Cable Television Act of 1992
Federal RegisterApr 15, 1994
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FEDERAL COMMUNICATIONS COMMISSION
47 CFR Part 76
[MM Docket No. 93-215, CS Docket No. 94-28; FCC 94-39]
Cable Television Act of 1992
AGENCY: Federal Communications Commission.
ACTION: Final rule.
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SUMMARY: The Commission has adopted a Report and Order and a Further
Notice of Proposed Rulemaking establishing rules to implement the cost
of service alternative to the primary benchmark/price cap approach to
setting regulated cable service rates. The Further Notice of Proposed
Rulemaking (FNPRM) segment may be found elsewhere in this Federal
Register. The Report and Order sets forth regulatory requirements to
govern cost-of-service showings for cable operators who elect to
justify rates above levels determined under benchmark/price cap
requirements. The Report and Order, summarized here, adopts a
regulatory model based on the cost-of-service formulation that permits
cable operators to recover reasonable operating expenses and a fair
return on investment, while protecting consumers from unreasonably high
rates. Although the Report and Order adopts requirements designed to be
consistent with the Commission's telephone ratebase/rate of return
formula, the requirements are simpler and easier to administer than the
telephone model and can accommodate individual case review. The Report
and Order establishes (1) procedural and filing requirements for cost-
of-service showings; (2) rules for determining the cable operator's
ratebase; (3) rules for determining the appropriate level of
recoverable expenses; (4) an interim overall return of 11.25% on
ratebase; (5) accounting and cost allocation requirements; (6)
accounting and cost allocation requirements for external cost
treatment; (7) requirements for affiliated transactions; (8)
streamlined filing requirements for small systems; (9) streamlined
filing requirements for network upgrades; (10) procedures for emergency
rate review based on a showing of special circumstances; and (11) an
experimental Upgrade Incentive Plan.
EFFECTIVE DATE: May 15, 1994.
FOR FURTHER INFORMATION CONTACT:
JoAnn Lucanik (202) 416-1163; Paul D'Ari (202) 416-1166; John Adams
(202) 416-1165.
SUPPLEMENTARY INFORMATION: The text of this document is available for
inspection and copying during normal business hours in the FCC
Reference Center (Room 239), 1919 M Street, NW., Washington, DC 20554,
and may be purchased from the Commission's copy contractor,
International Transcription Service, (202) 857-3800, 2100 M Street,
NW., Washington, DC 20037.
Synopsis of the Report and Order
The Commission began its implementation of the 1992 Cable Act with
an initial Notice of Proposed Rulemaking (Notice of Proposed Rulemaking
in CC Docket No. 93-215, FCC 93-353, 58 FR 40762, released July 30,
1993), and established initial rules to implement the Cable Act of 1992
in the Rate Order.\1\ The Commission adopted a benchmark and price cap
approach to serve as the primary regulatory mechanism for setting
initial regulated rates and for governing rates on a going forward
basis. The Commission also concluded in the Rate Order that the
benchmark/price cap framework might not produce fully compensatory
rates in all cases, and accordingly decided to permit cable systems to
establish rates based on costs pursuant to individual cost-of-service
showings. The cost-of-service approach was to serve as a backup to the
benchmark/price cap mechanism which a cable operator could invoke if it
believed that the maximum rate under the benchmark/price cap formula
would not enable the operator to recover costs that it reasonably
incurred in the provision of regulated cable services.
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\1\Implementation of Sections of the Cable Television Consumer
Protection and Competition Act of 1992, Rate Regulation, Notice of
Proposed Rulemaking in MM Docket No. 92-266, 58 FR 48, released
January 4, 1993; (NPRM); Report and Order and Further Notice of
Proposed Rulemaking, 58 FR 29736, released May 21, 1993 (Rate
Order); Second Further Notice of Proposed Rulemaking in MM Docket
No. 92-266, 58 FR 41042, released August 18, 1993 (Second Notice);
First Reconsideration Order, Second Report and Order, and Third
Further Notice of Proposed Rulemaking in MM Docket No. 92-266, 58 FR
4678, released Sept. 29, 1993 (First Rates Reconsideration); Third
Report and Order in MM Docket No. 92-266, 58 FR 60141, released
November 15, 1993.
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The Rate Order concluded that the use of the benchmark/price cap
approach as the primary regulatory mechanism, and the use of a cost-of-
service safety valve as a supplemental mechanism, for regulating cable
services is fully consistent with the applicable statutory
requirements. However, the record in MM Docket 92-266 did not provide
sufficient information to allow for development of detailed cost-of-
service rules for the cable industry. Accordingly, the Commission
indicated that general cost of service principles would apply for cost-
of-service showings for the time being, and the present proceeding was
initiated by issuing a Notice of Proposed Rulemaking that invited
comment on the adoption of cost-of-service goals and rules, and on the
role that a cost-based approach to ratemaking should play in our
regulation of cable service rates.\2\
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\2\Notice of Proposed Rulemaking in MM Docket No. 93-215, FCC
93-353, 58 FR 40762, released July 30, 1993 (Notice).
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This Report and Order establishes rules implementing a cost of
service alternative to our primary benchmark and price cap approach to
setting regulated cable service rates.\3\ In this Report and Order the
following regulatory requirements to govern cost-of-service showings
are adopted:
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\3\In a separate decision, the Commission is adopting
significant modifications to the benchmark and price cap approach to
setting regulated cable service rates. Implementation of Sections of
the Cable Television Consumer Protection and Competition Act of
1992: Rate Regulation, MM Docket 92-266, Second Order on
Reconsideration, Fourth Report and Order, and Fifth Notice of
Proposed Rulemaking, FCC 94-38 (Benchmark Order).
