David KrauseAt first glance it is about equity valuation. But the core is exactly the question Chapter 6 turns on: the book value of an asset says little about its economic value. For intangibles the balance sheet understates — internally created brands and patents don't appear at all. For machines it understates too, just the other way round: a written-off but fully productive asset sits at a token value or zero in the books, while its replacement value is a multiple of that. Both times book value is the wrong yardstick — and both times the solution is the same: work with the economic value, not the balance-sheet one.
The problem with book value
Fundamental analysis uses the price-to-book ratio (P/B) as one of the most common price multiples: share price divided by book value per share. In theory book value equals the liquidation value — what creditors can expect. Buying companies with a low P/B was historically profitable as long as company value consisted mainly of assets, inventory and financial holdings — values that are easy to appraise and liquidate.
With the rise of software and internet companies the picture shifted. Patents, licenses, brands and human capital now make up a large part of value — but are hard to appraise and even harder to liquidate. Human capital, the economic value of employee skills, can walk out the door any day.
Three categories: rights, relationships, intellectual property
Intangible assets fall into three groups: rights (licenses, certifications, lease, employment and supply contracts, franchise), relationships (qualified employees, customer base, distribution relationships) and intellectual property (patents, copyrights, trademarks, proprietary technologies, know-how).
Decisive in accounting terms: internally generated intangible assets may not be capitalized, even though they often represent significant value. Under IFRS 3, only acquired intangibles appear separately in the acquirer's consolidated balance sheet — so the value only becomes visible once a transaction has evidenced it.
Accounting capitalizes intangibles only after a value-evidencing transaction. That very prudence logic sits behind the balance-sheet depreciation of machines too: it depreciates from the evidenced historical acquisition cost, not from today's value. For external reporting that is right. For costing it is wrong — for the same reason the P/B ratio fails for software firms: the evidenced past value is not the economic present value.
The historical finding: from 17 % to 84 %
How much the weight has shifted is shown by the long-term analysis by Aon and the Ponemon Institute for the S&P 500 companies: in 1975 intangibles made up 17 % of total value — in 2018 it was 84 %, around $21 trillion in total.
In 1975 IBM, Exxon Mobil, Procter & Gamble, GE and 3M dominated — companies with hard assets. In 2018 Apple, Alphabet, Microsoft, Amazon and Facebook led — companies whose value consists mostly of software, brands, network effects and data. The trend has continued since 2018: today's trillion-dollar corporations — reinforced by the AI boom of the 2020s — consist in balance-sheet terms of an even larger share of values that appear in no balance sheet.
The calculation bridge: replacement value closes exactly this gap
What equity analysis laboriously reconstructs from intangible drivers, cost accounting solves for fixed assets with a simple, cleanly defined tool: the replacement value, derived via the producer price index for machinery. It translates the evidenced past price into today's economic value.
Source: Destatis GENESIS 61241, producer price index GP09-284 (metalworking machinery)
| Quantity | Derivation | Value |
|---|---|---|
| Acquisition cost 2018 | invoice / purchase contract | €520,000 |
| Book residual value 2026 | after 8 yrs straight-line book depreciation | ~€148,600 |
| Price index 2018 → 2026 | 116.4 → 149.8 | × 1.287 |
| Replacement value 2026 | 520,000 × 1.287 | €669,000 |
| Gap book value → replacement value | 669,000 − 148,600 | +€520,400 |
The residual book value (€148,600) quantifies what the machine is still "worth" for tax purposes — the replacement value (€669,000) what it is worth economically. Whoever charges imputed depreciation on book value instead of replacement value understates it by 28.7 % in the example (Chapter 6, error #02) — the same understatement the P/B ratio produces for intangible-driven companies, only with the opposite sign. The method is the answer to both: compute with the economic value, and evidence it traceably.
What this means for valuation and costing practice
Book value loses significance as a sole yardstick — in equity analysis as in cost accounting. An "expensive" P/B of 8 can be more appropriate for a scalable software company than a P/B of 1.2 for a machine builder with an aging asset base. The consequence is not to ignore book value but to supplement it with the economic value: for companies with an explicit analysis of the intangible drivers, for machines with the replacement value. Both times the same discipline applies — evidence traceably, don't estimate.
Manufacturing companies rarely carry intangibles in the billions — but the reasoning transfers directly: your own machine park is almost always undervalued on the balance sheet, and the process know-how and certifications (ISO 9001, IATF 16949, NADCAP) don't appear at all. For costing, the economic value counts: imputed depreciation on the replacement value (Chapter 6), clean separation of imputed costs (Chapter 4). Whoever costs only the book value gives away substance on every written-off machine — as invisibly as the market overlooks intangible value.
Sources: Aon / Ponemon Institute (Intangible Asset Financial Statement Impact Comparison); Brand Finance Global Intangible Finance Tracker (GIFT) 2019; Statistisches Bundesamt (Destatis, GENESIS table 61241, producer price index GP09-284). The example calculation uses the book's reference company (5-axis machining center, acquisition cost €520,000, replacement value €669,000).
