Fair Value Disclosures and Reconciliation: Framework, Requirements, and Practical Example

In modern financial reporting, fair value measurement is not only about determining a price — it is also about transparently communicating how that price was determined, and how it changed over time.

For many financial and non-financial instruments, especially those falling under Level 3 of the fair value hierarchy, accounting standards require companies to provide detailed disclosures, including a reconciliation of opening and closing balances.

These disclosures help users of financial statements understand the risk, judgment, and valuation methodology involved in fair value estimates, and improve the comparability and reliability of financial reporting.

This article explores the key disclosure requirements under IFRS 13 and ASC 820, and provides a step-by-step numerical example of how to prepare a Level 3 fair value reconciliation.

1. Disclosure Objective and Scope

Under both IFRS 13 – Fair Value Measurement and ASC 820 – Fair Value Measurement, entities are required to disclose information that helps financial statement users assess:

• The valuation techniques and inputs used

• The fair value hierarchy level (Level 1, 2, or 3)

• The sensitivity of fair value to unobservable inputs (for Level 3)

• The reconciliation of changes in Level 3 fair value balances during the reporting period

These requirements apply to all items measured at fair value, whether they appear on the balance sheet or are subject to fair value disclosure only.

2. Fair Value Hierarchy Refresher

The fair value hierarchy ranks inputs based on their observability:

• Level 1: Quoted prices in active markets for identical assets/liabilities

• Level 2: Observable inputs for similar items, or prices in inactive markets

• Level 3: Unobservable inputs based on management’s own assumptions

Level 3 disclosures are the most extensive, due to the high degree of subjectivity and estimation involved.

3. Required Disclosures for Level 3 Instruments

Entities must provide:

• A reconciliation of the opening and closing balances, showing each of the following components separately:

  • Total gains/losses recognized in profit or loss

  • Total gains/losses recognized in other comprehensive income

  • Purchases, sales, issuances, and settlements

  • Transfers into or out of Level 3

• The amount of total gains or losses included in profit or loss that is attributable to unrealized gains or losses at the reporting date

• A description of the valuation techniques and inputs used

• A sensitivity analysis (IFRS only), showing how changes in significant unobservable inputs would affect the valuation

4. Step-by-Step Numerical Example: Level 3 Fair Value Reconciliation

Let’s assume a company holds a Level 3 financial asset: a private equity investment measured at fair value.

Opening Balance (January 1, 2024):

• Fair value = $1,200,000

Changes During the Year:

• Unrealized gain recognized in profit or loss: +$150,000

• Purchase of additional shares: +$300,000

• Disposal of a portion of the investment: –$200,000

• Settlement of part of the asset (e.g., partial exit): –$100,000

• Transfer into Level 3 due to change in market activity: +$250,000

Closing Balance (December 31, 2024):

• Fair value = $1,600,000

Reconciliation Presentation (Narrative)

At the beginning of the year, the carrying amount of the Level 3 private equity investment was $1.2 million. During the year, the company:

• Recognized an unrealized gain of $150,000 in profit or loss, based on updated valuations from a third-party appraisal;

• Purchased additional ownership interests totaling $300,000;

• Disposed of a portion of the investment for $200,000, resulting in a realized gain included in profit;

• Settled part of the investment for $100,000;

• Reclassified another investment from Level 2 to Level 3, due to reduced observability of inputs — with a carrying amount of $250,000.

As a result, the closing fair value of the Level 3 investment increased to $1.6 million as of December 31, 2024.

5. Disclosure Sample (IFRS-Compliant Narrative)

The Group holds a private equity investment classified as Level 3 under the fair value hierarchy. The fair value of this investment as of December 31, 2024, was $1.6 million (2023: $1.2 million). During the year, the Group recognized a $150,000 unrealized gain in profit or loss, reflecting updated internal valuations and input from external valuation experts. The Group also purchased additional units for $300,000 and disposed of part of its holdings for $200,000. A settlement of $100,000 was received, and an additional instrument was transferred into Level 3 from Level 2 due to a decline in market activity and the lack of observable prices. The valuation was performed using a discounted cash flow model, incorporating an estimated discount rate of 12% and terminal growth rate of 3%. A 10% increase in the discount rate would reduce the fair value by approximately $120,000, while a 10% decrease would increase it by approximately $140,000. No transfers out of Level 3 occurred during the reporting period.

6. Practical Tips and Common Mistakes

Tips for Compliance:

• Maintain clear documentation of valuation models and inputs

• Coordinate with valuation specialists early, especially for private investments

• Build reconciliation schedules into monthly or quarterly close processes

• Tag changes accurately: distinguish between unrealized vs. realized gains/losses

Common Pitfalls:

• Omitting the unrealized gain/loss split for profit or loss vs. OCI

• Failing to disclose valuation techniques for Level 3 assets

• Using boilerplate sensitivity disclosures without entity-specific analysis

• Reporting net movements without clear breakdowns