Fair Value IFRS 13 Hierarchy: Levels 1, 2, and 3

What is the fair value IFRS 13 hierarchy?

The fair value IFRS 13 hierarchy is the rule that tells you how reliable the inputs are when an entity measures an asset or liability at [fair value](/glossary#fair-value). It does not start with the accountant's opinion. It starts with market evidence, then moves down only when stronger evidence is not available.

Under [IFRS](/glossary#ifrs), fair value is an exit price: 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. That wording matters. It is not the price you paid, not the price management hopes to receive, and not the number needed to hit a budget.

The hierarchy has three levels. Level 1 uses quoted prices in active markets for identical assets or liabilities. Level 2 uses observable inputs other than those direct quoted prices. Level 3 uses unobservable inputs, which means management assumptions become more important and disclosure becomes heavier.

For Saudi and Gulf students, the topic appears in investment property, financial instruments, impairment support, business combinations, and exam questions that ask whether a valuation is defensible. The journal entry may be short, but the professional work is in proving which inputs support the number.

Fair value IFRS 13 hierarchy: how do Levels 1, 2, and 3 work?

The fair value IFRS 13 hierarchy ranks inputs, not job titles, not spreadsheet complexity, and not whether a valuation specialist was involved. A model can still produce a Level 2 measurement if its significant inputs are observable. A simple model can become Level 3 if a significant input is unobservable.

A useful way to remember the levels is to ask one question: how much of this number comes from the market, and how much comes from our own assumptions?

IFRS 13 also says that if different inputs fall into different levels, the whole fair value measurement is categorized based on the lowest-level input that is significant to the entire measurement. That is why one important unobservable assumption can pull the result into Level 3, even when the rest of the model uses market data.

The hierarchy is not a punishment scale. Level 3 does not automatically mean wrong. It means readers need more information about the assumptions, sensitivity, and uncertainty behind the measurement.

When do you use fair value under IFRS?

IFRS 13 explains how to measure fair value. It does not decide when fair value is required. That decision comes from another standard. This is one of the most common exam traps: students quote IFRS 13 as if it creates a fair value model for every asset, then forget to identify the standard that triggered the measurement.

For example, IFRS 9 may require or permit fair value for certain financial assets. IAS 40 allows an investment property fair value model, which is why [investment property IFRS](/learn/investment-property-ias-40) questions often include valuers, market rent, and capitalization rates. IAS 16 allows a revaluation model for property, plant and equipment, but initial recognition still starts with cost, so it connects differently to [PPE capitalization under IAS 16](/learn/ppe-capitalization-ias-16).

Fair value also appears around impairment, business combinations, and some disclosures. If you are new to the standards, start with [IFRS for beginners](/learn/ifrs-for-beginners) before trying to memorize every fair value use case.

The clean workflow is:

• Identify the standard that requires or permits fair value.
• Define the unit of account and the asset or liability being measured.
• Find the principal market, or the most advantageous market if there is no principal market.
• Choose a valuation technique that fits the asset and available data.
• Classify the result in Level 1, Level 2, or Level 3 based on significant inputs.

That sequence keeps you from jumping straight to a number. In real close work, it also gives the reviewer a trail from the accounting requirement to the evidence used in the valuation.

Worked example 1: listed shares measured at Level 1

Riyadh Learning Tools Co. holds 10,000 listed shares in a Saudi technology supplier. The shares are actively traded, and the quoted market price at 31 December is SAR 28 per share. The carrying amount before year-end fair value adjustment is SAR 245,000. The shares are classified at fair value through profit or loss under IFRS 9.

Because the shares are identical to the item being measured and trade in an active market the entity can access, the input is Level 1. The fair value is not an average of analyst targets, not the purchase price, and not management's preferred exit price.

The [journal entry](/glossary#journal-entry) is straightforward because the accounting classification sends changes to profit or loss:

This gain increases profit in the [income statement](/glossary#income-statement) and increases the asset carrying amount in the [balance sheet](/glossary#balance-sheet). The key learning point is not the arithmetic. It is the evidence. If a quoted active-market price exists for the exact shares, IFRS 13 expects you to use it without adjustment except in limited cases.

