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.
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.