What are Level 1 Inputs?

Level 1 inputs are at the top of a hierarchy of information sources that range from Level 1 (best) to Level 3 (worst). The general intent of these levels of information is to step the accountant through a series of valuation alternatives, where solutions closer to Level 1 are preferred over Level 3. A Level 1 input is a quoted price for an identical item in an active market on the measurement date. This is the most reliable evidence of fair value, and should be used whenever this information is available. It may be necessary to adjust a Level 1 input when a quoted price does not represent fair value, as may be the case when significant events alter the price that parties are willing to pay. When a quoted Level 1 price is adjusted for valuation purposes, doing so automatically shifts the result into a lower level. Also, do not alter a Level 1 price just because the company’s holdings of a security are quite large in comparison to the normal daily trading volume of the relevant market. Level 1 pricing is commonly available for securities, which may be actively traded in multiple markets, such as the New York Stock Exchange or the NASDAQ.

Types of Level 1 Inputs

The types of inputs that are classified as belong within the Level 1 classification include the following:

Quoted equity securities. These are shares of public companies actively traded on major stock exchanges like the NYSE or NASDAQ. Their prices are directly observable and updated regularly, making them ideal Level 1 inputs.
Exchange-traded funds (ETFs). ETFs are investment funds traded on stock exchanges, much like individual stocks. Because their market prices are readily available, they qualify as Level 1 fair value inputs.
Government bonds (actively traded). U.S. Treasury securities and other sovereign bonds with active markets fall into Level 1. Their quoted prices are reliable and frequently updated in transparent trading environments.
Mutual fund shares (publicly traded). Some mutual funds are listed on exchanges and have readily observable prices. When their prices are quoted in active markets, they meet the criteria for Level 1 inputs.
Corporate bonds (actively traded). When corporate bonds are traded on active markets and have easily accessible market prices, they are considered Level 1. These prices are not based on models or estimates but on actual market activity.
Precious metals (traded on exchanges). Gold and silver traded on commodities exchanges like COMEX have transparent pricing. These quoted prices are considered Level 1 inputs due to their frequent and observable nature.

Presentation of Level 1 Prices

Depending on the disclosures being used by a reporting entity, it may present a table as part of its financial statements that shows the types of inputs used to derive the prices of various assets and liabilities. An example of this disclosure appears in the following exhibit.

The Fair Value Hierarchy

These three levels are known as the fair value hierarchy. These inputs are only used to select inputs to valuation techniques (such as the market approach). The three levels are not used to directly create fair values.