Level 3 inputs are at the bottom 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 3 input is an unobservable input. It may include the company’s own data, adjusted for other reasonably available information. These inputs should reflect the assumptions that would be used by market participants to formulate prices, including assumptions about risk. Examples of a Level 3 input are an internally-generated financial forecast and the prices contained within an offered quote from a distributor. These inputs are considered to supply the most subjective information, since they are largely derived internally.
The 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.