Financial Reporting · Ind AS 113 Fair Value Measurement

Fair Value Hierarchy under Ind AS 113: Level 1, Level 2 and Level 3 Inputs

Updated 5 October 2026 · Fact-checked

The fair value hierarchy in Ind AS 113 ranks the inputs used in valuation techniques. Level 1 is unadjusted quoted prices in active markets for identical items. Level 2 is other observable inputs. Level 3 is unobservable inputs. To solve a question, list the inputs, classify each, then take the lowest level that is significant to the whole measurement.

Understand Fair Value Hierarchy: Level 1, 2 and 3 Inputs

Fair value is an exit price. Ind AS 113 does not tell you which valuation technique to use. It tells you how reliable your inputs are, and it ranks them. The ranking is called the fair value hierarchy. It gives the highest priority to quoted prices and the lowest priority to your 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 NSE and quoted on the reporting date is the usual example. Level 1 is the most reliable evidence of fair value. When a quoted price exists for each asset, you use it without adjustment. Matrix pricing is a practical expedient for a large group of similar assets or liabilities where a quoted price is not readily available for each item. It is a Level 2 measurement where it uses observable inputs, and Level 3 only if significant unobservable inputs are used. It is never Level 1. A quoted price may also stop being fair value because of a significant event. If a significant event occurs after the market closes but before the measurement date, and you adjust the quoted price for it, the result is a lower-level (Level 2 or Level 3) measurement. A Level 1 price should not be adjusted for block size (blockage factor).

Level 2 inputs are inputs other than Level 1 prices that are observable for the asset or liability, directly or indirectly. Examples: quoted prices for similar assets in active markets, quoted prices for identical or similar assets in markets that are not active, and inputs observable at commonly quoted intervals such as interest rates and yield curves, implied volatilities and credit spreads. Also included are market-corroborated inputs. If a Level 2 input needs an adjustment that is significant (for example, for condition or location of the asset), the adjustment can push the measurement down to Level 3 when it uses unobservable data.

Level 3 inputs are unobservable inputs. You use them only when relevant observable inputs are not available. They reflect the assumptions that market participants would use in pricing, including assumptions about risk. You may start with your own data, but you must adjust it if reasonably available information shows that market participants would use different assumptions. Examples: a cash flow forecast for an unlisted subsidiary and a long-term price for a thinly traded asset.

The level of the whole fair value measurement is the level of the lowest level input that is significant to the entire measurement. This needs judgement and you must consider factors specific to the asset or liability. If observable data needs a significant adjustment using unobservable data, the result is Level 3. The hierarchy applies to the inputs, not to the valuation technique. A discounted cash flow can be Level 2 or Level 3, depending on its inputs.

When the volume or level of activity has significantly decreased, prices may not be reliable. Ind AS 113 does not assume that every transaction in such a market is distressed, and it does not let you ignore the market price. You evaluate whether the transaction is orderly. A transaction price from a transaction that is not orderly gets little or no weight. A price from an orderly transaction gets weight depending on factors such as comparability and size. If you cannot conclude on the transaction, give it less weight than other indications. You may need to change the valuation technique or use more than one technique. The objective stays the same: the price at which an orderly transaction would take place between market participants at the measurement date under current market conditions.

Key rules to remember

Level 1 inputs: Quoted price (unadjusted) + active market + identical item + accessible at measurement date; All four conditions must hold. If any one fails, check Level 2. Do not apply a blockage factor to a Level 1 price.
Level 2 inputs: Observable inputs other than Level 1 prices (direct or indirect); Includes similar items in active markets, identical or similar items in inactive markets, yield curves, implied volatilities, credit spreads and market-corroborated inputs.
Level 3 inputs: Unobservable inputs, used only when relevant observable inputs are not available; Reflect market participant assumptions, including risk. Own data is a starting point and must be adjusted for contrary market information.
Level of the whole measurement: Level of the lowest-level input that is significant to the entire measurement; Significance is a judgement. A technique with one significant Level 3 input is a Level 3 measurement.
Activity significantly decreased: Evaluate whether the transaction is orderly → weight the price → consider changing or combining techniques; The objective stays an exit price in an orderly transaction under current market conditions. Do not ignore transaction prices automatically and do not use a distressed price as fair value.

