revenue $\left(20\text{students}\times \$400\text{per}\text{student}\right)$	$ 8,000		$ 8,000
Total cost of instruction	($ 4,600)	$\left(20\times \$230\right)$	($ 4,600)
Net income	$ 3,400		$ 3,400

Table (1)

b

To determine

Prepare  an  income  statement  for  University O,  assuming  that  the  university  is  successful and enrols 40 students in its course.

Explanation of Solution

Given information:

The tuition fee is reduced to $220 by University O and enrolled 40 students to the course.

Prepare income statement of University O:

University	O
Tuition revenue $\left(40\times \$220\right)$	$8,800
Total cost of instruction (fixed)	($4,600)
Net income	$4,200

Table (2)

c

To determine

Prepare  an  income  statement  for  University D,  assuming  that  the  university  is  successful and enrols 40 students in its course.

Explanation of Solution

Given information:

The tuition fee is reduced to $220 by University D and enrolled 40 students to the course.

University		D
Tuition revenue	$\left(40\times \$220\right)$	$ 8,800
Total cost of instruction (variable)	$\left(40\times \$230\right)$	($ 9,200)
Net income (loss)		($ 400)

Table (3)

d

To determine

Explain the reason for profit in part b) and loss in part c)

Explanation of Solution

Fixed cost remains constant when volume of activity changes but per unit value will change inversely with change in volume of the activity.

Variable cost will change proportionately or directly with the change in the volume of the activity on the other hand per unit value will remain constant irrespective of the change in volume of activity.

The cost of University O is fixed. So, rise in the number of students did not raise the total cost of instruction.

On the other hand, the University D cost is variable as when the number of students increase will lead to increase in total cost of instruction. Thus, the revenue in University D is insufficient to cover the increase in cost and leads to the loss.

e

To determine

Prepare income statement of University O and University D.

Explanation of Solution

Given information:

Prepare income statement of University O and University D:

10 Students attend the course on original fee $450.

University	O		D
Tuition revenue $\left(10\times \$400\right)$	4,000		4,000
Total cost of instruction	(4,600)	$\left(10\times \$230\right)$	(2,300)
Net income (loss)	(600)		1,700

Table (4)

The cost of University O is fixed at $4,600 and University D is variable at $\left(10\times \$230=\$2,300\right)$

f

To determine

Justify the given statement is false

Explanation of Solution

Given statement:

It is better to have a fixed cost rather than the variable cost.

Justification:

Fixed is not better always than the variable cost because the loss of the company can be avoided if cost is variable. That is if the volume is not sufficient to produce the revenue the company will incur loss like part e), simply above the fixed cost level.

Thus, it is not better to have a fixed cost rather than the variable cost.

g

To determine

Justify the given statement is false

Explanation of Solution

Given statement:

It is better to have a variable cost rather than the fixed cost.

Justification:

When revenue per unit of the company is less than the variable cost per unit of the company, the enterprises will produce extra loss of each unit sold or produced. This is illustrated in Part c). In part b) the lower per unit revenue will be compensated by the increase in sales volume if the cost is fixed.

Thus, it is not better to have a variable cost rather than the fixed cost.