Strategic Business Reporting (International) · Fair value measurement

The Fair Value Hierarchy: IFRS 13 Levels Explained

Updated 11 October 2026 · Fact-checked

The fair value hierarchy in IFRS 13 ranks the inputs used to measure fair value into three levels. Level 1 is quoted prices for identical items in active markets. Level 2 is other observable inputs. Level 3 is unobservable inputs. You classify the whole measurement by its lowest-level significant input.

Understand The Fair Value Hierarchy

IFRS 13 defines 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. Often you cannot just look up a price. So the standard lets you use valuation techniques. The fair value hierarchy tells you how much weight to give the inputs to those techniques.

The idea is simple. The more the input comes from the market, the more reliable and comparable the number. The hierarchy gives the highest priority to observable market data and the lowest to the entity's own assumptions.

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date. A share listed on a major exchange is the classic case. This is the most reliable evidence of fair value, and you use it without adjustment whenever it is available (with limited exceptions in IFRS 13, for example where the price is not representative of fair value at the measurement date).

Level 2 inputs are inputs other than Level 1 quoted prices that are observable for the asset or liability, directly or indirectly. Examples are quoted prices for similar assets in active markets, quoted prices for identical items in inactive markets, interest rates and yield curves observable at common intervals, and implied volatilities. Level 2 inputs may need adjustment, for example for the condition or location of the asset. If that adjustment is significant and uses unobservable data, the measurement may fall to Level 3.

Level 3 inputs are unobservable inputs. You use them only when relevant observable inputs are not available. They reflect the entity's own assumptions about what market participants would assume, using the best information available. Examples are a discounted cash flow for an unlisted business using management's forecasts, or a risk adjustment built from internal data.

The level applies to the whole measurement, not to each input. A measurement takes the level of the lowest-level input that is significant to the entire measurement. Significance needs judgement. It is about the effect on the result, not the number of inputs.

Key rules to remember

Level 1 inputs: Quoted price (unadjusted), identical item, active market, accessible at measurement date; Highest priority. Use it where available, subject to the exceptions in IFRS 13.
Level 2 inputs: Observable inputs other than Level 1 prices (direct or indirect); Includes similar items in active markets, identical items in inactive markets, yield curves, and market-corroborated inputs.
Level 3 inputs: Unobservable inputs; Used only when relevant observable inputs are not available. Reflect market participant assumptions.
Classification rule: Level of measurement = lowest level of any input that is significant to the whole measurement; Classify the measurement, not the individual inputs. Significance is a matter of judgement.
Priority rule: Maximise relevant observable inputs; minimise unobservable inputs; Applies when choosing and applying valuation techniques.

How to solve The Fair Value Hierarchy questions

Use this method for any question that asks you to classify, explain or discuss a fair value measurement.

1Identify the asset or liability and what is being measured at fair value.
2Check for a quoted price for an identical item in an active market that the entity can access at the date. If yes, it is Level 1.
3If not, list the other inputs used in the valuation technique and mark each one as observable or unobservable.
4Decide which inputs are significant to the overall result. Ask whether changing the input would move the value materially.
5Assign the level of the lowest-level significant input. One significant unobservable input makes the whole measurement Level 3.
6State your conclusion and give the reason, quoting the scenario facts.
7Add the consequence if asked: IFRS 13 disclosure is more extensive for Level 3, and note the greater estimation uncertainty and need for scepticism.

Quickest way: Three-question level test

When to use it: Use this when you have a short scenario and need a fast, defensible classification.

Question 1: Is there an unadjusted quoted price for the identical item in an active market? Yes means Level 1.
Question 2: If not, are all significant inputs observable, directly or indirectly? Yes means Level 2.
Question 3: Is any significant input based on the entity's own data or assumptions? Yes means Level 3.
Write one sentence naming the deciding input and why it is significant.