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The regulatory requirements adopted in the Report and Order are on
an interim basis, pending completion of cost studies of the cable
industry as described elsewhere in the FNPRM. The interim rules, which
apply only in cases where the cable operator elects to rely on a cost-
of-service showing rather than on benchmark/price cap requirements,
will apply to rates charged or to be charged after the effective date
of the cost rules; general cost of service principles will govern rates
in effect prior to the effective date of these rules. Thus, to the
extent that a franchising authority's examination of basic rates
relates to both periods, it would apply the appropriate rules to each
period. The Commission will take a similar approach to resolve cable
programming complaints that cover both periods. Subsequent cable
programming service complaint proceedings or basic tier proceedings
relating to rates while the interim rules remain effective will be
determined in accordance with the interim rules if the cable operator
elects to justify rates as cost-based. If the permanent rules differ
from the interim rules, the permanent rules will apply to proceedings
relating to rates after their effective date.
Cost of Service Rates Effective
The Report and Order requires that the rate established in a cost-
of-service proceeding is the permitted rate, even if it is lower than
the rate that would have been determined under the benchmark/price cap
approach. Once a rate is established through a cost-of-service
proceeding, the rate will be governed by the price cap mechanism.
(1) Procedural and Filing Requirements
Two year interval and election by cable operator only. The Report
and Order requires that after setting initial regulated rates under
either the benchmark or cost-of-service approach, absent a special
showing, operators may not file a cost-of-service showing to justify a
new rate for two years. This two-year period will be measured from the
effective date of the rates set in a local or Commission decision. The
Report and Order finds that a period of two years is a reasonable
frequency limitation and will adequately reflect changes in both cost
and revenue. A two-year period will also allow for the development of
regulatory stability, and the reduction of regulatory burdens. This
approach will lessen the administrative burdens of duplicative cost-of-
service showings, while furnishing operators a reasonable opportunity
to recoup the costs of providing regulated cable services. Although the
rules adopted in the Report and Order do not foreclose a cable
operator's presenting new cost-of-service data to justify a rate that
exceeds the capped rate after a two-year period, multiple cost-of-
service showings should be rare, since future adjustments to rates are
provided for under the price cap mechanism. The Commission may find it
reasonable, following a cost-of-service showing, to set rates that
include a scheduled reduction or other adjustment; or may establish
rates that are not expected to change, other than under the price cap,
pending subsequent cost-of-service showings.
The Report and Order does not allow for local franchising
authorities to initiate cost-of-service proceedings or general data
collections. Any benefits that might be derived from such a provision
would be outweighed by the cost, and could conflict with the statutory
requirement to minimize the administrative burdens of rate regulation.
Moreover, the primary benchmark/price cap approach to setting rates
will assure that rates for regulated cable service are reasonable.
Accordingly, the election to choose to set rates pursuant to a cost-of-
service showing remains with the cable operator, the Report and Order
does not provide for local authorities to initiate cost of service
regulation.
Presumptive standards. While the rules adopted in the Report and
Order are of general applicability, the rules establish presumptive
standards that operators may seek to overcome in individual
proceedings. Thus, in certain circumstances, as described further in
the Report and Order, operators can present evidence seeking to justify
higher rates than would otherwise be permitted under the cost rules.
This provision assures that application of the cost rules will not
adversely impact the cable industry, and achieves the goal of assuring
that cable operators can recover reasonable costs of providing service
in high cost areas. Thus, the cost of service alternative provides a
safeguard for the industry from possible adverse effects in individual
cases of the primary, benchmark/price cap approach and from any adverse
effects resulting from general applicability of the cost rules.
Cost of service form. The Report and Order adopts the use of a
uniform cost of service form. Use of a form will lessen administrative
burdens for industry and regulators by providing uniformity in
presentation and review of cost information. The cost of service form
will provide a clear standard for the cost support required from
operators, and permit easy comparison with previously filed
information. The Report and Order adopts a general cost of service form
and a simplified cost of service form for small systems; operators
seeking to justify rates based on cost of service are required to use
one of these two forms. Form 1220 is the general cost of service form
in hard copy; Form 1225 is the simplified version of the cost of
service form, for small systems, in hard copy. The forms are being
released as separate documents. Operators may attach additional
worksheets to explain form entries or unusual circumstances. In
addition, cable operators must submit with their cost of service form,
FCC Forms 1200, 1210, 1211, and 1215 to show the rate that will be
permitted under the benchmark/price cap approach.
For purposes of evaluating proposed rates in pending cost-of-
service proceedings for the period that commences after the effective
date of these new cost rules, the Report and Order requires that all
cable operators with pending cost-of-service proceedings for any
regulated tier file the cost of service forms that are being adopted
with this Report and Order by July 14, 1994.
(2) Rules for Determining Ratebase
The Report and Order adopts the used and useful and prudent
investment standards to govern amounts that may be included in the
ratebase. The used and useful and prudent investment standards allow
into the ratebase portions of plant that directly benefit the
ratepayer, and exclude any imprudent, fraudulent, or extravagant
outlays.
Valuation of ratebase at original cost. The Commission considered
various approaches to determining the value of plant included in the
ratebase, including: Market value, original cost, replacement cost,
reproduction cost, a combination of these approaches, and other
approaches that were proposed by commenters. The Report and Order notes
that under applicable judicial precedent, regulators have wide
discretion to select a methodology for purposes of valuating ratebase,
provided that the end result is reasonable, and the approach selected
should be the one that best implements the goals for cost-based rates
of cable service.
The Report and Order concludes that an original cost approach is
most likely to produce fair and reliable valuations of plant in
service, and allows the best opportunity for balancing operators'
reasonable recovery of costs with consumers' payment of rates that
reflect only costs reasonably incurred in providing regulated service.
The Report and Order goes into considerable detail addressing the other
methods proposed by commenters for valuation of the ratebase, and finds
that none of the other valuation approaches provides the same
reliability and fairness as the original cost valuation approach.
