Fair value hierarchy: classify inputs and the entire measurement
Distinguish Level 1, Level 2, and Level 3 valuation inputs, then apply the lowest-significant-input rule to a FAR measurement.
The decision that earns the point
Classify the item before measuring it
Level 1 uses unadjusted quoted prices for identical assets or liabilities in active markets accessible at the measurement date. Level 2 uses other observable inputs, directly or indirectly. Level 3 uses unobservable inputs. The entire fair value measurement is categorized at the lowest hierarchy level of any input significant to that measurement.
Exam use
FAR can ask you to classify quoted prices, yield curves, comparable-market inputs, or internal assumptions and then assign the hierarchy level for the complete measurement.
Your scratch-paper plan
Solve it in three moves
- 1
Look for an identical active-market quote
Use Level 1 only when the quoted price is unadjusted, for the identical item, in an active market the entity can access.
FASB ASC 820: Fair Value Measurement - 2
Separate observable from unobservable inputs
Classify quoted similar items and market-corroborated data as Level 2, while significant internal assumptions belong in Level 3.
FASB ASC 820: Fair Value Measurement - 3
Classify the whole measurement
Use the lowest-level input that is significant to the entire measurement instead of averaging or counting the inputs.
FASB ASC 820: Fair Value Measurement
Worked problem
Work the facts before choosing the answer
An identical exchange-traded security has an unadjusted active-market quote of $102. A similar bond has an observable market price of $98. A third valuation starts with that $98 observable input but subtracts a significant $6 internal liquidity adjustment unsupported by observable market data.
CPAPass exam analysis using the stated assumptions
Show the work
The $102 identical active-market quote is Level 1. The unadjusted comparable bond input is Level 2. The adjusted $92 measurement uses a significant unobservable input, so the complete measurement falls in Level 3.
Rule source: FASB ASC 820: Fair Value MeasurementAnswer
Classify the three outcomes as Level 1 at $102, Level 2 at $98, and Level 3 at $92. The observable starting point does not keep the third measurement in Level 2.
Rule source: FASB ASC 820: Fair Value MeasurementDo it now
Test the same decision with a fresh question
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The trap and the repair
Common trap
Choosing the level used by most inputs ignores the rule for the lowest-level input significant to the entire measurement.
Repair
Classify each input, mark significance, and let the lowest significant input determine the measurement's hierarchy level.
Authority and scope boundary
FASB ASC 820 controls fair value measurement and hierarchy classification when another Topic requires or permits fair value. ASC 820 does not itself decide which assets must be measured at fair value, and this route does not own goodwill or held-for-sale impairment decisions.
2026 Uniform CPA Examination Blueprints and FASB ASC 820: Fair Value Measurement were reviewed on 2026-08-14. Check a newer authority when the effective date or facts change.
Input decision ladder
Classify evidence before classifying the measurement
The hierarchy prioritizes observable market evidence, but one significant unobservable adjustment can move the whole measurement to Level 3.
| Input evidence | Hierarchy classification | Reason | Authority |
|---|---|---|---|
| Unadjusted quote for identical item in active accessible market | Level 1 | Direct highest-priority observable input | FASB ASC 820: Fair Value Measurement |
| Quoted similar item or observable yield curve | Level 2 | Observable but not a qualifying identical-item Level 1 quote | FASB ASC 820: Fair Value Measurement |
| Significant internal liquidity or default assumption | Level 3 | Unobservable market-participant assumption | FASB ASC 820: Fair Value Measurement |
| $98 observable base less significant $6 internal adjustment | Entire $92 measurement is Level 3 | Lowest significant input controls the full measurement | FASB ASC 820: Fair Value Measurement |
After a miss
Repair a fair-value hierarchy miss
- 1
Underline identical, similar, observable, unobservable, active, adjusted, and significant in the fact pattern.
- 2
Reclassify the $92 example after the $6 adjustment becomes insignificant and state what additional evidence would support Level 2.
- 3
Answer a fresh FAR hierarchy question and record the individual input levels before assigning the entire measurement level.
Your exam workflow
- Step 1Identify the requirementUse Level 1 only when the quoted price is unadjusted, for the identical item, in an active market the entity can access.FASB ASC 820: Fair Value Measurement
- Step 2Classify the factsClassify quoted similar items and market-corroborated data as Level 2, while significant internal assumptions belong in Level 3.FASB ASC 820: Fair Value Measurement
- Step 3Apply the authorityUse the lowest-level input that is significant to the entire measurement instead of averaging or counting the inputs.FASB ASC 820: Fair Value Measurement
- Step 4Check the outputClassify the three outcomes as Level 1 at $102, Level 2 at $98, and Level 3 at $92. The observable starting point does not keep the third measurement in Level 2.FASB ASC 820: Fair Value Measurement
Keep the next step narrow
Quick questions
What is the key rule?
Level 1 uses unadjusted quoted prices for identical assets or liabilities in active markets accessible at the measurement date. Level 2 uses other observable inputs, directly or indirectly. Level 3 uses unobservable inputs. The entire fair value measurement is categorized at the lowest hierarchy level of any input significant to that measurement.
How can this topic be tested on the CPA Exam?
FAR can ask you to classify quoted prices, yield curves, comparable-market inputs, or internal assumptions and then assign the hierarchy level for the complete measurement.
What mistake most often changes the result?
Choosing the level used by most inputs ignores the rule for the lowest-level input significant to the entire measurement. Classify each input, mark significance, and let the lowest significant input determine the measurement's hierarchy level.
Where should I practice the decision?
After the worked example, open the FAR free-practice link and work a fresh question that tests the same decision. If the miss depends on Goodwill impairment, review that handoff before trying another set.