Common mistakes in The Fair Value Hierarchy

Classifying each input separately and giving several levels to one measurement.
Students see a mix of observable and unobservable inputs and label each one.
Fix: Give one level to the whole measurement, set by the lowest-level significant input.
Calling a measurement Level 2 because it uses a valuation model.
Students think any model is Level 2 and only market prices are Level 1.
Fix: Look at the inputs, not the technique. A model with only observable inputs is Level 2. A model with a significant unobservable input is Level 3.
Treating a quoted price for a similar asset as Level 1.
The price looks like a market quote, so students stop there.
Fix: Level 1 needs an identical item in an active market. Similar items give Level 2.
Letting an insignificant unobservable input push the measurement to Level 3.
Students apply the rule mechanically without judging significance.
Fix: Only inputs significant to the whole measurement matter. Say why the input is or is not significant.
Assuming Level 3 means the number is wrong or not allowed.
Level 3 sounds like a lower-quality label.
Fix: Level 3 is permitted when observable inputs are unavailable. It means more judgement and more disclosure, not a prohibited measurement.
Forgetting to apply the scenario facts and giving only a definition.
Students recall the theory but do not use the case details.
Fix: Quote the facts, such as an inactive market or a management forecast, and link them to the level chosen.

Worked examples

Example 1

Alpha holds 10,000 shares in a listed company, classified as measured at fair value. The shares trade daily on a major stock exchange at $5.20 on the reporting date. Alpha can access that market. Explain the level of the fair value measurement and the value used.

Show the solution

The asset is an equity investment in a listed company.
The shares are identical to those traded, and the market is active because trading is daily.
Alpha can access the market at the measurement date.
The quoted price is therefore an unadjusted Level 1 input.
Fair value = 10,000 × $5.20 = $52,000.

Answer: The measurement is Level 1 and fair value is $52,000. The quoted price should be used without adjustment.

Example 2

Beta owns an unlisted investment in a private company. Beta values it using a discounted cash flow. The discount rate is derived from observable market yields on comparable bonds. The cash flow forecasts come from the private company's management and are not corroborated by market data. They drive most of the valuation. Classify the measurement and explain the effect on reporting.

Show the solution

There is no quoted price for an identical item, so Level 1 is not available.
The discount rate uses observable market yields. This input is Level 2.
The cash flow forecasts are based on management's own assumptions and are not observable. This input is Level 3.
The forecasts drive most of the value, so the unobservable input is significant to the whole measurement.
The measurement takes the lowest significant level, which is Level 3.
IFRS 13 requires more disclosure for Level 3, including a reconciliation of opening to closing balances and information about the significant unobservable inputs. You should also note the higher estimation uncertainty, so auditors and users should be sceptical of the forecasts.

Answer: The measurement is Level 3, because the management cash flow forecasts are a significant unobservable input, even though the discount rate is observable.

Exam tips

Always give the level and the reason in the same sentence. A bare label earns few marks.
Use the words 'significant to the measurement as a whole' when you decide between Level 2 and Level 3.
Expect the topic inside larger questions, such as investment property, financial assets or business combination fair values. Link the level to the disclosure and the reliability of profit.
Show professional scepticism on Level 3 values, especially where management has an incentive to report higher profits or assets.
If the scenario gives no clear facts, state your assumption about whether the market is active and continue.

Practice questions from Fair value measurement

The Fair Value Hierarchy in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

The Fair Value Hierarchy: frequently asked questions

What is the difference between Level 2 and Level 3 inputs?

Level 2 inputs are observable, directly or indirectly, such as yield curves or prices of similar assets. Level 3 inputs are unobservable and reflect the entity's own assumptions about what market participants would use. One significant Level 3 input makes the whole measurement Level 3.

Can a fair value measurement be Level 1 if it uses a model?

Level 1 is a quoted price for an identical item in an active market, used without adjustment. If you need a valuation model to reach the value, the measurement is normally Level 2 or Level 3, depending on the inputs.

How do I classify a measurement with inputs from different levels?

Classify the whole measurement by the lowest-level input that is significant to it. You need to judge significance by the effect on the value. State your reasoning in the answer.

Does the hierarchy say which valuation technique to use?

No. The technique should suit the circumstances and the data available. The hierarchy ranks the inputs, and IFRS 13 requires you to maximise relevant observable inputs and minimise unobservable ones.