# Classification of Cost by Nature (Element)
Every rupee a business spends can be traced to one of three elements. This classification is the foundation of the cost sheet.
## The Three Elements
```
COST
┌───────────┼───────────┐
MATERIAL EMPLOYEE EXPENSES
(Direct + (Direct + (Direct +
Indirect) Indirect) Indirect)
```
### Direct vs Indirect — the key test
- Direct = can be conveniently identified with and allocated to a specific cost object (job, product, batch).
- Indirect = cannot be conveniently traced to a single cost object; benefits multiple cost objects.
| Element | Direct example | Indirect example |
|---|---|---|
| Material | Wood used in a table | Glue, polish, lubricants |
| Employee | Wages of a machine operator | Salary of factory supervisor |
| Expense | Royalty paid per unit produced | Factory rent, electricity |
## The Concept of Overheads
All indirect material + indirect labour + indirect expenses are collectively called OVERHEADS.
```
OVERHEADS
┌──────────────┼──────────────┐
Production Administration Selling &
/ Factory Overhead Distribution
Overhead Overhead
```
### Sub-categories explained
- Production / Factory OH — incurred inside the factory (factory rent, supervisor salary, depreciation of plant).
- Administration OH — office-related (office rent, audit fee, directors' fee).
- Selling OH — promoting & securing sales (advertising, salesmen salary).
- Distribution OH — delivering goods to customers (warehouse, delivery van expenses).
> Tip: Whenever a question gives you a long list of expenses, first ask: Direct or Indirect? If indirect, then ask: Factory, Admin, Selling or Distribution? This two-step funnel will route every cost correctly.
## Quick Self-Check
- Salary of factory manager → Indirect Labour → Factory OH
- Carriage outward → Indirect Expense → Distribution OH
- Cost of raw cotton in a shirt → Direct Material
- Wages of tailor stitching the shirt → Direct Labour