How Fair Value Hierarchies and Level 3 Valuations Are Applied under IFRS 13 and ASC 820

Fair value accounting requires consistency in how assets and liabilities are measured and disclosed. IFRS 13 (Fair Value Measurement) and US GAAP (ASC 820 – Fair Value Measurement) establish a unified framework defining fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Both frameworks use a three-level hierarchy of inputs—from observable market data to unobservable internal assumptions—to promote transparency and comparability across entities and instruments.

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How fair value measurement is defined.

Fair value represents an exit price, not an entry or cost-based value. It assumes a hypothetical transaction between knowledgeable, willing market participants under current conditions, regardless of whether an actual market exists.

Measurement focuses on the principal market, or if none exists, the most advantageous market, considering transaction costs and market accessibility.

Fair value measurement applies widely—to financial instruments, investment properties, biological assets, share-based payments, and business combinations—and is especially relevant when active markets are absent or models must estimate prices.

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Understanding the fair value hierarchy.

Both IFRS 13 and ASC 820 classify inputs into three levels based on their observability and reliability:

Level	Definition	Examples of Inputs
Level 1	Quoted prices (unadjusted) in active markets for identical assets or liabilities.	Listed equities, government bonds, exchange-traded derivatives.
Level 2	Observable inputs other than quoted prices, directly or indirectly.	Yield curves, interest rate swaps, corporate bond spreads, implied volatilities.
Level 3	Unobservable inputs reflecting the entity’s own assumptions about market participants’ expectations.	Discounted cash flow models for private equity, illiquid loans, or unquoted instruments.

The hierarchy does not measure quality of valuation—it classifies how observable inputs are. Entities must prioritize Level 1 whenever available, and disclose any transfers between levels with reasons.

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Measurement principles under IFRS 13.

Under IFRS 13, fair value measurement involves three dimensions:

1. The asset or liability: specify its characteristics (condition, location, restrictions).

2. The market: identify principal or most advantageous market accessible to the entity.

3. The valuation technique: select an appropriate model and inputs consistent with market participant assumptions.

The three main valuation techniques are:

• Market approach: uses prices and information from comparable transactions.

• Income approach: converts future amounts to a present value (DCF, option pricing).

• Cost approach: reflects the amount needed to replace service capacity.

When observable market data are unavailable, management develops Level 3 unobservable inputs such as forecasted cash flows, discount rates, and control premiums. These assumptions must represent market participant views, not management intent.

Example (IFRS — unquoted equity DCF):An investment fund values a private company expected to generate annual cash flows of 1,500,000 for 5 years, terminal growth 2%, and discount rate 12%.

PV = ∑ (CFₜ / (1+12%)ᵗ) + (Terminal Value / (1+12%)⁵)Result ≈ 6,250,000.

The fair value is disclosed as Level 3, with sensitivity analysis for discount rate ±1%.

Journal entries (IFRS):

• Debit: Investment in Private Equity 6,250,000

• Credit: Gain on Fair Value Change 250,000

Gains/losses flow through P&L or OCI, depending on classification under IFRS 9 (FVTPL or FVOCI).

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Measurement principles under US GAAP (ASC 820).

ASC 820 mirrors IFRS 13, defining fair value as the exit price in the principal market. The hierarchy and disclosure framework are identical, but GAAP requires more granular disclosure for non-recurring measurements and policy election notes describing which items are measured at fair value recurring (e.g., derivatives) versus non-recurring (e.g., impairments, acquisitions).

Level 3 inputs must reflect assumptions a market participant would use, developed from the best available data. Management may adjust internal models to align with external market evidence, supported by documentation.

Example (GAAP — private bond fair value):A financial institution holds a corporate bond with no observable price. A valuation model estimates PV of expected cash flows at a discount rate of 8.5% using recent market spreads. Carrying amount changes from 9,700,000 to 9,950,000.

Journal entry:

• Debit: Investment – FVTPL 250,000

• Credit: Unrealized Gain on Fair Value 250,000

If classified as available-for-sale (AFS), gains/losses flow through OCI.

