Definition
The term Level 2 asset refers to a hierarchy framework that includes assets and liabilities whose values are based on models and have inputs that are observable. Companies are required to value certain assets and liabilities at their current value, not historical cost. The hierarchy framework used to value these assets includes three levels, with Level 2 requiring the use of a mathematical model.
Explanation
Generally Accepted Accounting Principles require companies to record certain assets at their current value, not historical cost. The three approaches used to determine these values include mark-to-market, mark-to-model, and mark-to-management. These processes were developed so assets appearing on a company's balance sheet reflected their true value, which can materially differ from historical cost.
Guidance is provided in Statements of Financial Accounting Standards No. 157, Fair Value Measurements, which describes both the fair value hierarchy as well as the disclosure requirements for assets and liabilities not recorded at historical cost. Generally, Level 2 assets are valued using a mark-to-model approach, which requires a combination of market prices and internal data.
Level 2 falls in the center of this hierarchy, and includes assets and liabilities that possess values determined using relatively simple models and / or extrapolated from prices quoted in an active marketplace. Examples of Level 2 assets and liabilities include interest rate swaps, securities that are not actively traded such as municipal bonds, currency swaps, loans, mortgage-related assets and derivatives.
Related Terms
Also known as a statement of financial position, the balance sheet is used to show the financial health of a company at a particular point in time. The balance sheet consists of assets, liabilities, and owner's equity in the company. It is one of the four key financial statements issued by public companies.
Moneyzine EditorJanuary 8th, 2024
The financial accounting term Historical Cost Principle refers to a valuation technique used in the preparation of financial statements. The Historical Cost Principle states the value of an asset or liability is recorded on the balance sheet at its cost at the time of acquisition.Moneyzine EditorJanuary 19th, 2024
The term mark-to-market refers to an accounting process that records the value of certain assets and liabilities at their current market price, not historical cost. Mark-to-market accounting rules are typically applied to actively-traded assets such as stocks, bonds and similar securities.Moneyzine EditorJanuary 24th, 2024
The term mark-to-model refers to an accounting process that records the value of certain assets and liabilities using a mathematical or financial model, not historical cost. Mark-to-model accounting rules are typically applied to complex financial instruments that are not actively traded.Moneyzine EditorJanuary 24th, 2024
The term mark-to-management refers to an accounting process that records the value of certain assets and liabilities using a combination of market and internal information, not historical cost. Mark-to-management accounting rules are typically applied to Level 3 assets, which are not actively traded or management's judgment is required due to volatility in the market.Moneyzine EditorJanuary 24th, 2024
The term Level 1 asset refers to a hierarchy framework that identifies assets and liabilities possessing the most transparent and tangible values. Companies are required to value certain assets and liabilities at their current value, not historical cost. The hierarchy framework used to value these assets includes three levels, with Level 1 being the easiest to verify.Moneyzine EditorJanuary 23rd, 2024
The term Level 3 asset refers to a hierarchy framework that includes assets and liabilities whose values are based on complex mathematical models and internal inputs. Companies are required to value certain assets and liabilities at their current value, not historical cost. The hierarchy framework used to value these assets includes three levels, with Level 3 requiring mathematical models as well as the expertise of internal subject matter experts.Moneyzine EditorJanuary 23rd, 2024
