How Fair Value Hierarchy Levels Are Applied under IFRS 13 and ASC 820

Fair value measurement provides a consistent framework for valuing assets and liabilities using observable market data whenever possible. IFRS 13 (Fair Value Measurement) and ASC 820 (Fair Value Measurement) define 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 standards establish a three-level hierarchy that prioritizes the reliability of inputs. This hierarchy ensures that entities disclose how much of their reported fair values rely on market-based data versus internal estimates. Fair value hierarchy classification influences transparency, comparability, and auditability of financial statements.

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How the fair value hierarchy is structured

Both IFRS 13 and ASC 820 define three levels of inputs to measure fair value:

Level 1 — Quoted prices in active markets for identical assets or liabilitiesThese are directly observable, unadjusted prices available in active markets. Examples include listed equity securities, government bonds, or exchange-traded funds.Fair value measurements using Level 1 inputs are the most reliable because they require minimal estimation or adjustment.

Example:An entity holds 5,000 publicly traded shares priced at 45 each on the reporting date.Fair value = 5,000 × 45 = 225,000.Entry:

• Debit: Investment in Equity Securities 225,000

• Credit: Fair Value Gain 225,000

Level 2 — Inputs other than quoted prices that are observable for the asset or liabilityLevel 2 inputs include quoted prices for similar assets in active markets or identical assets in less active markets. Examples include corporate bonds, interest rate swaps, and property valuation models based on observable data like rental rates or yield curves.

Example:A corporate bond’s fair value is derived from a yield curve of similar rated bonds.Observable interest rate = 4.8% → present value = 1,040,000.

Level 3 — Unobservable inputs based on internal models or assumptionsWhen market data is unavailable, fair value must be estimated using valuation techniques such as discounted cash flow (DCF), option pricing models, or replacement cost approaches.These measurements are most subjective and require detailed disclosure of key assumptions.

Example:Private company shares valued using projected free cash flows discounted at 10% → fair value 3,500,000.

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How fair value inputs are prioritized

The hierarchy emphasizes market observability over estimation. Level classification depends on the lowest significant input used in the valuation.

If a valuation uses both observable (Level 2) and unobservable (Level 3) inputs, the measurement is classified as Level 3 if unobservable data materially affects the outcome.

Priority principle:

• Maximize use of observable inputs.

• Minimize reliance on unobservable inputs.

• Disclose valuation techniques and sensitivity to assumptions.

Example:A real estate investment trust (REIT) values property using discounted cash flows and market rent benchmarks.If rental assumptions are observable, it may qualify as Level 2. If they rely heavily on internal projections, it becomes Level 3.

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How fair value is measured using valuation techniques

IFRS 13 and ASC 820 both permit three primary valuation approaches:

1. Market approach — uses prices and relevant information from market transactions.Example: Comparable sales or multiples for property valuations.

2. Income approach — converts future amounts (cash flows or income) into a present value using discounting.Example: DCF valuation for private equity investments.

3. Cost approach — reflects the amount required to replace the service capacity of an asset.Example: Replacement cost of specialized machinery.

When observable market data is unavailable, entities must ensure their valuation models are calibrated against market evidence at initial recognition and updated regularly to reflect changing conditions.

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Comparative framework between IFRS 13 and ASC 820

Aspect	IFRS 13	US GAAP (ASC 820)
Definition of fair value	Exit price from orderly transaction	Exit price from orderly transaction
Hierarchy levels	Levels 1, 2, 3	Levels 1, 2, 3
Highest priority input	Quoted market prices	Quoted market prices
Lowest priority input	Unobservable assumptions	Unobservable assumptions
Unit of account	Consistent with IFRS standard of asset/liability	Consistent with related ASC topic
Valuation techniques	Market, income, cost	Market, income, cost
Non-financial assets	Focus on “highest and best use”	Same principle
Disclosure depth	Qualitative + quantitative	Similar, slightly more prescriptive for SEC filers

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Disclosure requirements for fair value measurements

Both frameworks require extensive notes to help users understand valuation uncertainty.

Disclosures include:

• Fair value hierarchy level for each class of assets and liabilities.

• Valuation techniques and inputs used.

• Sensitivity of Level 3 measurements to changes in key assumptions.

• Reconciliation of opening and closing balances for Level 3 instruments.

Example disclosure table:

Fair Value Hierarchy Level	Assets (USD)	Liabilities (USD)
Level 1	3,200,000	850,000
Level 2	5,600,000	2,100,000
Level 3	2,800,000	1,200,000

Total fair value assets: 11,600,000Total fair value liabilities: 4,150,000

Reconciliation of Level 3 assets must include purchases, sales, gains/losses, and transfers between levels.

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Journal entries summary

1) Fair value increase – Level 1:

• Debit: Investment in Securities xx

• Credit: Unrealized Gain (P&L or OCI) xx

2) Fair value decrease – Level 2:

• Debit: Unrealized Loss xx

• Credit: Investment xx

3) Level 3 remeasurement:

• Debit: Investment xx

• Credit: Fair Value Gain xx

4) Transfer between levels:

• Disclosure only; no journal entry required, but narrative explanation is mandatory.

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Impact on financial performance and ratios

Fair value hierarchy classification affects key indicators such as volatility, transparency, and risk perception.

• Entities relying heavily on Level 3 inputs show higher valuation uncertainty.

• Frequent Level 2 to Level 3 transfers indicate reduced market liquidity.

• Heavy Level 1 exposure reflects stronger market reliance and higher comparability.

• OCI volatility can distort equity-based ratios if large unrealized gains or losses arise.

For financial institutions, fair value sensitivity analyses often reveal potential capital impacts under stressed market conditions.

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Operational considerations

To apply IFRS 13 and ASC 820 effectively, entities should:

• Maintain consistent valuation models validated by independent experts.

• Document assumptions for all Level 3 inputs.

• Reconcile all market data sources periodically.

• Integrate fair value measurement into risk management systems.

• Ensure robust internal controls and audit trails for valuations.

A transparent hierarchy classification framework ensures that fair value measurements convey reliability, comparability, and alignment with real market dynamics.

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