IFRS 13 Level 1 2 3 Fair Value Inputs

IFRS 13 Level — Core Rule

Under IFRS 13, all fair value measurements must be classified into a three-level hierarchy based on the observability of the inputs used, with Level 1 (most reliable) through Level 3 (least observable) determining both measurement quality and disclosure intensity.

How IFRS 13 Level Works

IFRS 13 Level 1, 2, and 3 fair value inputs form a hierarchy that prioritises observable market data over entity-specific assumptions, maximising transparency and comparability across reporting entities.

• Level 1 inputs (IFRS 13.76–13.80): Unadjusted quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date. Examples include listed equity share prices on the NYSE or LSE, or quoted government bond prices. The entity must use these prices without adjustment (IFRS 13.77), except in narrow circumstances such as a block discount prohibition (IFRS 13.69).

• Level 2 inputs (IFRS 13.81–13.85): Inputs other than quoted prices in Level 1 that are observable, either directly (prices) or indirectly (derived from prices). These include quoted prices for similar (not identical) assets in active markets, quoted prices for identical assets in inactive markets, observable yield curves, credit spreads, and implied volatilities. Adjustments to Level 2 inputs are permissible but may push the measurement into Level 3 if they are significant and unobservable (IFRS 13.84).

• Level 3 inputs (IFRS 13.86–13.90): Unobservable inputs reflecting the entity's own assumptions about what market participants would use. These arise when relevant market activity is absent or insufficient. Examples include projected cash flows for an unlisted investment, entity-specific discount rates, or long-term commodity price assumptions beyond observable market curves. Entities must develop Level 3 inputs using the best available information, including internal data adjusted to reflect market participant assumptions (IFRS 13.89).

• Hierarchy level classification (IFRS 13.72–13.73): The entire fair value measurement is classified based on the lowest level input that is significant to the measurement as a whole. A derivative using mostly observable inputs but one significant unobservable credit adjustment is classified as Level 3.

• Valuation techniques (IFRS 13.61–13.66): Three approaches are permitted — market approach, cost approach, and income approach. Entities must use techniques that maximise observable inputs (IFRS 13.67). Changes in valuation technique are treated as a change in accounting estimate (IFRS 13.66).

• Disclosure requirements (IFRS 13.91–13.99): Level 3 measurements require the most extensive disclosures: quantitative information about unobservable inputs, a reconciliation of opening to closing balances, sensitivity analysis showing the effect of changing one or more unobservable inputs to reasonably possible alternatives (IFRS 13.93(h)), and the valuation process used (IFRS 13.93(g)).

IFRS 13 Level — Practical Example

An entity holds an investment in an unlisted tech start-up carried at fair value through profit or loss (IFRS 9). Using a discounted cash flow model with internally projected revenue growth of 12% and a discount rate of 18% (both unobservable), the fair value is determined to be €4.2 million at year-end, up from €3.8 million at the prior year-end. This is a Level 3 measurement.

Journal entry — fair value uplift of €400,000

The entity must disclose in the notes: the valuation technique (DCF), the significant unobservable inputs (growth rate 12%, discount rate 18%), and a sensitivity showing, for example, that a 2% increase in the discount rate would reduce fair value by approximately €320,000.

IFRS 13 Level — Common Pitfalls

• Misclassifying Level 2 as Level 1: Using a quoted price for a similar instrument, or a price in an inactive market, does not qualify as Level 1. Auditors routinely challenge whether a market was genuinely active (sufficient frequency and volume per IFRS 13.Appendix A) at the measurement date.

• Ignoring the "significant input" test for Level 3 classification: Practitioners sometimes classify a measurement as Level 2 because most inputs are observable, overlooking one material unobservable input that drives the valuation. Under IFRS 13.73, even a single significant unobservable input forces Level 3 classification for the entire measurement.

• Insufficient Level 3 sensitivity disclosures: Entities frequently disclose the input range without explaining the interrelationship between inputs or the direction of sensitivity. IFRS 13.93(h) requires a narrative description of the sensitivity and, for financial instruments, a quantitative sensitivity — regulators (ESMA, FRC) have repeatedly criticised boilerplate disclosures here.

IFRS 13 Level — Key Paragraphs

• IFRS 13.72–13.73 — Definition and classification rules for the fair value hierarchy; the "lowest level significant input" principle.
• IFRS 13.76–13.80 — Level 1 inputs: quoted prices, active markets, no adjustment rule.
• IFRS 13.81–13.85 — Level 2 inputs: observable but not Level 1; when adjustments escalate to Level 3.
• IFRS 13.86–13.90 — Level 3 inputs: unobservable inputs, market participant assumption requirement.
• IFRS 13.93 — Core Level 3 disclosure requirements including the quantitative sensitivity analysis obligation.
• IFRS 13.67 — Overarching principle to maximise observable inputs in all valuation techniques.