Since its introduction in 2013, IFRS 13 Fair Value Measurement has fundamentally reshaped how financial professionals approach valuation for reporting purposes. As we navigate the complex market environment of 2025-2026, characterized by elevated interest rates, geopolitical uncertainty, and rapid technological change, the proper application of IFRS 13's fair value hierarchy has never been more critical—or more challenging.

The standard's three-level hierarchy appears deceptively simple on the surface, yet its practical application requires sophisticated judgment, deep market knowledge, and rigorous documentation. For CFOs preparing financial statements, auditors reviewing valuations, and M&A advisors structuring transactions, understanding the nuances of Level 1, 2, and 3 measurements can mean the difference between a clean audit opinion and significant restatements.

01 The Fair Value Hierarchy: Foundation and Philosophy

IFRS 13 defines fair value as "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." This exit price notion represents a fundamental shift from entity-specific value to market participant value, requiring preparers to adopt an external perspective even when measuring proprietary assets.

The three-level hierarchy prioritizes inputs based on observability:

Level 1: Quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date
Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly
Level 3: Unobservable inputs for the asset or liability

The hierarchy's design reflects a clear preference for market-based evidence over entity-specific assumptions. According to recent data from financial statement disclosures of S&P 500 companies, approximately 42% of fair value measurements fall into Level 1, 31% into Level 2, and 27% into Level 3 as of year-end 2024. This distribution has remained relatively stable, though Level 3 measurements have increased slightly as companies hold more complex financial instruments and intangible assets.

02 Level 1 Measurements: Simplicity with Constraints

Level 1 measurements represent the gold standard of fair value measurement—quoted prices in active markets for identical assets. The application seems straightforward: if you hold 10,000 shares of Apple Inc., you simply multiply the closing price on the measurement date by your holding. However, even Level 1 measurements present practical challenges.

Defining an Active Market

IFRS 13 doesn't provide a bright-line test for market activity. Instead, it requires judgment about whether transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis. In 2025, this assessment has become particularly complex for certain asset classes:

Consider corporate bonds, where trading activity has become increasingly fragmented across multiple platforms. A bond might trade several times daily on one platform but show no activity on others. Recent analysis suggests that approximately 35% of investment-grade corporate bonds experience no trading activity on any given day, raising questions about whether quoted prices truly represent Level 1 inputs.

Similarly, the rise of after-hours and pre-market trading in equity markets has complicated the determination of "the measurement date." While most entities use the official closing price, some argue that after-hours prices better reflect fair value when material information emerges after market close.

The Identical Asset Requirement

The requirement for "identical" assets creates particular challenges for certain holdings. A company holding restricted stock in a publicly traded entity cannot use the unrestricted trading price as a Level 1 input, despite the underlying equity being identical. The restriction represents a separate unit of account requiring a Level 2 or Level 3 measurement with an appropriate discount for lack of marketability.

In practice, restricted stock discounts have ranged from 15% to 35% in recent transactions, depending on the restriction period, the stock's volatility, and the availability of alternative liquidity mechanisms. These discounts have compressed slightly in 2025 as secondary markets for restricted securities have become more efficient.

03 Level 2 Measurements: The Valuation Professional's Domain

Level 2 represents the broadest category and requires the most sophisticated judgment. These measurements use observable inputs but require some degree of adjustment or modeling to arrive at fair value.

Common Level 2 Techniques

Interest Rate Derivatives: Plain-vanilla interest rate swaps typically qualify as Level 2 measurements. While the swaps themselves may not trade actively, the underlying interest rate curves are observable through government bond yields, LIBOR/SOFR rates, and swap spreads. In 2025, the transition from LIBOR to SOFR has largely completed, but basis adjustments between legacy LIBOR-based valuations and new SOFR-based measurements continue to require careful documentation.

A typical five-year interest rate swap might be valued using a discounted cash flow model with observable SOFR forward curves, credit spreads derived from the counterparty's CDS spreads, and standard market conventions for day-count and payment frequencies. While the model involves complexity, all significant inputs are market-observable, supporting Level 2 classification.

Private Debt Instruments: Loans and private debt securities often qualify for Level 2 treatment when comparable market transactions exist. For example, a senior secured term loan to a middle-market manufacturing company might be valued by reference to:

Traded loan indices (S&P/LSTA Leveraged Loan Index)
Spreads on comparable syndicated loans
Credit default swap spreads for similar credits
Recent primary market pricing for similar risk profiles

The key distinction between Level 2 and Level 3 often hinges on the degree of comparability. If adjustments for company-specific factors exceed 10-15% of the total value, many practitioners conclude that unobservable inputs have become significant, pushing the measurement into Level 3.

