Final answer:
Level 3 inputs in the fair value framework of U.S. GAAP represent unobservable inputs that require significant judgement. They are used when there is no active market for the asset or liability being valued, and examples include discounted cash flow models and option pricing models.
Step-by-step explanation:
In the fair value framework of U.S. generally accepted accounting principles (GAAP), level 3 inputs represent unobservable inputs that require significant judgement. These inputs are used when there is no active market for the asset or liability being valued. Examples of level 3 inputs include discounted cash flow models, option pricing models, and comparable company analysis.
Level 3 inputs are considered less reliable than level 1 or level 2 inputs, as they involve more subjectivity and are based on management's estimates or assumptions. They are typically used when calculating the fair value of illiquid or hard-to-value assets, such as certain derivatives, private investments, or complex securities.
It is important for companies to disclose the use of level 3 inputs in their financial statements, along with the valuation techniques and significant assumptions employed. This transparency helps investors and stakeholders understand the extent to which fair value measurements rely on management's judgement.