Level 2 inputs definition
/What are Level 2 Inputs?
Level 2 inputs are financial assets and financial liabilities that are in the mid-range of difficulty to value. They are in the middle 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. They are directly or indirectly observable inputs other than quoted prices. This definition includes prices for assets or liabilities that are (with key items noted in bold):
For similar items in active markets; or
For identical or similar items in inactive markets; or
For inputs other than quoted prices, such as credit spreads and interest rates; or
For inputs derived from correlation with observable market data.
Adjustments to Level 2 Inputs
It may be necessary to adjust the information derived from Level 2 inputs, since it does not exactly match the assets or liabilities for which fair values are being derived. Adjustments may be needed for such factors as the condition or location of assets and the transaction volume of the markets from which information is derived.
Example of Level 2 Inputs
Inscrutable Corporation has just acquired a competitor that has invested in privately-issued bonds. The CFO of Inscrutable wants to value these bonds correctly as part of the firm’s acquisition accounting. The CFO finds that the bond is not being actively traded on any active market, so there is no quoted price that can be used for valuation purposes (which would be a Level 1 input). Instead, she learns that there is a cluster of similar bond issuances that have been sold by other firms in the same industry. She conducts an analysis of these comparable bonds, noting their associated credit ratings, maturity dates, and coupon rates. These factors involve observable market data, which are Level 2 inputs. Based on this information, she concludes that the value of the bonds that the acquired business owns are now worth $825 each. She includes this value in the acquisition accounting for the acquired business.