Outsourcing production decision (Learning Objectives 1, 6)}

Suppose an Olive 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 \(\$ 0.50\) of ingredients, \(\$ 0.25\) of variable overhead (electricity to run the oven), and \(\$ 0.75\) of direct labor for kneading and forming the loaves. Allocating fixed overhead (depreciation on the kitchen equipment and building) based on direct labor assigns \(\$ 1.00\) of fixed overhead per loaf. None of the fixed costs are avoidable. The local bakery would charge Olive Garden \(\$ 1.75\) per loaf.

1. What is the unit cost of making the bread in-house (use absorption costing)?

2. Should Olive Garden bake the bread in-house or buy from the local bakery? Why?

3. In addition to the financial analysis, what else should Olive Garden consider when making this decision?