For purposes of the cable cost-of-service rules, the Report and
Order defines original cost as the actual money cost (or the money
value of any consideration other than money) of property at the time it
was first used to provide cable service. Costs for both constructed and
purchased systems will be subject to scrutiny by the appropriate
regulatory authority to determine whether the investment was prudent
and the plant is used and useful.\4\
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\4\The regulator may examine whether the construction costs were
reasonable, whether plant is operating at a reasonable level of
capacity, and whether costs are properly apportioned between
regulated and nonregulated activities. In this respect the
Commission requires operators subject to regulation under section
623 of the Communications Act, 47 U.S.C. 543, to keep, maintain and
protect records subject to regulations adopted in this Report and
Order for a period of not less than 5 years. The Commission has
authority to take this action under sections 4(i) and 623 of the
Communications Act, 47 U.S.C. 4(i) and 543.
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The Report and Order notes that original cost is the normal, now
traditional method used for public utility valuation, and is the method
this Commission has long used for telephone companies. By relying on
actual expenditures rather than speculative or contentious valuation
methods, original cost is far more likely to achieve the desired
result: Reasonable rates for customers, a fair opportunity for a
reasonable return for operators, and reduce administrative burdens. The
practical benefits of original cost valuation in general are that it is
less administratively burdensome on all involved, and well understood.
Thus, unlike the other valuation approaches, original cost does not
require estimates of current values that may be difficult or expensive
to determine, and that are in any event likely to be largely matters of
opinion. Unlike market-based valuation methods, it does not present the
problem of circularity, where the valuation method chosen itself
affects the value that the market is likely to place on the system. It
is also not constantly changing as the economy, technology, and
customer needs change. Original cost valuation is also recognized and
defined, and used for financial accounting purposes, as part of
Generally Accepted Accounting Principles (GAAP). Indeed, it has been
the Commission's policy in recent years to bring its regulatory
accounting into conformance with GAAP as far as possible.\5\ Use of
original cost for cable systems will help implement this policy and
minimize regulatory accounting burdens.
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\5\See, e.g., Revision of Uniform System of Accounts, Classes A,
B, and C Telephone Companies, CC Docket No. 78-196, Report and
Order, 51 FR 43498, Dec. 2, 1986. Continuing this Commission's
reliance on GAAP, the Commission directs that GAAP shall generally
apply in our regulation of cable rates, unless specifically noted
otherwise.
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The Report and Order took note of the numerous comments arguing
that original cost is often simply unascertainable, and found that
there is validity in this argument in some cases for purchased systems.
The Report and Order acknowledges that use of an estimated original
cost when actual original cost is not available is provided for under
telephone regulation, 47 CFR 32.2000(b)(2)(ii). Because this approach
creates the need for individual scrutiny not only of the estimated
original cost but also of underlying ``particulars,'' this is not a
preferred alternative to original cost for cable services regulation.
However, the Report and Order determines that in the event that an
operator does not possess adequate records of original cost, the
operator will be permitted to estimate original cost. The operator will
be required to show the basis for the estimate with supporting
documentation. In addition, the Report and Order permits valuation of
tangible plant in service at the book value recorded by the operator at
the time of acquisition, if the operator can demonstrate that book
value approximates original cost. All cost showings for acquired
systems must include the book value of tangible plant in service as
recorded at the time of acquisition, as required on Forms 1220 and
1225.
The Report and Order recognizes that original cost valuation, like
any valuation methodology, has theoretical limitations--in this case,
that it is a backward-looking approach to costs. However, these
limitations do not prevent it from being a practical, workable
foundation for establishing the value of tangible plant in service. To
the extent that use of original cost for computing the ratebase affects
the risks that investors may assign to cable systems, the Report and
Order takes account of such risks in determining a reasonable rate of
return that will allow the system to operate successfully and attract
the necessary capital. Thus, in setting the rate of return, the
Commission has adopted a rate toward the high end of the zone of
reasonable returns, as a cautious approach to assure continued
incentives for future investment.
Accumulated start-up loses. The Report and Order concludes that
some accumulated start-up losses, to the extent that they reflect
operating losses in the early years of the system, should be included
in the ratebase. These losses could be considered to meet the used and
useful standard in that it is frequently necessary for businesses
during a start-up phase to sustain a period of losses prior to
profitability. As such, the losses benefit customers because it is
necessary for the operator to incur them in order to bring future
service to subscribers. There is a concern, however, that current
customers not be burdened with excessive or unreasonable costs from
previous periods of operation; that cable operators' recovery of these
costs not be unlimited in time, especially after the losses have been
recouped; and that subscribers not pay for losses incurred in
expectation of recovery of future supra-competitive profits.
The Report and Order relies on Financial Accounting Statements
Board Standard No. 51 (``FASB 51'') which suggests that a two-year
period is a reasonable and representative start-up time for cable
systems. Based on the record, the Report and Order determines that this
period would permit recovery of losses necessary for start-up of a
cable system, and that a subscriber base is likely to be well
established by the end of the second year of operation. Therefore, an
allowance is made for recovery in the ratebase of accumulated start-up
losses that are equal to the lesser of the first two years of operating
costs or accumulated losses incurred until the system reaches the end
of its prematurity stage as defined by FASB 51. The Commission believes
that losses incurred during this period are most directly linked to the
creation of the system that is currently providing services to
subscribers.
Cable operators are, of course, free to make a showing that
demonstrates the appropriateness of a practical adjustment to this rule
in light of their particular circumstances. Operators are also free to
present evidence to rebut disallowance of other accumulated losses. In
challenging this or any presumptive disallowance, the operator must
present detailed evidence demonstrating that the cost has produced a
tangible benefit for subscribers that would not have existed but for
the cost; and that the relevant plant is used and useful in the
provision of regulated cable service, and represents a prudent
investment. The operator may present evidence that allowance is
necessary for compensatory rates. In making its determination, the
regulatory authority should take into account the effect that allowance
of these will have on the operator's rates in comparison to rates that
would have developed in a competitive environment, and whether
allowance of these costs will produce reasonable rates.
