Key Points
- Level 1 inputs are unadjusted quoted prices in active markets for identical (not similar) assets or liabilities.
- IFRS 13.77 prohibits adjusting a Level 1 price except in three narrowly defined circumstances.
- Auditors spend less time on Level 1 valuations because the price is observable, but verifying that the market qualifies as "active" still requires evidence.
- Roughly 80% of inspection findings on fair value relate to Level 2 and Level 3 measurements, not Level 1.
What is Fair Value Hierarchy: Level 1?
IFRS 13.76 places quoted prices in active markets at the top of the fair value hierarchy because they leave the least room for management judgment. A Level 1 input is the price at which an orderly transaction would occur between market participants. The entity does not adjust the quoted price for block size, even when its holding exceeds normal daily trading volume (IFRS 13.80). If an entity holds 200,000 shares of a listed company and the closing price is €14.60 per share, fair value is €14.60 multiplied by quantity. No liquidity discount applies.
The critical audit question is whether the market is genuinely active. IFRS 13.A defines an active market as one in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis. When trading volume drops or bid-ask spreads widen beyond normal ranges, the input may slip to Level 2. ISA 540.13(a) requires the auditor to evaluate whether the entity's method for the estimate is appropriate, which at Level 1 means confirming the price source, the measurement date, and the active-market conclusion.
IFRS 13.77 permits adjustment of a Level 1 price in only three situations: when the entity holds a large number of similar (not identical) assets, when a quoted price does not represent fair value at the measurement date (for instance, a significant event occurs after market close but before the reporting date), and when the quoted price is for a liability or the entity's own equity but the item is traded as an asset. Any adjustment moves the measurement out of Level 1.
Worked example: Bergström Skog AB
Client: Swedish forestry and paper group, FY2025, revenue €75M, IFRS reporter. Bergström holds a portfolio of listed equity investments and government bonds within its treasury function.
Step 1 — Identify instruments with potential Level 1 classification
Bergström's treasury portfolio at 31 December 2025 contains three positions: 45,000 shares of Stora Enso Oyj (listed on Nasdaq Helsinki), €5M in Finnish government bonds maturing 2028 (traded on MTS Finland), and a €2M investment in an unlisted private equity fund.
Step 2 — Confirm active-market status for the listed equity
Stora Enso's 30-day average daily trading volume exceeds 1.2 million shares. Bergström's holding of 45,000 shares represents less than 0.04% of average daily volume. The bid-ask spread at 31 December 2025 is €0.03 on a closing price of €12.85. The market qualifies as active under IFRS 13.A.
Step 3 — Measure fair value of the listed equity
Fair value is 45,000 shares multiplied by €12.85, producing €578,250. IFRS 13.80 prohibits a discount for block size. The entity cannot argue that selling 45,000 shares would depress the price, because the holding is well within normal daily volume.
Step 4 — Assess the government bonds
The Finnish government bonds traded 14 times on MTS Finland during December 2025, with a total volume of €48M. The bid-ask spread at year-end is 8 basis points. This qualifies as an active market for a sovereign instrument. Fair value: €5M nominal at a clean price of 98.72, producing €4,936,000. Accrued interest is presented separately.
Conclusion: Bergström classifies the listed equity at €578,250 and the government bonds at €4,936,000 as Level 1 fair values, supported by active-market evidence and unadjusted quoted prices. The private equity fund proceeds to a Level 3 assessment.
Why it matters in practice
Teams classify instruments as Level 1 without documenting that the market is active at the measurement date. A bond that traded actively in June may have negligible volume in December. IFRS 13.A requires ongoing pricing information, and the auditor's file should contain evidence of trading activity around the reporting date, not merely the existence of a listed price. ISA 540.20 expects the auditor to evaluate whether the data and assumptions supporting the measurement are relevant to the measurement date.
Entities sometimes apply a liquidity discount or portfolio-level adjustment to a Level 1 quoted price when selling the full position would take several days. IFRS 13.69 and IFRS 13.80 are explicit: the unit of account determines quantity, but the quoted price per unit is not adjusted for the size of the holding. Any such adjustment reclassifies the measurement to Level 2.
Level 1 vs. Level 2 inputs
| Dimension | Level 1 | Level 2 |
|---|---|---|
| Price source | Quoted price in an active market for the identical item | Observable inputs other than Level 1 quoted prices (quoted prices for similar items, yield curves, implied volatilities) |
| Adjustment permitted | No adjustment to the price, except in three narrow IFRS 13.77 exceptions | Adjustments allowed for differences in condition, location, or market activity |
| Auditor effort | Verify active-market status and price source; limited judgment involved | Evaluate the model, inputs, and any adjustments applied to arrive at fair value |
| Typical instruments | Listed equities, actively traded government bonds, exchange-traded derivatives | Corporate bonds with infrequent trading, interest rate swaps valued from yield curves, real estate valued from comparable sales |
| Disclosure | IFRS 13.93(b) requires the level classification; no sensitivity analysis needed for Level 1 | IFRS 13.93 requires the level classification plus a description of the valuation technique |
The practical consequence: reclassifying an instrument from Level 1 to Level 2 increases the auditor's work because ISA 540.18 requires evaluation of the valuation technique, the inputs, and any adjustments. A Level 1 price requires verification of the source and the active-market condition. That difference in audit effort often surfaces during planning.
Related terms
Frequently asked questions
Does a closing price from 31 December always count as Level 1?
A 31 December closing price qualifies as Level 1 only if the market was active on that date. If the exchange was closed on 31 December (common in some European markets), the entity uses the last available price from the most recent active trading day, provided no significant event occurred between that date and the reporting date. IFRS 13.79 addresses measurement-date considerations. If a material event intervened, adjusting the price moves the input to Level 2.
How do I classify a mutual fund or ETF in the fair value hierarchy?
If the fund publishes a daily net asset value at which the entity can transact and redemptions occur with sufficient frequency, the NAV functions as a quoted price in an active market. IFRS 13.BC155 acknowledges that a NAV per unit can serve as a Level 1 input when the fund is open-ended and transactions at NAV occur regularly. A closed-end fund trading on an exchange uses the exchange-quoted price as its Level 1 input.
Does Level 1 require the entity to use the bid price or the ask price?
IFRS 13.70 permits use of the price within the bid-ask spread that is most representative of fair value in the circumstances. For assets, the bid price is common; for liabilities, the ask price. IFRS 13.71 does not mandate one side of the spread. The entity applies its policy consistently and discloses the approach.