Certain transactions are inherently difficult to account for. Investments in illiquid financial instruments may be impossible to value without heavy reliance on unverifiable assumptions from management. Transactions that include explicit or implicit rights of return must be recorded as sales or as a bundle of options, neither of which is quite accurate. Transactions with customers that bundle short- and long-term obligations make it difficult to distinguish between current and long-term performance.

There is no end of disagreement on how to account for these “difficult transactions”, but perhaps we can all agree on this: no solution is likely to be very satisfactory because the very nature of the transactions in question impedes meaningful reporting in a summary financial statement. This possibility in turn leads me to wonder whether difficult transactions should be subject to heightened regulatory scrutiny. More to the point, perhaps we should ban publicly-traded companies from engaging in transactions that are difficult to account for.

Did I get your attention? Most accountants would blanche at this proposal because they view the accountant as a scorekeeper. Managers of the firm are supposed to run their business, and the accountant simply does the best possible job in aggregating the state and performance of the firm in financial statements. If the best possible job is not very good, well c’est la vie! The managers can find supplementary channels to convey their information, or the market may simply face more uncertainty about the firm than they otherwise would.

But decades of research on the agency problems between shareholders and the managers they employ have undermined the notion that the scorekeeper is a passive participant in the behavior of the firm. Accountants keep the score that determines how managers get paid, when debt covenants are violated, and (because regulators and tax authorities often piggyback on financial accounting standards) whether a bank is closed or a firm has a tax liability. Intelligent managers therefore choose their actions in light of how they will be scored.

But what if the accountant has no good way to keep score, because the structure of the transaction intentionally or unintentionally makes scorekeeping impossible? Difficult accounting makes the manager unaccountable to all parties who rely on summary financial statements, including Boards of Directors setting compensation, creditors monitoring their risk exposure, and regulators hoping to mitigate systemic risk or assess appropriate tax liabilities.

Banning difficult transactions is an extreme course of action, but various halfway measures are possible. Accounting standards could demand that difficult transactions are accounted for in ways managers are likely to find unpalatable (e.g., delaying gains, accelerating losses, demanding immediate recognition of liabilities and so on). Alternatively, managers who wish to engage in difficult transactions could be forced to justify those transactions to their Board of Directors.

I can imagine a number of arguments against such regulatory proposals. But it is worthwhile to note one argument that does not have much force. “You can’t restrict these transactions—they generate more economic value than the alternative.” My answer? “Good luck proving that!” By virtue of the fact that the transaction in question is difficult to account for, establishing its worth will be a challenge!