The Report and Order finds that these accumulated start-up losses
may be included in the ratebase, and the operator may earn on them the
reasonable rate of return as defined below. However, these accumulated
losses must be amortized over a reasonable period. The Report and Order
finds that presumptively this amortization period should not be longer
than fifteen years. The Report and Order requires the cable operator to
submit detailed evidence of the effect the amortization period has on
rates in comparison to competitive rates of similar systems. The Report
and Order allows the regulatory authority, after careful scrutiny, to
revisit the amortization period if it will produce unreasonable rates.
The Report and Order holds that, unless otherwise provided by this
Commission, amortization, for purposes of the rules adopted in this
proceeding, shall be computed on the straight-line method, i.e., equal
amounts shall be recovered in each year of the amortization period.
This approach has been applied successfully in common carrier
regulation; see 47 CFR Sec. 32.2000(h). Finally, recovery of these
costs is permitted only to the extent that they are recorded on the
company's books as such. The amortization of allowed start-up losses
must begin at the end of the prematurity phase of operation, and should
generally be completed during the service life of the longest-lived
depreciable assets.
Other losses. The Report and Order concludes that other losses are
presumptively excluded from the ratebase: These include continuing
operating losses after the system reaches maturity (for these purposes
a system reached maturity as defined by FASB 51, i.e., presumptively
within two years), and accumulated losses associated with amortization
of disallowed goodwill or interest expenses associated with disallowed
goodwill. This treatment is appropriate because these costs presumably
benefited past subscribers, or were incurred in the expectation of
monopoly profits or profits from nonregulated activities, and thus
should not be borne by current and future subscribers.
Cable operators have the opportunity of making a showing to
overcome this presumption. Such a showing would demonstrate that these
costs benefit both current and future ratepayers, and that they were
prudently invested in plant that is used and useful in the provision of
regulated services. Operators may also present evidence that allowance
is necessary to produce compensatory rates.
Treatment of intangibles. The Report and Order addresses the
treatment of intangibles in the ratebase. In instances where there is a
lack of effective competition, as in the period prior to the adoption
of the Cable Act of 1992, the Report and Order finds that acquisition
prices are likely to include amounts paid in expectation of supra-
competitive profits and growth premiums for unregulated services.
Traditional principles of ratemaking and the policies embodied in the
Cable Act of 1992 also warrant disallowance of costs that do not
represent reasonable costs of providing regulated services to
customers, equivalent to the costs that would be incurred under
competition. This generally includes acquisition costs recorded as
goodwill. The Report and Order makes clear that disallowance of these
costs, contrary to some parties' assertions, is not a penalty but part
of the normal and proper balancing of the interests of investors and
ratepayers.
However, the Report and Order finds that operators are correct in
pointing out that some intangible costs do represent cost of providing
service that are legitimately included in the operator's ratebase or
revenue requirement. This is true whether the operator is an original
owner or a purchaser of an established system. Further, such allowance
is consistent with the Commission's Part 32 rules, which allow
telephone companies to recover intangible costs related to ``organizing
and incorporating the company, original costs of franchise rights,
patent rights, and other intangible property having a life of more than
one year.'' (47 CFR 32.2690). These costs produce assets that provide
benefits to subscribers and are reasonably recoverable from
subscribers.
To balance investors' and ratepayers' interests fairly, the Report
and Order holds that in some cases intangible costs are presumptively
allowed in the ratebase. Intangible costs that are generally reasonable
costs of providing service, that would be incurred under competition,
and that are used and useful in the provision of regulated services,
are properly recoverable in rates. In some cases intangible costs may
be included in the ratebase; in other cases, they may be treated as an
expense, and amortized over a period of years. The Report and Order
holds that other intangible costs, including goodwill, will be
presumptively excluded.
Organizational costs. The Report and Order finds that
organizational costs are presumptively allowed into the ratebase to the
extent they are prudently invested and are useful in the provision of
regulated cable service. Organizational costs typically consist of the
cost of organizing and incorporating the company. They will ordinarily
have been incurred by the entity originally providing cable service in
the franchise area in question. These organizational costs should
represent costs that benefit customers, in that they must necessarily
be incurred for the entity to be able to provide service. See 47 CFR
32.2690. The Report and Order however presumptively disallows from this
category stock given to the organizer the value of which is in excess
of reasonable salary.
The Report and Order allows operators to continue to recover their
capitalized organizational costs based on GAAP through amortization
over a reasonable period, subject to scrutiny by the appropriate
regulatory authority as to the reasonableness of rates produced by the
recovery period. However, the Report and Order notes that it is not
necessarily the case that the time period until renewal of a franchise
is the appropriate capitalization period for organizational costs,
because generally there is an expectation of franchise renewal.
Proponents of some period other than the franchise period should
support their proposal.
Franchise costs. The Report and Order concludes that the original
costs associated with a government franchise are allowed into the
ratebase if the costs: (1) Are associated with the costs of winning the
franchise; and (2) in the case of purchased systems, are costs that
were directly borne by the seller. The Report and Order finds that
these costs are presumptively allowed to the extent they are prudently
invested and are useful in the provision of regulated cable service.
The Report and Order notes that original costs of government franchises
are often allowed into the ratebase under traditional cost-of-service
principles, because they must necessarily be incurred for the entity to
be able to provide service. (See 47 CFR 32.2690). The Report and Order
holds that operators will be allowed to continue to recover their
capitalized franchise right based on GAAP through amortization over a
reasonable period, subject to scrutiny by the appropriate regulatory
authority as to the reasonableness of rates produced by the recovery
period.
