Ind AS 113 Fair Value Measurement — The Three-Level Hierarchy Explained
If you have ever wondered how a company decides what price to put on an asset it rarely sells — or a liability it rarely settles — you are already thinking about Ind AS 113. This standard does one focused job: it tells you how to measure fair value whenever another Ind AS requires or permits it. It does not tell you when to use fair value; that is the job of standards like Ind AS 109 or Ind AS 40.
Let us walk through the most important concept in this standard — the three-level fair value hierarchy — in a way that actually sticks.
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What Is Fair Value Under Ind AS 113?
Fair value is the price you would receive to sell an asset, or the price you would pay to transfer a liability, in an orderly transaction between market participants at the measurement date. Two words matter enormously here:
- Orderly — not a distress sale or a forced liquidation.
- Market participants — independent, knowledgeable buyers and sellers, not your related parties.
The standard also anchors fair value to the principal market (the market with the highest volume and activity for that asset), or, if no principal market exists, the most advantageous market (the one that maximises the net amount received).
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Why a Hierarchy at All?
Not every asset has a live stock-market ticker. Some assets trade daily; others barely trade at all. The hierarchy simply ranks the quality of the information (called inputs) you use to arrive at fair value. Higher quality = more observable = more reliable = lower level number.
Think of it this way: if you can read the price off a screen, that is the gold standard. If you have to build a model with your own assumptions, that is the last resort.
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Level 1 Inputs — The Gold Standard
Definition: Quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date.
Key word: identical. Not similar, not comparable — identical.
Everyday logic: Imagine your company holds 1,000 shares of a large listed company. The BSE shows a closing price of ₹450 per share. You simply multiply 1,000 × ₹450. No judgment, no model, no assumption. That quoted price is the fair value. You cannot adjust it for a 'block discount' just because selling 1,000 shares at once might move the market — Ind AS 113 does not allow that adjustment at Level 1.
Exam tip: If an asset has a quoted price in an active market, you must use it. You cannot skip Level 1 and move to Level 2 because you prefer a model.
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Level 2 Inputs — Observable but Indirect
Definition: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.
Level 2 covers situations where you still rely on real market data, but the data is not a direct quote for your identical asset. Common examples:
- Quoted prices for similar (not identical) assets in active markets.
- Quoted prices for identical assets in markets that are not active.
- Observable inputs such as benchmark interest rates, credit spreads from market data services, or foreign exchange rates.
Worked logic: Suppose your company owns a commercial property in Pune. An identical property has not sold, but three comparable properties nearby sold last month at prices implying ₹8,500–₹9,000 per sq ft. You adjust for differences (floor, age, amenities) using observable data. The resulting price sits at Level 2 because your primary input is real market evidence, just not a direct quote.
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Level 3 Inputs — Unobservable
Definition: Inputs that are not based on observable market data — they reflect the entity's own assumptions about what market participants would use.
You arrive at Level 3 when there is little or no market activity for the asset. Here you build a valuation model (discounted cash flow, option-pricing model, etc.) and feed it with your own internally developed assumptions — expected cash flows, growth rates, discount rates, probability weights.
Worked logic: A startup holds an equity stake in an unlisted subsidiary that operates in a niche segment. No comparable transactions exist. The accountant builds a DCF model, projects five years of cash flows, applies a risk-adjusted discount rate, and adds a terminal value. Every key input comes from internal estimates. This is Level 3.
Important: Level 3 does not mean the measurement is wrong. It means it needs more disclosure — the entity must explain its valuation techniques, significant unobservable inputs, and sensitivity analysis.
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Classifying the Measurement — The Lowest Level Rule
Here is a rule many students miss: the classification of the entire fair value measurement depends on the lowest-level input that is significant to the measurement.
So if you are pricing a bond and 90% of your model uses observable rates (Level 2) but one critical input — say, an entity-specific credit risk adjustment — is unobservable, the whole measurement is classified as Level 3. One significant unobservable input pulls everything down.
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Quick Summary Table
| Level | Input Type | Example | |-------|-----------|--------| | 1 | Quoted price, identical asset, active market | Listed equity shares on BSE/NSE | | 2 | Observable, indirect or similar | Comparable property sales; benchmark swap rates | | 3 | Unobservable, entity's own assumptions | DCF for unlisted subsidiary; intangible asset model |
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Disclosures — Why They Matter in Exams
Ind AS 113 requires entities to disclose the level of the hierarchy for each class of asset/liability measured at fair value. For Level 3, disclosures are more extensive — including a reconciliation of opening and closing balances and sensitivity information. Exam questions often ask students to identify the level and justify the disclosure requirement, so always link your answer back to the input type.
(Always verify specific disclosure requirements and any recent amendments in the latest ICAI study material / announcement before your exam.)
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FAQs
Q1. Can a company choose Level 2 instead of Level 1 to avoid volatility? No. If a reliable Level 1 input exists, the standard requires you to use it. You cannot move to a lower-priority level simply because the quoted price creates earnings volatility.
Q2. Does Ind AS 113 apply to share-based payments and lease liabilities? No. Ind AS 113 explicitly excludes measurements that look similar but are governed by other standards — such as Ind AS 102 (Share-based Payment) and Ind AS 116 (Leases). Always check the scope section. Verify any further exclusions in the latest ICAI study material / announcement.
Q3. What is the difference between 'transaction price' and 'fair value' at initial recognition? Transaction price is what you actually paid or received. Fair value is the exit price a market participant would use. In most cases they are equal at initial recognition, but if they differ, Ind AS 113 and the relevant standard guide you on how to account for the 'Day 1' difference.
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Mastering Ind AS 113 is about understanding the logic behind each level, not just memorising definitions. Once you connect the level to the quality of evidence, exam questions become far easier to navigate. To build a structured daily revision routine around topics like this, use the free day-by-day study planner at caparveensharma.com/free-planner?src=article. And if you want to test your understanding through real case-scenario practice — the kind that mirrors actual exam questions — explore the courses at caparveensharma.com. CA Parveen Sharma's 36 years of teaching experience are packed into every resource, designed to make complex standards feel simple and exam-ready.