How to solve Fair Value Hierarchy: Level 1, 2 and 3 Inputs questions

Use this method for any classification or activity-decrease question. Write each step in the answer so the examiner can see the logic.

1Identify the item being measured and the measurement date. Note whether it is an asset or a liability and whether it is listed or unlisted.
2List every input used in the valuation: prices, rates, volatilities, cash flow forecasts, discount rates, adjustments.
3Test for Level 1: is it an unadjusted quoted price, in an active market, for an identical item, accessible to the entity at the measurement date? If yes, classify as Level 1.
4For the rest, ask if each input is observable directly or indirectly. Observable inputs go to Level 2. Inputs based on the entity's own assumptions go to Level 3.
5Check adjustments to Level 2 inputs. If an adjustment is significant and uses unobservable data, the input becomes Level 3 in effect.
6Decide which inputs are significant to the whole measurement. The overall level is the lowest level among those significant inputs.
7If the case says activity has fallen, assess whether the transactions are orderly. Decide the weight for each price and whether to change or add a valuation technique.
8Conclude in one sentence: state the level, the reason and, where asked, the disclosure impact.

Quickest way: Four-question sort

When to use it: Use this for case-scenario MCQs and for the first half of a descriptive answer when time is short.

Ask: is it a quote, active market, identical item, unadjusted? Yes means Level 1.
Ask: can a market participant see this input, directly or from a market-corroborated source? Yes means Level 2.
Ask: is it the entity's own forecast or assumption? Yes means Level 3.
For the overall level, circle the lowest level that moves the answer materially. That is the level of the measurement.
If a question mentions a fall in activity, add one line: check whether the transactions are orderly and weight accordingly.

Common mistakes in Fair Value Hierarchy: Level 1, 2 and 3 Inputs

Classifying the valuation technique as Level 1, 2 or 3 instead of the inputs.
Students link DCF with Level 3 and market approach with Level 1 or 2.
Fix: The hierarchy ranks inputs. A DCF using observable yield curves and observable cash flows can be Level 2. Always name the inputs first.
Treating a Level 1 price as adjustable for the size of the holding.
Students think a large block would move the price, so they apply a discount.
Fix: Use the unadjusted quoted price multiplied by the quantity held. Ind AS 113 does not permit a blockage factor for Level 1.
Calling a quoted price Level 1 when the market is not active or the item is not identical.
Students see the word 'quoted' and stop reading.
Fix: Check all four conditions. A quote for a similar item, or in an inactive market, is Level 2.
Classifying the whole measurement by the average or highest level of inputs.
Students count how many inputs are Level 1 or 2 and pick the majority.
Fix: Take the lowest level input that is significant to the whole measurement. One significant Level 3 input makes it Level 3.
Ignoring all transaction prices once market activity falls, or using a distressed sale price as fair value.
Students over-correct in either direction.
Fix: Judge whether each transaction is orderly. Give little or no weight to disorderly ones, give weight to orderly ones, and consider changing or combining techniques.
Leaving a Level 2 input unchanged after a significant adjustment using unobservable data.
Students stop at the observable starting point.
Fix: Ask whether the adjustment is significant to the whole measurement. If it is, and it uses unobservable data, the result is Level 3.

Worked examples

Example 1

At 31 March, Alpha Ltd holds three items. (a) 10,000 equity shares of Beta Ltd listed on NSE, closing price ₹250, actively traded. Alpha's holding is large and a broker says selling it all at once would fetch about 5% less. (b) A corporate bond of Gamma Ltd that is thinly traded. Alpha values it using the observable yield on a similar-rated, similar-maturity bond, and makes no significant adjustment to that observable yield. (c) 20% unlisted shares of Delta Ltd valued by a DCF using Alpha's own five-year cash flow forecasts. Classify each and state the fair value of (a).

Show the solution

Item (a): quoted price, active market, identical shares, accessible at the date. All Level 1 conditions are met.
The 5% discount for the size of the holding is a blockage factor. Ind AS 113 does not allow it for a Level 1 price.
A Level 1 fair value is the quoted price multiplied by the quantity held, with no blockage factor. Fair value of (a) = ₹250 × 10,000 = ₹25,00,000.
Item (b): the bond is thinly traded, so the market is not active for it. The yield on a similar bond is an observable input. As the problem states, no significant adjustment is made to that observable yield. This is Level 2.
Item (c): the cash flow forecasts are the entity's own unobservable data, which are significant to the DCF. This is Level 3.