Customer lists. The Report and Order finds that customer lists,
too, are presumptively allowed into the ratebase, to the extent that
they reflect costs capitalized during prematurity, as defined by FASB
51, and are prudently invested and useful in the provision of regulated
cable service. Operators will be allowed to continue to recover these
costs through amortization over a reasonable period based on GAAP,
subject to scrutiny by the appropriate regulatory authority as to the
reasonableness of rates produced by the recovery period.
Acquisition costs. The issue of whether the acquisition costs of
cable systems should be considered or accepted for computing ratebases
and revenue requirements overlaps to a degree with the question of the
plant valuation method that should apply. But the Report and Order
emphasizes that the two matters are distinct, especially under the
particular circumstances presented by the reimposition of cable service
rate regulation by the Cable Act of 1992. Regardless of the valuation
method that might be applied now and in the future, the issue cable
operators raise is whether the cost-of-service methodology should
recognize the prices paid for cable systems in the past, especially
during the period when systems were unregulated. The Report and Order
concludes that the prices paid for cable systems, especially during the
period when those systems possessed market power, are not a reliable or
reasonable basis for ratemaking, and that excess acquisition costs, or
``goodwill'', are therefore from ratebase.
The Report and Order defines ``goodwill'' as the portion of plant
purchase price that cannot be assigned specifically to identifiable
property acquired and that is not recorded on the operators' books of
account as accumulated losses, subscriber lists, franchise rights,
patent rights or organizational costs. The Report and Order concludes
that ``goodwill,'' including going-concern value, should be
presumptively disallowed from the ratebase because it is likely to
represent expectations of supra-competitive profits and other outlays
that should not be borne by regulated service customers.
The Report and Order recognizes the importance and controversy that
this issue generates, both for operators and customers, because many
cable systems changed hands during the years when cable service was
essentially unregulated, and in many cases the prices paid exceeded the
original cost or the book value of the purchased cable system's
tangible assets. These costs to the buyer, termed ``excess acquisition
costs,'' are generally recorded as ``goodwill''. The Report and Order
addresses the many arguments made by cable operators for recognition of
acquisition costs for computing costs of service. Cable operators
claim, variously, that the price paid is either a measure of the fair
value of the system, or the proper valuation for assets brought into
regulation, or a proper exception to the usual valuation rules to
recognize the need for a transition tailored to the characteristics of
the cable industry, or a constitutional requirement to prevent
confiscation.
The Report and Order sustains the Commission's belief that the
prices paid for cable systems, especially during the period when those
systems possessed market power, are not a reliable or reasonable basis
for ratemaking, and that their use is not required or supported by
public utility practice, the purposes of the Cable Act of 1992, or the
Constitution. The Report and Order notes that on the FCC's own analysis
conducted as part of the development of governing rates set under the
benchmark approach, and the study submitted in support of the use of
acquisition prices, the Kolbe/Vitka Study, by Viacom, one of the
largest cable operators, in reaching the conclusion that acquisition
prices often include some expectation of supra-competitive profits that
the market power of cable systems operating in a less than fully
competitive environment could expect to generate. The Report and Order
notes that the magnitude of this expectation probably varied over time,
increased by the growing list of cable channels that could be obtained
only by subscribing to cable service, and discounted by investors'
assessment of the risks of competitive entry and re-regulation. Buyers
and sellers negotiating acquisition prices clearly took into account
the competitive status of cable systems and their consequent market
power. Individual investors purchasing shares in cable companies no
doubt also included this factor.
The Report and Order further notes that it is likely that
acquisition prices included assessments of the profits that might be
gained from emerging cable services that remain unregulated but could
be expected to experience more rapid growth and penetration than those
services that were made subject to regulation. Premium services such as
HBO and Showtime, pay-preview services, interactive services such as
home shopping, and other offerings all represent newer sources of
profit with greater potential for expansion. System prices can
reasonably be expected to include the potential earnings for these
actual and planned offerings. Moreover, it is certainly possible that
even arm's-length transactions resulted in prices that were simply too
high; transactions were based upon overly optimistic projections of
growth, the direction of the economy, and the buyer's ability to reduce
operating costs or increase the value to customers. The Report and
Order finds that acceptance of these prices as a fair measure of the
value of the facilities used to provide regulated services would
require customers for those services to act as guarantors of the
recovery of those prices, regardless of how inflated they might have
been. Such allowance would not be appropriate or reasonable or in the
public interest.
The Report and Order points out that traditionally, such excess
acquisition costs have been partly or wholly excluded from the ratebase
of regulated concerns, because these costs are seen as inappropriate
costs for ratepayers to bear. (E.g., 47 CFR 32.2005, 32.2007; San Diego
Land & Town Co. v. National City, 174 U.S. 739, 757-758 (1899); Simpson
v. Shepard (Minnesota Rate Cases), 230 U.S. 352, 454 (1913)). This is
because these costs typically benefit the seller, not the ratepayer;
they do not contribute to the plant supporting regulated service. The
Report and Order also notes that disallowance of goodwill for monopoly
cable systems is consistent with findings of the United States Tax
Court in Tele-Communications, Inc. v. Commissioner of Internal Revenue,
95 T.C. No. 36 (1990).
The Report and Order holds that the decision to disallow
acquisition costs, to the extent they include capitalized supra-
competitive profits, is consistent with, if not indeed compelled by,
the theory and purposes of the Cable Act of 1992. The Act does not
instruct the consideration of acquisition costs or the prices
individual shareholders paid for cable companies before the adoption of
the Act. The language and legislative history of the Cable Act of 1992
demonstrate a primary concern with preventing the undue market power of
cable operators subject to neither regulation nor effective competition
from setting supra-competitive rates. The Report and Order concludes
that allowance of the acquisition price of cable systems as part of the
costs of service would present a substantial probability of passing on
to customers costs that reflect neither the costs of providing service
nor the costs that would be incurred under competition.