Worked example 2: investment property measured at Level 3

Dammam Logistics Hub owns a warehouse leased to third-party tenants. Management uses the fair value model under IAS 40. At year end, an external valuer estimates fair value using market rent, expected vacancy, operating costs, and a capitalization rate. Recent rental evidence exists for similar warehouses, but the property is larger, has a specialized loading setup, and depends on assumptions about tenant renewal.

The carrying amount before remeasurement is SAR 8,400,000. The valuation result is SAR 8,950,000. The fair value increase is SAR 550,000.

Because significant inputs are unobservable, the whole measurement is Level 3. It is not enough to say, "A valuer signed it." The accounting team still needs to understand which assumptions drove the number and whether those assumptions are supportable.

If IAS 40 fair value model applies, the entry is:

If the same property were owner-occupied under IAS 16, the accounting answer could be different. That is why classification comes before measurement. IFRS 13 gives the measurement framework; the asset standard tells you where the change goes.

How do disclosures change by hierarchy level?

The lower you move in the hierarchy, the more explanation users need. A Level 1 amount is usually easier to understand because the market price is visible. A Level 3 amount depends on assumptions, so the notes must help readers judge uncertainty.

For recurring fair value measurements, financial statements normally explain the hierarchy level, valuation technique, key inputs, and transfers between levels when relevant. Level 3 measurements need extra attention because users cannot independently observe the major inputs in the same way they can observe a quoted share price.

A practical Level 3 note might explain:

• The valuation technique used, such as discounted cash flow or income capitalization.
• Significant unobservable inputs, such as growth rates, vacancy rates, discount rates, or capitalization rates.
• Sensitivity of the result to changes in those assumptions.
• A reconciliation from opening to closing Level 3 balances when required.
• Where gains or losses were recognized.

This disclosure discipline is part of faithful reporting. It also protects the accountant. If the valuation is material and sensitive, a reviewer should not have to reverse-engineer the model from one final number. The note should tell the story: what was measured, what market evidence existed, what management estimated, and how much uncertainty remains.

Common mistakes in fair value measurement

Fair value questions look technical, but many wrong answers come from a few repeat habits.

First, students confuse fair value with cost. Cost tells you what the company paid. Fair value asks for an exit price at the measurement date. The two can be the same on day one, but they are not the same concept.

Second, they classify the valuation technique instead of the inputs. Discounted cash flow is not automatically Level 3. If the significant inputs are observable, the result may be Level 2. If a major assumption is unobservable, the result may be Level 3.

Third, they ignore the lowest significant input. A property valuation may include observable rent data, but if the capitalization-rate adjustment is significant and unobservable, Level 3 classification may be required.

Fourth, they record the entry before identifying the standard. A fair value gain under IAS 40 usually goes to profit or loss. A PPE revaluation under IAS 16 can affect revaluation surplus. A financial asset under IFRS 9 depends on its classification. The hierarchy does not decide presentation by itself.

Fifth, they forget disclosure. Level 3 is not solved by posting the number in the [general ledger](/glossary#general-ledger). The notes are part of the accounting answer, especially when assumptions can move the valuation by a material amount.

How should Saudi and Gulf students practice IFRS 13?

To practice IFRS 13 properly, do not start by memorizing definitions. Start with evidence. For every scenario, write down the asset, the standard that requires or permits fair value, the observable data available, the assumptions management used, and the statement line affected.

A good study drill is to classify the same broad asset under different facts. Listed shares on Tadawul may be Level 1. A sukuk valued using observable yield curves may be Level 2. A private logistics investment based on internal cash-flow forecasts may be Level 3. A warehouse may move between Level 2 and Level 3 depending on whether the significant adjustments are observable.

Then connect the measurement to reporting. Does the gain affect profit or loss? Does it change equity? Does it change the asset carrying amount only? Does the question ask for a disclosure explanation rather than a full entry?

Accountery practice exercises help because they force you to choose the account, amount, and explanation instead of recognizing a definition on a flashcard. For this topic, build a mini routine: classify the fair value level, defend the significant inputs, post the entry only after the relevant standard is clear, then write one sentence explaining the disclosure risk.

That routine is what real accountants need at close. Anyone can copy a valuation number. The professional skill is knowing whether the number belongs in the accounts, how reliable its inputs are, and how clearly the uncertainty is explained.