Classify cost according to its nature.

On the basis of nature, costs are classified into two broad categories — Direct Cost and Indirect Cost.

1. Direct Cost — These are those costs which can be easily, directly and wholly related to a particular cost unit or cost centre. Direct costs are also called the prime cost when totalled. They consist of three components:

• Direct Material — All materials which become an integral part of the finished product and can be easily measured and directly charged. Example: cloth used in dress making.
• Direct Labour — Wages of labour which can be wholly and directly identified with a particular product. Example: wages paid to a machine operator or carpenter.
• Direct Expenses — Expenses which can be wholly and directly identified with a particular product. Example: hire charges of a machine used for a specific job.

2. Indirect Cost — These are those costs which cannot be identified easily, directly and wholly with a particular cost unit or cost centre. They are also known as overheads or common costs. They consist of three components:

• Indirect Material — Materials that cannot be directly assigned to a specific product. Example: oil, grease, consumable stores.
• Indirect Labour — Labour that cannot be wholly identified with a particular product. Example: wages of storekeeper, foreman, timekeeper.
• Indirect Expenses — Expenses that cannot be directly identified with a specific product. Example: factory rent, office rent, advertising.