Operating efficiencies provide rebuttable presumption. The Report
and Order recognizes that there may be sales of cable systems, as some
commenters claim, that benefit subscribers by generating operating
efficiencies that are unobtainable by the seller. The Report and Order
finds that it is appropriate to consider whether these efficiency gains
warrant inclusion of some part of the goodwill in the rate calculation.
However, in any such case, the Report and Order requires that the
operator clearly rebut the presumption against including goodwill by
demonstrating the nature and value of the net efficiency gains and,
most importantly, that these gains resulted in concrete, tangible
benefits to subscribers, especially in the form of better and more
varied regulated services. Efficiency gains that permitted the buyer to
improve its margins but did not benefit subscribers will not lay the
foundation for allowing goodwill to be included in the rates
subscribers pay.
The Report and Order requires that operators wishing to overcome
the presumption that goodwill is excluded from inclusion in the
ratebase demonstrate that allowance of these costs will result in
reasonable rates, that the costs are the result of an arm's-length
transaction, and that the goodwill has produced for subscribers
concrete benefits that would not have been realized otherwise. To the
extent that the operator seeks to justify rates above competitive
levels based on inclusion of goodwill, there is a heavy presumption
against inclusion of these costs. Operators making such a showing will
be required to show the nature of each cost they are seeking to justify
for inclusion in the ratebase, and should provide all pertinent data
relating to the acquisition. At a minimum, this includes the purchase
price of plant, its book value, a description of plant, the effect on
subscribers, the results of a valuation study, and the results of any
request for franchise approval.
The Report and Order provides that in reviewing such showings, the
franchising authority or the Commission is to scrutinize the extent to
which inclusion of these costs will produce rates above competitive
levels. To the extent that they do, the operator will need to
demonstrate why its particular situation justifies inclusion of these
costs in the ratebase.
Plant under construction. The Report and Order adopts the
capitalization method to govern ratemaking treatment of plant under
construction. The capitalization method is the traditional method for
considering plant under construction. Under this approach, plant under
construction is excluded from the ratebase, but the operator calculates
an allowance for funds used during construction (AFUDC) and includes
this allowance in the cost of construction. As construction is
completed and the plant is placed into service, the cost of
construction (including AFUDC) is included in the ratebase and
recovered through depreciation. This method has been used by various
regulatory authorities to provide reasonable rates for utilities.
Further, this method will allow operators to recover interest from the
construction period only after the plant is placed in service. Interest
is to be computed at prime rate or at the operator's demonstrated cost
of the funds used for the construction. AFUDC is allowed only to the
extent the related costs are not already included in start-up losses.
Cash working capital. The Report and Order adopts a presumption of
a zero allowance for cash working capital. The Report and Order finds
that cable subscribers are generally billed in advance for regulated
cable services, and billed in arrears for nonregulated services such as
pay-per-view. Cable operators generally pay vendors, employees, and
taxing authorities in arrears. The Report and Order also notes that it
is possible, where receipts lead outlays, to establish a negative cash
working capital allowance. Given these circumstances, the Report and
Order finds it appropriate to adopt a presumption that a zero allowance
is needed to support the regulated cable services. A cable operator may
rebut the presumption by establishing that its operations do not fit
the industry mold, and that it requires the establishment of a cash
working capital allowance.
Excess capacity. The Report and Order concludes that operators are
allowed to include in the ratebase any excess capacity that will be
used within a twelve-month period. As with start-up losses, recovery of
these costs is allowed only to the extent that they are recorded on the
company's books as such. The amortization of allowed costs must begin
at the end of the prematurity phase of operation, and should generally
be completed during the service life of the longest-lived depreciable
assets. This will generally be no longer than fifteen years.
The Report and Order notes that the price cap adjustment and
network upgrade plans (discussed below) make adequate provision for the
addition of channels and capacity. Thus, while there is an allowance in
the ratebase for any facilities that are not currently used and useful,
but will be used and useful within one year, if they are included in
the ratebase, they may not in any part be reflected in annual operating
expenses or in any price cap adjustment. This will assure that no
double or excessive recovery of costs, and no double payment for
capacity, can occur.
Cost overruns. The Report and Order determines that cost overruns
should be presumptively disallowed from the ratebase. Subscribers
should not bear the burden for unnecessary, extravagant, or imprudent
expenses, which cost overruns may be. At the same time, however, the
Report and Order recognizes that cable operators should be able to
recover the costs of overruns that have occurred through no fault of
the operator. Therefore, cable operators may overcome this presumption
on a case-by-case basis by showing that the costs were prudently
invested. In reviewing such showing, factors that will be considered
include whether the overrun was preventable, who was responsible for
the overrun, and whether including the overrun in the ratebase will
produce reasonable rates.
Premature abandonments. The Report and Order finds that the cost of
premature abandonments should be a recoverable operating expense rather
than an element in the ratebase. In removing prematurely abandoned
plant from the ratebase, a cable operator must bring plant to full
recovery before retiring it. Plant that has never entered into service
cannot be retired and expensed, but is disallowed. To retire plant, the
operator must remove both plant and accumulated depreciation reserve
from the balance sheet. Once the plant is retired, an operator may
amortize the unrecovered investment (i.e., the original cost less
accumulated depreciation) over a term equal to the remainder of the
original expected life.
(3) Rules for Determining Recoverable Expenses
Operating expenses. The Report and Order permits recovery of all
operating expenses normally incurred by cable operators in the
provision of regulated cable service. Thus cable operators may recover
fully the reasonable costs of providing regulated service, and
subscribers are protected from paying rates that reflect costs not
reasonably associated with regulated services. The Report and Order
affirms the decision to exclude from recovery those operating expenses
and other costs unrelated to the provision of regulated cable service.