Real Estate: A Persistent Challenge

Commercial real estate presents one of the most contentious areas for hierarchy classification. While property transactions occur regularly, each property is unique, making "identical asset" comparisons impossible. The question becomes whether observable inputs are sufficiently similar to support Level 2 classification.

Consider a Class A office building in a major metropolitan area. Recent sales of comparable properties in the same submarket provide capitalization rates ranging from 6.2% to 7.8%, with a median of 6.9%. If the subject property's characteristics (age, tenant quality, lease terms) fall within the range of comparables, many practitioners classify this as Level 2, applying the market-derived cap rate to the property's stabilized net operating income.

However, if the property has unique characteristics—perhaps a single-tenant build-to-suit with a long-term lease to a credit-challenged tenant—the measurement likely falls into Level 3, as significant adjustments to observable cap rates would be required.

Recent surveys of real estate valuation practices indicate that approximately 65% of commercial real estate fair value measurements are classified as Level 3, with the remainder split between Level 2 (30%) and Level 1 (5% for REIT shares and publicly traded property funds).

04 Level 3 Measurements: Where Judgment Meets Rigor

Level 3 measurements rely on unobservable inputs that reflect the reporting entity's own assumptions about what market participants would use in pricing the asset or liability. These measurements demand the highest degree of professional judgment and the most extensive disclosure.

Common Level 3 Scenarios

Contingent Consideration in Business Combinations: When a company acquires another business with earn-out provisions tied to future performance, IFRS 13 requires the contingent consideration to be measured at fair value. These measurements almost invariably fall into Level 3.

Consider a 2025 acquisition where the buyer agrees to pay an additional €20 million if the target achieves €50 million in revenue within three years. The fair value measurement requires:

Probability-weighted revenue projections (unobservable)
Discount rate reflecting the risk of the contingent payment (partially observable through comparable credit spreads, but requiring adjustment for the specific contingency)
Assumptions about correlation between the target's performance and broader market conditions

In practice, such measurements often result in fair values ranging from 40% to 80% of the maximum contingent amount, depending on the probability assessment and discount rate. Recent market data suggests that technology sector earn-outs are being valued more conservatively in 2025, with average fair values at 52% of maximum consideration, down from 67% in 2022, reflecting increased uncertainty about growth trajectories.

Intangible Assets: Customer relationships, developed technology, and trade names acquired in business combinations require fair value measurement under IFRS 3, typically falling into Level 3. The relief-from-royalty method for trade names, multi-period excess earnings method for customer relationships, and cost-to-recreate approach for technology all rely heavily on unobservable inputs.

A recent case study illustrates the complexity: A pharmaceutical company acquired a competitor in early 2025, requiring fair value measurement of in-process research and development (IPR&D) for three drug candidates in various stages of clinical trials. The valuation required:

Probability of technical success estimates (ranging from 15% for Phase I to 65% for Phase III)
Probability of regulatory approval (60-75% for Phase III candidates)
Revenue projections extending 15+ years into the future
Discount rates of 12-18% depending on development stage
Peak market share assumptions in highly competitive therapeutic areas

The resulting fair values ranged from €45 million for the Phase I candidate to €380 million for the Phase III candidate, with extensive sensitivity analysis required to support the conclusions.

Valuation Techniques for Level 3 Measurements

IFRS 13 identifies three broad valuation approaches: market approach, income approach, and cost approach. The standard doesn't mandate a specific technique but requires the use of methods appropriate in the circumstances and for which sufficient data are available.

Market Approach: Even for Level 3 measurements, market evidence should be considered when available. Guideline public company multiples, precedent transactions, and market royalty rates all provide relevant benchmarks, even if adjustments are necessary. The key is documenting why observable market data, after appropriate adjustment, supports the conclusion.

For example, valuing a minority interest in a private software company might reference public SaaS company multiples (currently averaging 6.2x revenue for high-growth companies in 2025, down from 12.8x in 2021), adjusted for differences in growth rates, profitability, customer concentration, and lack of marketability. The adjustments might total 40-50%, but the starting point remains market-observable.

Income Approach: Discounted cash flow analysis dominates Level 3 measurements, particularly for operating businesses and long-lived assets. The technique's flexibility allows for incorporation of asset-specific factors while maintaining a market participant perspective through the discount rate.

