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.
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.