The intrinsic value method is a specific accounting method that relates to the valuation of assets owned and used by a company. Generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS) usually require companies to use the historical cost principles for assets. A problem with this method is that the historical cost paid for assets does not necessarily mean the assets are still worth this amount of money. The intrinsic value method allows a company to value its assets by using the current market value of the items under current economic conditions. In a free market, this valuation method allows a company to value items using both tangible and intangible value.
Companies use historical cost for assets as this information is readily available and usually accurate, at least when the company purchases the asset. As time goes by, however, the information that relates to the purchase price of the asset becomes less relevant. Due to this scenario, both GAAP and IFRS may allow a company to revalue certain assets on its books in order to reflect current market values. This intrinsic value method may work best for securities and other investments that have values that can change drastically over time. Additionally, investments tend to have more intrinsic value placed on them by outside parties in an open market.
In a free market system, companies are able to sell goods for more than the item costs due to the value placed on goods by consumers. The additional price paid above an item’s cost represents the intangible value of the item in the transaction. Additionally, this is why a company may need to use the intrinsic value method when recording assets in its accounting books. In a free market, the cost for assets can change due to inflation and the value placed on highly demanded goods. Companies that have already purchased assets at lower costs may then be underreporting the value of their overall assets and business operations.
Not all assets in a company’s operations may be able to fall under the intrinsic value method. When this occurs, a company may be required to use the historical cost principles for valuing assets. Or, a company needs to make a close estimate on the current value of the assets that do not have open market values. Companies must be very careful when making these estimates so they do not overstate an asset’s value. Other specific rules may apply to assets without current market values.