ASC 820 Fair Value: Understanding Level 1, 2, and 3 for Fund Managers

If you manage a fund long enough, you'll eventually have a conversation with an auditor that starts with: "Walk me through how you got to Level 2 on this position." ASC 820, Fair Value Measurement, is the standard that governs how every investment on your books gets classified — and the classification isn't cosmetic. It determines how much support you need on file and how much scrutiny a position will draw.

What the fair value hierarchy is actually measuring

ASC 820 organizes fair value inputs into three levels based on one question: how directly observable is the price? The hierarchy isn't about the asset type — it's about the quality and source of the pricing inputs used to value it. That distinction matters because two nearly identical assets can sit in different levels depending on how liquid and observable their markets happen to be at the measurement date.

Level 1: Quoted prices in active markets

Level 1 is reserved for assets with unadjusted quoted prices in active markets that the fund can access at the measurement date — publicly traded equities, exchange-traded funds, and highly liquid, exchange-traded cryptocurrencies with continuous two-sided markets are the classic examples. There's no modeling and no judgment call here: you take the quoted price, full stop. The appeal of Level 1 is its simplicity, but it's also the most misused level — plenty of positions get called "Level 1" because they trade on an exchange somewhere, even though the actual market accessible to the fund is thin, restricted, or one-sided.

Level 2: Observable inputs, but not a direct quote

Level 2 covers assets valued using inputs other than quoted prices that are still observable — quoted prices for similar assets in active markets, quoted prices for identical assets in markets that aren't active, or inputs derived from or corroborated by observable market data. A corporate bond priced using a matrix based on comparable bond yields, or a token priced using an over-the-counter quote from a reputable market maker, typically lands here. Level 2 requires more documentation than Level 1 — you need to show what the observable inputs were and how they mapped to your valuation — but you're still anchored to real market data rather than an internal model.

Level 3: Unobservable inputs and real judgment

Level 3 is where most of the audit risk — and most of a fund accountant's actual work — lives. These are assets valued using unobservable inputs, meaning the fund has to rely on its own assumptions about what a market participant would pay. Early-stage venture investments, private equity portfolio companies between financing rounds, locked or restricted tokens, and any thinly-traded or privately-negotiated position typically fall here. A Level 3 valuation might use a recent financing round as an anchor, a discounted cash flow model, a market comparables approach adjusted for company-specific risk, or an option-pricing model for instruments with optionality. What all Level 3 methods share is that the fund — not the market — is generating the key assumptions, which is exactly why auditors probe these positions hardest.

Why the classification itself is a judgment call

It's tempting to think of leveling as a mechanical lookup: "it trades on an exchange, so it's Level 1." In practice, the classification depends on facts specific to your fund's position — trading volume, any transfer restrictions or lock-ups unique to your holding, whether the market you can access is actually active, and whether the quotes available are for the identical instrument or merely a similar one. Two funds holding the same underlying asset can legitimately classify it differently if one fund's shares are subject to a lock-up and the other's aren't.

This is where I spend a disproportionate amount of my time with clients — not plugging numbers into a model, but building the documentation trail that shows why a position was classified the way it was, using the specific facts of that holding rather than a generic rule of thumb.

What auditors actually want to see

Auditors reviewing your ASC 820 disclosures are looking for three things: a documented, consistently applied valuation policy; specific support for each Level 3 input (not just "management's judgment"); and a reasonable explanation for any transfers between levels during the period. A fund that can produce a clean memo for every Level 3 position — showing the methodology, the key assumptions, and why they were reasonable — moves through audit fieldwork dramatically faster than one that reconstructs its reasoning after the fact.

A few practices make this easier across an entire portfolio: maintain a standing valuation policy document that describes your general approach by asset type; update Level 3 memos when a triggering event occurs (a new financing round, a material business change) rather than only at year-end; and require any third-party valuation specialist's work to be reviewed and understood internally, not simply filed as a black box. Auditors are increasingly skeptical of "we outsourced the valuation" as a substitute for management's own understanding of the number.

The takeaway

ASC 820 leveling isn't busywork — it's the mechanism that tells your investors and auditors how much confidence to place in a given number. Getting it right consistently, with real documentation behind every Level 3 position, is one of the highest-leverage things a fund's accounting function can do to keep its audit smooth and its financial statements credible.

If your fund holds positions that are hard to level cleanly — locked tokens, early-stage portfolio companies, thinly-traded instruments — get in touch and we can talk through how to build a defensible valuation policy for your specific portfolio.

Related: fair value for digital asset funds and fair value support services.