Critical considerations in 2025 include:

Terminal value assumptions in an environment where long-term growth expectations have moderated (most practitioners now use 2.5-3.5% perpetual growth rates, down from 3.5-4.5% pre-pandemic)
Discount rates that reflect current risk-free rates (10-year government bonds averaging 4.2-4.6% across major economies) plus appropriate risk premiums
Working capital assumptions that reflect supply chain normalization after years of disruption
Tax considerations, particularly for cross-border structures affected by OECD Pillar Two minimum tax rules

Cost Approach: While less common, the cost approach provides relevant evidence for certain asset classes, particularly specialized equipment, internally developed software, and real estate improvements. The challenge lies in estimating appropriate obsolescence factors—physical depreciation, functional obsolescence, and economic obsolescence.

05 Selecting the Appropriate Technique: A Framework

The selection of valuation technique should follow a structured decision framework:

Step 1: Identify the Unit of Account
IFRS 13 requires fair value measurement at the level of the individual asset or liability, unless another IFRS specifies otherwise. This seemingly simple requirement creates complexity when assets function as part of a larger group. For example, a manufacturing facility's fair value might differ significantly depending on whether it's valued as a standalone asset or as part of an integrated production network.

Step 2: Determine the Principal (or Most Advantageous) Market
Fair value assumes a transaction in the principal market—the market with the greatest volume and level of activity for the asset. For a company holding a portfolio of commercial aircraft, the principal market might be the global secondary aircraft market, not the scrap value market, even if the company intends to retire the aircraft.

Step 3: Assess the Highest and Best Use (for Non-Financial Assets)
Non-financial assets must be valued based on their highest and best use from a market participant perspective, which may differ from the entity's current use. A warehouse in a gentrifying urban area might have a highest and best use as residential development, even if the company uses it for storage. This requirement has significant implications in 2025 as remote work trends continue to reshape real estate markets.

Step 4: Select Valuation Technique(s)
With the unit of account, market, and use determined, the valuation technique selection should prioritize:

Techniques that maximize observable inputs
Consistency with prior periods (unless changes are justified by new information or market developments)
Techniques commonly used by market participants for similar assets
Methods that can be calibrated to actual transaction prices when available

Many sophisticated valuations employ multiple techniques as a cross-check. For example, a private equity fund valuing a portfolio company might use both a discounted cash flow analysis and a guideline public company multiple approach, reconciling differences and weighting the results based on the reliability of inputs.

06 Documentation and Disclosure Requirements

IFRS 13 imposes extensive disclosure requirements, particularly for Level 3 measurements. These disclosures serve multiple purposes: providing transparency to financial statement users, demonstrating the robustness of the valuation process, and facilitating audit review.

Quantitative Disclosures

For Level 3 measurements, entities must disclose:

A reconciliation of opening to closing balances, showing separately purchases, sales, issues, settlements, transfers into/out of Level 3, and gains/losses recognized in profit or loss versus other comprehensive income
Quantitative information about significant unobservable inputs
Sensitivity analysis showing how fair value would change with reasonably possible alternative assumptions

The sensitivity disclosure has become increasingly important. In 2025, with elevated market volatility and uncertainty about economic conditions, users demand robust sensitivity analysis. Leading practice involves presenting multiple scenarios (e.g., base case, downside case with 15% revenue decline, upside case with accelerated growth) rather than simple one-variable sensitivities.

Qualitative Disclosures

Equally important are qualitative disclosures describing:

The valuation techniques and inputs used
The level of the fair value hierarchy into which measurements are categorized
For Level 2 and 3 measurements, a description of the techniques and inputs used
For Level 3 measurements, the effect of changing unobservable inputs to reasonably possible alternatives

High-quality disclosures tell a coherent story about the valuation, explaining not just what techniques were used but why they were appropriate, how key assumptions were developed, and what uncertainties exist. This narrative approach has become standard practice among well-advised companies.

A 2024 study of FTSE 100 companies found that the median length of IFRS 13 disclosures increased to 4.2 pages, up from 2.8 pages in 2020, reflecting both increased complexity of holdings and enhanced disclosure expectations from regulators and investors.

07 Common Pitfalls and How to Avoid Them

Inappropriate Hierarchy Classification: The most frequent error involves misclassifying measurements, particularly placing Level 3 measurements into Level 2 by understating the significance of unobservable inputs. Robust documentation of the classification decision, including quantitative analysis of the impact of unobservable versus observable inputs, provides essential support.

