You are the owner of a bakery that makes a complete line of specialty of breads, pastries, cakes and pies for the retail and wholesale markets. A summer intern has just completed an activity-based costing study that concluded, among other things, that one of your largest recurring jobs is losing money. A local luxury hotel orders the same assortment of desserts every week for its Sunday brunch buffet for a fixed price of $975 per week. The hotel is quite happy with the quality of the desserts the bakery has been providing, but it would seek bids from other local bakeries if the price were increased.
The activity-based costing study conducted by the intern revealed that the cost to the bakery of providing these desserts is $1,034 per week, resulting in an apparent loss of $59 per week or over $3,000 per year, Scrutinizing the intern’s report, you find that the weekly cost of $1,034 includes facility-level costs of $329. These facility-level costs include portions of the rent on the bakery’s building, your salary, depreciation on the office personal computer, and so on. The facility-level costs were arbitrarily allocated to the Sunday brunch job on the basis of direct of labor-hours.
Should you demand an increase in price from the luxury hotel for the Sunday brunch desserts to at least $1,034? If an increase is not forthcoming, should you withdraw from the agreement and discontinue providing the desserts? Explain.