Definition of 'Level 1'
Level 1 assets and liabilities are considered to be the most reliable because the fair value can be determined with the greatest degree of certainty. For example, a company that owns shares of a publicly traded company would use the closing price of the stock on the last trading day of the reporting period to determine the fair value of its investment.
Level 2 is the second level of the fair value hierarchy. It includes assets and liabilities that are not quoted in an active market, but for which there is another market or valuation technique that can be used to determine fair value. For example, a company that owns a piece of land that is not actively traded would use a valuation technique, such as the discounted cash flow method, to determine the fair value of the land.
Level 3 is the third and lowest level of the fair value hierarchy. It includes assets and liabilities for which there is no active market or valuation technique that can be used to reliably determine fair value. For example, a company that owns a patent would use a valuation technique, such as the income approach, to determine the fair value of the patent.
The fair value of an asset or liability is important because it is used to determine the amount of equity and liabilities that a company reports on its balance sheet. The fair value of an asset or liability can also be used to calculate the amount of income or expense that a company reports on its income statement.
The IFRS fair value hierarchy is used to ensure that the fair value of assets and liabilities is determined in a consistent and reliable manner. By using the fair value hierarchy, companies can provide investors with more information about the value of their assets and liabilities.
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