Suppose a Roasted Olive restaurant is considering whether to (1) bake bread for its restaurant in-house or (2) buy the bread from a local bakery. The chef estimates that variable costs of making each loaf include $.52 of ingredients, $.24 of variable overhead (electricity to run the oven), and $.70 of direct labor for kneading and forming the loaves. Allocating fixed overhead (depreciation on the kitchen equipment and building) based on direct labor assigns $.96 of fixed overhead per loaf. None of the fixed costs are avoidable. The local bakery would charge $1.75 per loaf. a. What is the unit cost of making the bread in-house (use absorption costing)?
b. Should Roasted Olive bake the bread in-house or buy from the local bakery? Why?

Roasted Olive should  bake the bread in-house.

Because, It is cheaper to bake the bread in-house than to purchase as this saves $0.29 per loaf of bread.

Explanation:

Cost of Making

Unit Cost (Absorption Costing) = All Manufacturing Cost (Fixed and Variable)

                                                   = $0.52 + $0.24 + $0.70 + $0.96

                                                   = $2.42

Cost of Buying from Local Bakery

Note that the fixed costs are note avoidable, meaning that they would be incurred whether or not the bread is made internally or purchased from local Bakery

Cost of Purchase Option per unit :

Purchase Price                             $1.75

Add Fixed Overhead per loaf    $0.96

Total unit cost                              $2.71

Conclusion :

It is cheaper to bake the bread in-house than to purchase as this saves ( $2.71 - $2.42) $0.29 per loaf of bread.

Therefore, Roasted Olive should  bake the bread in-house.

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