Answer: (a) Level 1, fair value ₹25,00,000 (quoted price × quantity held, with no blockage discount). (b) Level 2. (c) Level 3.

Example 2

Zeta Ltd values an unlisted debt security at the reporting date. Trading in the security has fallen sharply over the last quarter. Two recent trades were: ₹92 per ₹100 face value in an orderly trade between willing parties after proper marketing, and ₹70 per ₹100 face value in a forced sale by a lender in default, with no marketing. A model using observable market yields for similar securities gives ₹90. The model needs a small liquidity adjustment based on Zeta's own estimate, which is not significant to the result. Explain how Zeta should measure fair value and classify it.

Show the solution

Volume has significantly decreased, so you cannot rely on prices blindly. Test each trade to see whether it is orderly.
The ₹92 trade was orderly: willing parties, proper marketing. It is relevant evidence and gets weight. The market is not active, so this trade price is not a Level 1 quote. It is an observable transaction input, which is Level 2.
The ₹70 trade was a forced sale by a lender in default with no marketing. It is not orderly and gets little or no weight.
The model using observable yields for similar securities gives ₹90. These yields are observable inputs, so the model inputs are also Level 2.
The liquidity adjustment is based on Zeta's own estimate, but it is not significant to the measurement. So it does not move the measurement to Level 3.
Zeta weighs the orderly trade (₹92) and the model value (₹90) equally and gives no weight to ₹70. The weighted estimate is (₹92 + ₹90) ÷ 2 = ₹91 per ₹100 face value. Equal weights are a judgement, and Zeta could weight the trade more or less depending on its comparability and size. The result should reflect an orderly exit price under current market conditions.
Classification is by the lowest significant input. The orderly trade price and the observable-yield model are both Level 2 inputs, and the only unobservable input is not significant. So the measurement is Level 2.

Answer: Zeta gives no weight to the ₹70 forced-sale price and weighs the orderly ₹92 trade with the ₹90 model value. On equal weights, fair value is ₹91 per ₹100 face value. The measurement is Level 2 because the orderly trade price and the observable-yield model are both Level 2 inputs, and the unobservable liquidity adjustment is not significant.

Exam tips

In case MCQs, read each input word by word. 'Identical', 'unadjusted', 'active' and 'similar' decide between Level 1 and Level 2.
When asked for the level of a measurement, always say 'lowest level input that is significant' and name that input.
For activity-decrease questions, structure the answer as: orderly or not, weight given, technique change, objective unchanged.
Do not use old AS 30 or other pre-Ind AS ideas. Write 'Ind AS 113' and 'exit price' in your answer.
Link the hierarchy to disclosures: if a case mentions Level 3 items, mention that Ind AS 113 requires extra disclosures for them, such as a reconciliation and information on unobservable inputs.

Practice questions from Ind AS 113 Fair Value Measurement

Fair Value Hierarchy: Level 1, 2 and 3 Inputs in other exams

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

Fair Value Hierarchy: Level 1, 2 and 3 Inputs: frequently asked questions

What is the difference between Level 2 and Level 3 inputs in Ind AS 113?

Level 2 inputs are observable, directly or indirectly, for the asset or liability. Level 3 inputs are unobservable and reflect your assumptions about what market participants would use. If a significant adjustment to an observable input uses unobservable data, the measurement becomes Level 3.

Can a valuation technique be a Level 3 technique?

No. The hierarchy classifies the inputs, not the technique. The level of the overall measurement comes from the lowest level input that is significant to it. So a DCF is Level 2 or Level 3 depending on its inputs.

Can I apply a discount for a large holding to a quoted price?

Not for a Level 1 price. Ind AS 113 requires you to use the unadjusted quoted price in an active market for identical items, so you multiply the price by the number of units held. You do not apply a blockage factor.

What should I do when market activity has significantly decreased?

Assess whether the transactions are orderly, and give little or no weight to those that are not. Give weight to orderly transactions based on factors such as comparability and size. You may also change or combine valuation techniques. The aim stays an orderly exit price under current market conditions.