Suppose a Luca's Garden 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 $0.54 of ingredients, $0.20 of variable overhead (electricity to run the oven), and $0.71 of direct labor for kneading and forming the loaves.
Allocating fixed overhead (depreciation on the kitchen equipment and building) based on direct labor assigns $1.04 of fixed overhead per loaf. None of the fixed costs are avoidable. The local bakery would charge Luca's Garden $1.72 per loaf.
1. What is the absorption cost of making a loaf of bread in-house? What is the variable cost per loaf?
2. Should Luca's Garden bake the bread in-house or buy from the local bakery? Why?
3. In addition to the financial analysis, what else should Luca's Garden consider when making this decision?