The fair value hierarchy, established by IFRS 13 (Fair Value Measurement) and its US GAAP counterpart ASC 820, categorises the inputs used to measure fair value into three levels. The hierarchy reflects the degree of observability of those inputs — from directly observable market prices (Level 1) to wholly unobservable assumptions (Level 3).
For intangible assets, the fair value hierarchy has practical consequences that go well beyond classification. The level determines the rigour of disclosure required, the degree of management judgement involved, and the intensity of audit scrutiny the valuation will face.
Almost all intangible assets are Level 3 measurements, meaning they rely on unobservable inputs and significant management judgement. Understanding this classification is essential for preparing the extensive disclosures that Level 3 measurements require and for anticipating the audit challenges they attract.
Level 1 inputs are unadjusted quoted prices for identical assets in active markets. Examples in the financial asset world include stock prices and exchange-traded commodity prices.
For intangible assets, Level 1 inputs essentially do not exist. There is no active exchange where you can look up the price of a customer relationship or a patent. Even tradeable intellectual property — such as domain names or broadcast spectrum licences — rarely has sufficient transaction frequency to qualify as an "active market."
Level 2 inputs are observable data other than Level 1 quoted prices. These include:
A small number of intangible asset valuations may qualify as Level 2. For example, a trade name valued using the Relief from Royalty method where the royalty rate is derived entirely from observable, publicly disclosed licensing transactions could be classified as Level 2 — if the other significant inputs (revenue forecast, useful life) are also corroborated by market data.
Level 3 inputs are unobservable assumptions based on the reporting entity's own data and judgement. The entity must develop these inputs using the best information available in the circumstances, which may include the entity's own data.
The classification depends on the significance of the unobservable inputs to the overall measurement, not on whether any observable data was used. Consider a customer relationship valued using MPEEM:
| Input | Observable? | Significance |
|---|---|---|
| Revenue forecast | No — management projection | High |
| Customer attrition rate | No — internal historical data | High |
| Contributory asset charges | Partially — some rates benchmarked | Moderate |
| Discount rate | Partially — built from WACC | Moderate |
| Useful life | No — management estimate | Moderate |
Because the most significant inputs (revenue forecast and attrition rate) are unobservable, the overall measurement is classified as Level 3 regardless of how many secondary inputs are market-corroborated.
The classification is based on the level of the lowest-level input that is significant to the entire measurement. Even if 80% of the inputs are Level 2, a single significant Level 3 input makes the entire measurement Level 3.
Level 3 measurements trigger the most extensive disclosure requirements under both IFRS 13 and ASC 820:
Describe the method used (RFR, MPEEM, cost approach, etc.) and why it was selected for the specific asset.
List each significant unobservable input, its value or range, and the basis for determining it. For a customer relationship: attrition rate, revenue growth assumption, discount rate premium.
Describe how changes in unobservable inputs would affect the fair value measurement. For example: "A 1% increase in the discount rate would reduce the customer relationship value by £1.2M."
For recurring Level 3 measurements (e.g., annual impairment testing of goodwill), provide a roll-forward of the balance showing gains, losses, purchases, disposals, and transfers between levels.
Plan the documentation from the start. Since almost all intangible assets will be Level 3, the valuation report must be designed from the outset to support the required disclosures. Sensitivity analysis, assumption documentation, and valuation technique justification should be integral parts of the work — not afterthoughts.
Maximise the use of observable data. While the classification may still end up as Level 3, using observable inputs wherever possible strengthens the valuation's defensibility. A royalty rate benchmarked to public licensing transactions is more defensible than one based solely on industry ranges.
Anticipate auditor challenges. Auditors focus intensely on Level 3 measurements because they involve the most judgement. Be prepared to defend every significant assumption with evidence, and maintain a clear audit trail from data sources to final values.
Attempting to classify an intangible asset valuation as Level 2 when significant inputs are unobservable is a common source of audit findings. It is better to classify conservatively as Level 3 and provide thorough disclosure than to face a reclassification challenge.
| Intangible Asset | Typical Level | Rationale |
|---|---|---|
| Broadcast spectrum licences | Level 2 | Secondary market with observable transactions |
| Taxi medallions (where tradeable) | Level 2 | Observable market prices exist |
| Trade names (strong licensing market) | Level 2-3 | Depends on royalty rate observability |
| Technology / patents | Level 3 | Revenue and useful life are unobservable |
| Customer relationships | Level 3 | Attrition and earnings forecasts are unobservable |
| Non-compete agreements | Level 3 | Probability of competition is unobservable |
| In-process R&D | Level 3 | Completion probability is unobservable |
| Assembled workforce | Level 3 | Replacement costs are estimated |
| Goodwill | Level 3 | Residual — inherently unobservable |
The fair value hierarchy is not just a classification exercise — it determines the disclosure obligations and audit scrutiny that follow every intangible asset valuation. Treat Level 3 classification as the default for intangible assets, build documentation to support the required disclosures, and use observable data wherever possible to strengthen defensibility. The Opagio Calculator documents all inputs and assumptions in a format designed for Level 3 disclosure compliance.
Tony Hillier is an Advisor at Opagio with 30 years of experience in structured finance, M&A advisory, and asset valuation. His work across regulated financial services provided deep familiarity with fair value measurement requirements. Meet the team.
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