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Comparative table: IFRS vs US GAAP.

Aspect	IFRS (IFRS 13)	US GAAP (ASC 820)
Fair value definition	Exit price between market participants	Same definition
Hierarchy levels	3 levels (observable to unobservable inputs)	Identical hierarchy
Recurring vs non-recurring	Disclosure by class of assets/liabilities	Must specify recurring/non-recurring fair value use
Valuation techniques	Market, income, cost approach	Same; GAAP allows additional calibration notes
Transfers between levels	Disclose with reasons and timing	Same, plus policy for transfer timing
Sensitivity analysis	Mandatory for Level 3 inputs	Required if material to investors
Unit of account	IFRS 13 defines per standard; follows valuation premise	Defined consistently with relevant ASC Topic
Disclosure emphasis	Reconciliation of opening and closing Level 3 balances	Reconciliation + quantitative unobservable input tables

The frameworks are conceptually aligned, differing mainly in disclosure depth and terminology rather than valuation mechanics.

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Presentation and disclosure requirements.

Under both standards, recurring fair value measurements appear in the balance sheet with hierarchy classification disclosed in the notes. Entities must also present reconciliations of Level 3 movements, sensitivity analyses, and valuation techniques used.

Example disclosure (Level 3 reconciliation, IFRS):

Movement in Level 3 Investments (USD)	Amount
Opening balance at 1 January	5,800,000
Purchases and additions	400,000
Disposals and settlements	(150,000)
Gains recognized in profit or loss	200,000
Foreign exchange differences	(20,000)
Closing balance at 31 December	6,230,000

Disclosures must identify the valuation technique, significant unobservable inputs, and range/weighted average for each input (e.g., discount rate 10–14%, terminal growth 1–3%). Entities must also describe how sensitivities were derived.

Under US GAAP, note disclosures include quantitative and narrative descriptions of Level 3 valuation processes, input sources, and any use of third-party pricing services.

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Journal entries and remeasurement examples.

1) Level 1 asset (quoted equity):

• Debit: Equity Investments 1,000,000

• Credit: Gain on Fair Value 1,000,000

2) Level 2 liability (interest rate swap, valuation gain):

• Debit: Derivative Liability 75,000

• Credit: Gain on Derivative 75,000

3) Level 3 private equity write-down (IFRS/GAAP):

• Debit: Loss on Fair Value Change 180,000

• Credit: Investment in Private Equity 180,000

Each entry aligns carrying values with current market or model-derived pricing at the reporting date.

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Impact on financial performance and ratios.

Level 1 valuations increase transparency and comparability, while Level 3 valuations introduce subjectivity and volatility. High exposure to Level 3 assets may reduce earnings predictability and affect analysts’ perceptions of reliability.

Under IFRS, fair value gains flow either through profit or loss (FVTPL) or OCI (FVOCI). Under GAAP, classification between trading, AFS, or amortized cost instruments drives presentation differences but not measurement logic.

Ratios impacted include:

• Earnings Volatility: higher when Level 3 movements are recognized in P&L.

• Fair Value Coverage Ratio: proportion of assets measured using observable inputs.

• Return on Assets (ROA): affected by recurring remeasurements.

Analysts examine Level 3 sensitivity tables to evaluate the risk of over-optimistic valuation assumptions.

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Operational considerations.

Fair value governance requires robust valuation controls, model validation, and independent price verification. Entities must document input sources, justify any unobservable estimates, and monitor transfers between levels when markets become illiquid or reactivate.

Audit readiness involves traceable model documentation, back-testing of assumptions, and consistency of valuation policies across reporting periods. Boards and audit committees should review Level 3 exposure as part of enterprise risk oversight.

Transparent fair value measurement under IFRS 13 and ASC 820 ensures that investors and regulators can distinguish between market-observed values and management-estimated models, preserving credibility in volatile or thinly traded markets.

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