For disclosure and comparability purposes, IFRS 13 establishes a fair value hierarchy that categorises the inputs to valuation techniques into three levels (IFRS 13.72):
When inputs used to measure fair value fall into different levels, the whole fair value measurement is categorised in the same level of the fair value hierarchy as the lowest level input that is significant to the entire measurement (IFRS 13.73, 75).
Level 1 inputs
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 typical examples of Level 1 inputs are prices of financial assets and liabilities traded on stock exchanges that meet the definition of an active market. An active market is a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis (IFRS 13.Appendix A).
A quoted price in an active market provides the most reliable evidence of fair value and should be used without adjustment to measure fair value whenever available (IFRS 13.76-77). As an exception to this rule, adjustments to Level 1 inputs are permitted in circumstances specified in paragraph IFRS 13.79.
Level 2 inputs
Overview of level 2 inputs
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable, either directly or indirectly (including market-corroborated data). Examples of Level 2 inputs are given in paragraph IFRS 13.82 and paragraph IFRS 13.B35 gives examples of Level 2 inputs for particular assets and liabilities.
Over-the-counter (OTC) derivatives
Entities often use over-the-counter (OTC) derivatives which serve as hedging instruments (irrespective of whether the hedge accounting is applied). OTC derivatives cannot, by definition, be included in Level 1 inputs as they are tailored to meet the needs of a particular entity and there are no quoted prices for identical instruments.
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Level 3 inputs
Level 3 inputs are unobservable inputs and are used when relevant observable inputs are not available. Unobservable inputs should be developed using the information available to the entity, which can often be entity’s own data adjusted to account for assumptions of other market participants and exclude entity-specific factors (IFRS 13.86-87, 89). Paragraph IFRS 13.88 stresses that fair value measurement based on Level 3 inputs should take into account assumptions about risk.
Paragraph IFRS 13.B36 gives examples of Level 3 inputs for particular assets and liabilities.
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