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Glossary/Accounting and GAAP

Level 3 inputs

Level 3 inputs are unobservable inputs, such as management's forecasts, discount rates, or private company multiples, used when little or no market data exists and that require the greatest audit scrutiny.

CORAA TeamUpdated November 5, 2026

Definition

Level 3 inputs under ASC 820 reflect the entity's own assumptions about what market participants would use, developed from the best information available. Common examples: discount rates and growth in projected cash flows, volatility of illiquid options, and revenue multiples adjusted for size and marketability. Fair value measurements relying on significant Level 3 inputs include contingent consideration, private investments, and some intangible valuations.

Why it matters in an audit or review

Judgment and estimation uncertainty are highest here, so AU-C 540 expects the auditor to evaluate method, data, and assumptions, and to consider whether the specialist's work (AU-C 620) is needed. Sensitivity analyses and back-testing against past estimates are useful. Public entities disclose a Level 3 rollforward and the range and weighted average of significant unobservable inputs. Nonpublic entities are not required to give the rollforward; under ASU 2018-13 they instead disclose transfers into and out of Level 3 and purchases and issues of Level 3 items.

Example

(Illustrative) A contingent earn-out is valued by probability-weighting future payments and discounting at 12%. A higher discount rate lowers the liability, and each remeasurement is recognized in earnings. The auditor tests the probabilities against forecasts and the rate against market evidence.

Common mistakes

  • Using management's budgets without checking support.
  • Forgetting that earn-out liabilities are remeasured each period.

Sources

  • FASB ASC 820-10-35 (fair value hierarchy and Level 3 inputs) and ASC 820-10-50 (disclosures)
  • FASB ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework
  • FASB ASC 805-30-35-1 (contingent consideration classified as a liability is remeasured at fair value each reporting date)
  • AICPA, AU-C Section 540, Auditing Accounting Estimates and Related Disclosures
  • AICPA, AU-C Section 620, Using the Work of an Auditor’s Specialist

Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error

Standards

ASC 820

Related terms

  • Fair value hierarchy
    The fair value hierarchy ranks inputs as Level 1 (quoted prices in active markets), Level 2 (other observable inputs) or Level 3 (unobservable inputs); a measurement takes the level of its lowest significant input.
  • Business combination
    A business combination is a transaction in which an acquirer obtains control of a business, accounted for under ASC 805 using the acquisition method at fair value.
  • Goodwill impairment testing
    Goodwill is tested for impairment at the reporting unit level under ASC 350, comparing fair value with carrying amount, while private companies may elect to amortize goodwill and test only on triggering events.

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