Suppose Sally’s Restaurant is considering whether to bake bread for its restaurant in-house or buy the bread from a local bakery. The chef estimates that variable costs of making each loaf include $0.50 of ingredients, $0.25 of variable overhead (electricity to run the oven), and $0.75 of direct labour for kneading and forming the loaves. Allocating fixed overhead (depreciation on the kitchen equipment and building) based on direct labour assigns $1.00 of fixed overhead per loaf. None of the fixed costs are avoidable. The local bakery would charge Sally’s $1.75 per loaf.
1. What is the unit cost of making the bread in-house (use absorption costing)?
2. Should Sally’s bake the bread in-house or buy from the local bakery? Why?
3. In addition to the financial analysis, what else should Sally’s consider when making this decision?