Reference no: EM132713682

Enron Corporation's 2001 third-quarter 10-Q report disclosed the following transaction with LJM2, a nonconsolidated special purpose entity (SPE) that was formed by Enron:

• In June 2000, LJM2 purchased dark fiber optic cable from Enron for a purchase price of $100 million.
• LJM2 paid Enron $30 million in cash and the balance in an interest bearing note for $70 million.
• Enron recognized $67 million in pretax earnings in 2000 related to the asset sale. Pursuant to a marketing agreement with LJM2, Enron was compensated for marketing the fiber to others and providing operation and maintenance services to LJM2 with respect to the fiber.
• LJM2 sold a portion of the fiber to industry participants for $40 million, which resulted in Enron recognizing agency fee revenue of $20.3 million.
• As investigations later discovered Enron controlled LJM2 in many ways.
• The FASB ASC now requires the consolidation of SPEs (variable interest entities) that are essentially controlled by their primary beneficiary.

Problem 1: By selling goods to SPEs that it controlled but did not consolidate, did Enron overstate its earnings? What effect does consolidation have on the financial reporting for transactions between a firm and its controlled entities?