Question

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?

Answer 1

The unit cost for the Roasted Olive to bake bread in-house is $2.42 per loaf after considering ingredients, variable overhead, direct labor, and fixed overhead costs. The local bakery charges $1.75 per loaf. Thus, it is more cost-effective for Roasted Olive to buy the bread from the local bakery.

Step-by-step explanation:

To determine whether the Roasted Olive should bake bread in-house or buy from a local bakery, we need to calculate the unit cost of making the bread in-house using absorption costing and compare it to the quoted price from the local bakery.

A. Unit Cost Calculation (Absorption Costing)

Using absorption costing, the unit cost of making bread in-house is calculated by adding the variable costs which include ingredients ($0.52), variable overhead ($0.24), and direct labor ($0.70), as well as the allocated fixed overhead ($0.96). The sum gives us:

• Ingredients: $0.52
• Variable Overhead: $0.24
• Direct Labor: $0.70
• Fixed Overhead Allocation: $0.96

Total unit cost = $0.52 + $0.24 + $0.70 + $0.96 = $2.42 per loaf.

B. Make or Buy Decision

Given that the local bakery charges $1.75 per loaf and the in-house cost of production is $2.42 per loaf, it is more cost-effective for the Roasted Olive to buy the bread from the local bakery instead of baking it in-house as long as the quality and delivery terms meet the restaurant's requirements.

Answer 2

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.

Step-by-step 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.