Generally, costs incurred in the provision of regulated cable service
are recoverable if legitimate and reasonable. The Report and Order
directs that the Commission and local franchising authorities review
operating expenses in each cost showing to assure that they are in
conformance with the cost standards.
The Report and Order also adopts the tentative conclusion that
certain special expenses (47 CFR 76.924 (f) and (g)) are presumptively
excluded from recovery as not reasonably related to the provision of
regulated cable services. Cable subscribers should not be responsible
for reimbursing cable operators for unreasonable costs. Further, the
Report and Order concludes that GAAP should guide the determination of
what costs are to be expensed and what capitalized.
Depreciation. The Report and Order declines to adopt the tentative
conclusion to prescribe depreciation rates. The Report and Order finds
that prescription of depreciation rates is unnecessary, at least
pending completion of the cost study and analysis that the Cable Bureau
is to undertake. See, FNPRM elsewhere in this Federal Register.
Further, the Report and Order finds that a depreciation prescription
requirement would impose unjustified burdens without providing a
balancing benefit to subscribers. Instead, the Report and Order directs
regulators to monitor industry depreciation practices closely, and to
review depreciation showings in individual cost proceedings carefully
to assure that these depreciation practices are reasonable. In
addition, the Report and Order notes that the Commission and local
franchising authorities will examine depreciation practices of
operators in individual cases to assure that resulting rates are
reasonable.
Taxes. The Report and Order develops a method of income tax
treatment that permits recovery of income taxes regardless of the form
of ownership of the regulated cable service enterprise. The Report and
Order maintains the principle that taxes related to the provision of
regulated service may be recovered from subscribers, but taxes on
dividends paid to owners may not. The Report and Order affirms the
tentative conclusion that Chapter C corporations will be allowed to
include in annual expense calculations all taxes on the provision of
regulated cable service. For other ownership forms of cable operators--
subchapter S corporations, partnerships, sole proprietors--the income
tax allowance is to be determined as follows: The permitted rate of
return on the ratebase is first calculated; this amount is adjusted to
remove any portion of the previous year's distributions after
adjustment for capital contributions and interest paid; the resulting
sum, the amount retained in cable operations, will constitute the cable
operator's earnings subject to the income tax calculation. The allowed
income tax will be calculated by applying the grossed-up federal and
state statutory corporate tax rates (as opposed to individual tax
rates) to the amount calculated as subject to the income tax
calculation, regardless of the actual business form. The calculated tax
amount may then be included in calculating the total revenue
requirement.
The Report and Order notes that while traditional cost-of-service
regulation allows for recovery of allowable tax expense on an annual
basis, it is possible that cable rates set by cost of service will not
be reviewed, nor any further cost support submitted, for a substantial
period of time. Retained earnings depend closely upon the cable
system's current financial requirements. Because this is a showing the
Commission does not intend to revisit, proposed tax expense in a cable
cost-of-service showing should incorporate an adjustment of retained
earnings to reflect likely changes. The following illustration of tax
calculation methodology adjusts retained earnings over a three-year
period:
------------------------------------------------------------------------
Year 1 Year 2 Year 3
------------------------------------------------------------------------
1. Ratebase...................... 1000000 1000000 1000000
2. Allowed Return (@ 11%)........ 110000 110000 110000
3. Less Interest Expense......... (10000) (10000) (10000)
4. Tax Gross-up:
5.Allowed Taxable Return......... 100000 100000 100000
6.Distributions.................. 50000 25000 160000
7.Capital Contributions.......... 0 25000 10000
8. Amount Subject to Tax calc.... 50000 100000 (50000)
9. Tax allowed at corp. rate (@
estimate 34% grossed up)........ 25758 51515 (25758)
10. Revenue Requirement:
11.Allowed Return................ 110000 110000 110000
12.Tax Allowed................... 25758 51515 (25758)
13.Expenses...................... 500000 500000 500000
14. Total Revenue Requirement.... 635758 662515 584242
15. Cumulative Tax Allowed:
16.Beginning Balance............. 0 25758 77273
17.Current Provision............. 25758 51515 (25758)
18.Ending Balance\6\............. 25758 77273 51515
------------------------------------------------------------------------
\6\Explanation of terms and calculations:
1. Line 3: An eleven percent rate of return is used only for purposes of
illustration.
Line 6: A portion of distributions made must be associated with the
provision of regulated cable services.
Line 7: A portion of contributions made must be associated with the
provision of regulated cable services.
Line 8: Tax allowed is determined by subtracting distributions from
allowed return and adding the amount of capital contributions. The
amount of contributions added shall be no more than the amount of
distributions for the period, however.
Line 9: The rate used in this illustration is a federal tax rate grossed
up as follows: (.34/(1-.34))=.51515)
2. Lines 8-9 of Year 3 demonstrate that, where distributions offset the
total of allowed return and capital contributions, the amount subject
to the tax calculation may be negative. In effect, this calculation
would require operators to pay back to subscribers the tax benefits
associated with earnings that had been achieved previously but were
distributed in the current period. Since no annual adjustment will be
made, this offset should be reflected in an operator's one-time
showing.
The Report and Order does not require the three-year calculation
shown above. However, it does require that cost-of-service showings
that include a tax allowance show some calculation of likely changes in
retained earnings.
The Report and Order also adopts the Commission's tentative
conclusion that cable operators may include state and federal taxes,
such as property and sales taxes, incurred on the provision of
regulated cable service as an operating expense regardless of business
form.
Test year methodology. The Report and Order adopts the use of an
adjusted historic test year. The test year may be adjusted for ``known
and measurable'' changes that have occurred by the time the rates take
effect. The Report and Order further finds that the historic test year
should be the operator's fiscal year. Thus, cost-of-service showings
must be based upon the operator's most recently completed fiscal year.