Inconsistent Application: Companies sometimes apply different techniques to similar assets without adequate justification. For example, valuing one private equity investment using recent transaction prices while using DCF for another similar investment creates questions about consistency. While different techniques may be appropriate based on specific circumstances, the rationale must be clearly documented.

Inadequate Calibration: When actual transaction prices are available, valuation models should be calibrated to those prices. A company that sells a business unit for €150 million but had been carrying it at a fair value of €200 million faces difficult questions about the reliability of its valuation process. Regular back-testing of valuation models against actual transactions provides critical validation.

Insufficient Sensitivity Analysis: Boilerplate sensitivity disclosures that show immaterial impacts from "reasonably possible" alternatives lack credibility. Meaningful sensitivity analysis should reflect genuine uncertainty. For a technology startup valued at €50 million, showing that a 10% change in the discount rate would change value by only €2 million suggests the analysis hasn't captured true sensitivity.

08 Emerging Issues in 2025-2026

Several developments are reshaping fair value measurement practice:

Artificial Intelligence and Machine Learning Assets: As companies invest heavily in AI capabilities, questions arise about fair value measurement of these assets. Proprietary algorithms, trained models, and data sets often lack observable market transactions. Valuation approaches are evolving, with many practitioners using a combination of cost-to-recreate (for the data and training infrastructure) and relief-from-royalty (for the economic benefit of the AI capability). These measurements invariably fall into Level 3, with significant uncertainty about appropriate royalty rates and useful lives.

Cryptocurrency and Digital Assets: While major cryptocurrencies like Bitcoin and Ethereum have active markets supporting Level 1 classification, many digital assets trade on thinly traded exchanges or have restrictions that complicate classification. The collapse of several crypto exchanges in 2023-2024 has made market participants more cautious about relying on quoted prices without assessing market depth and quality.

ESG-Linked Instruments: The proliferation of sustainability-linked loans, green bonds, and ESG-contingent earn-outs creates new measurement challenges. When a loan's interest rate adjusts based on the borrower's achievement of carbon reduction targets, the fair value measurement must incorporate assumptions about both the probability of target achievement and the market's valuation of that contingency—both largely unobservable inputs.

Climate Risk Adjustments: Increasingly, fair value measurements must consider climate-related risks. A coastal property's fair value should reflect the risk of sea-level rise and increased storm frequency. A carbon-intensive manufacturing facility's value should consider the cost of future emissions regulations. These adjustments remain highly judgmental, but regulators are increasingly expecting their explicit consideration in Level 3 measurements.

09 The Role of Technology in Fair Value Measurement

Sophisticated valuation platforms have transformed fair value measurement practice. Modern systems integrate market data feeds, automate routine calculations, maintain audit trails, and generate disclosure-ready reports. These tools don't replace professional judgment but enhance consistency, efficiency, and documentation quality.

Leading organizations have implemented systematic approaches to fair value measurement that include:

Centralized valuation policies and procedures
Regular calibration of models against market transactions
Independent price verification for Level 2 and 3 measurements
Formal governance processes for significant valuation judgments
Technology platforms that ensure consistent application across the organization

The efficiency gains are substantial. A multinational corporation with hundreds of legal entities and thousands of fair value measurements can reduce the quarter-end close cycle by several days through systematic automation of routine measurements, allowing valuation professionals to focus on complex judgments and emerging issues.

10 Looking Forward: The Evolution of Fair Value Measurement

As markets evolve and new asset classes emerge, IFRS 13 will continue to be tested and refined. The International Accounting Standards Board has signaled potential future amendments addressing digital assets, intangible assets, and climate-related measurements, though no major changes are expected before 2027.

For valuation professionals, the imperative remains constant: apply rigorous methodology, maintain professional skepticism, document thoroughly, and communicate clearly. The fair value hierarchy provides a framework, but professional judgment determines the quality of the outcome.

In an environment of continued uncertainty—whether from geopolitical tensions, technological disruption, or climate change—the ability to develop supportable fair value measurements that withstand scrutiny from auditors, regulators, and investors represents a critical competency for financial professionals.

Organizations that invest in robust valuation processes, qualified professionals, and appropriate technology infrastructure position themselves for success. Tools like iValuate provide the systematic framework and market data integration that modern fair value measurement demands, enabling professionals to focus on judgment and insight rather than mechanical data gathering and calculation. As the complexity of fair value measurement continues to increase, the combination of deep technical expertise and sophisticated analytical tools becomes not just advantageous but essential for maintaining the quality and credibility of financial reporting.

IFRS 13 Fair Value Measurement: Mastering the Hierarchy in Practice