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
As investigations later discovered, Enron controlled LJM2 in many ways.
The FASB ASC now requires the consolidation of SPEs (as variable interest
entities) that are essentially controlled by their primary beneficiary.
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?