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 over¬ head (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?