In the case of a cost-of-service showing arising in response to a
complaint, the fiscal year should be the one most recently completed at
the time of the filing of the complaint. In the case of new systems,
for which no historic data are available, projected data may be used,
but careful scrutiny shall be paid to the assumptions used.
(4) Use of Unitary 11.25% Rate of Return
A major component of the ratemaking methodology for cable operators
that elect cost-of-service regulation is the rate of return those
operators will be given an opportunity to earn on their allowed
ratebase. The Report and Order prescribes an interim, overall rate of
return of 11.25% for use in cable cost-of-service proceedings.
Uniform rate of return. The Report and Order finds that the record
confirms that the burden of establishing an individualized rate of
return for each cable operator that elects cost-of-service regulation
would be substantial. Such an undertaking would require cable operators
to present, and franchising authorities or the Commission to review,
analyses of matters such as the risks individual cable systems
encounter in providing regulated cable service and the sources of
capital available to finance those risks. Not persuaded that it is
necessary for cable operators and regulators to undertake such analyses
to ensure that cable operators can attract the capital needed to
provide regulated cable service, the Report and Order defines a uniform
rate of return for use by all cable operators in cost-of-service
showings.
Presumptive. The Report and Order acknowledges that some cable
operators may believe that the overall rate of return is inadequate to
compensate them for the risks they encounter in providing regulated
cable service. Similarly, consumers may find this overall rate
excessive, given the individual operator's specific circumstances. To
ensure the reasonableness of all rates set in cable cost-of-service
proceedings, the Report and Order states that parties to such
proceedings are not foreclosed from attempting to justify different
rates of return. Parties that seek rates of return different from the
prescribed interim rate of return, or any subsequently prescribed rate
of return, bear a heavy burden. In particular, each cable operator
seeking a higher rate of return is required to show exceptional facts
and circumstances that make its cost of capital for regulated cable
services exceed the prescribed rate of return, and must demonstrate
that those facts and circumstances will persist. All necessary
supporting information shall be included in the challenging cable
operator's initial cost-of-service showing. Similarly, local
franchising authorities may collect and consider evidence that the
operator's cost of capital for the individual system is lower than the
prescribed rate. The Commission will review all evidence relied upon by
local franchising authorities in setting rates of return different from
the prescribed rate.
General methodology. The Report and Order determines to use the
weighted average cost of capital as the methodology for establishing
the rate of return. The Report and Order describes in detail each of
the components: Cost of equity, cost of debt, and capital structure.
This weighted average cost of capital approach assumes a post-tax
return on equity.
In applying this methodology, an estimate of the cost of the
capital contributing to the provision of regulated cable service is
required, since most cable companies have diverse operations. The
record provided no company which engaged only in provision of regulated
cable service. Thus, the Commission selected surrogate firms to
represent the risks of regulated cable for capital analysis.
The Report and Order notes that the surrogate firms must operate a
levels of risks comparable to those of regulated cable service in order
to be consistent with the fundamental goal of determining the return
required to compensate investors for the perceived risks of regulated
cable service and to attract capital to that service. In choosing
surrogate firms, recognition is given to the limitations imposed by the
available information. Because different kinds of information are
available with regard to cost of equity, cost of debt, and capital
structure, each of these components of the overall cost of capital is
addressed separately.
Cost of equity. The Report and Order espouses the principle that
the ideal cost of equity estimate should accurately reflect investor
expectations as to the returns, in terms of both capital gains and
dividends, investors will earn. Since investor expectations are not
directly measurable, a variety of indirect methods are used. The Report
and Order reviews the methods used by commenters in this proceeding,
which fall into three categories: risk premium, discounted cash flow
(DCF), and comparable earnings. Commenters submitted four studies,
using the capital asset pricing model (CAPM) version of the risk
premium method, one study relying upon the DCF method to analyze the
Standard & Poors 400 (S&P 400), and one applying the comparable
earnings methodology. In Attachment D to the Report and Order, these
three methods of estimating the cost of equity are described and
analyzed.
The Report and Order concludes that the DCF methodology will be
applied to the S&P 400 to develop the cost of equity for companies
providing regulated cable service. The Report and Order and the
separate attachment present the basis for rejecting commenters'
arguments against use of the DCF methodology and against the use of the
S&P 400 as a surrogate, and rejects other approaches suggested in the
cost of equity studies by commenters. Thus, the Report and Order
affirms the tentative proposal in the Notice to apply the DCF method to
the companies composing the S&P 400. (Notice at 52).
The DCF method, like the other methods the parties advocate,
requires an assessment of the risks of regulated cable service in
comparison to those of the chosen surrogate. The record provides little
definitive analysis of the risks of regulated cable service and thus
does not make clear which specific subgroup of the S&P 400 regulated
cable most resembles in terms of risks. Given the paucity of the
record, the Report and Order determines that the S&P 400 should be
viewed broadly and a broad zone of reasonableness for the cost of
equity should be defined. Based on the Vander Weide analysis, estimates
for the cost of equity for regulated cable service are between 11.80%
(the midpoint of the DCF cost of equity estimates for the first
quartile of the S&P 400) and 15.11% (the midpoint of the DCF cost of
equity estimates for the third quartile). The Report and Order finds
that these estimates provide reasonable outside bounds for the cost of
equity for regulated cable service, approximately 12% and 15%. The
Report and Order adopts use of this range, in combination with other
elements of the weighted average cost of capital, to develop a zone of
reasonable rates of return for regulated cable service.
Cost of debt. The record on the cost of debt includes compilations
of debt costs for specific cable operators. The information is both
industry-specific and concrete. The Report and Order concludes that it
appropriate to rely on this information, instead of S&P 400 data, as a
surrogate for the cost of debt for regulated cable service, because it
is industry-specific and provides a sufficient basis for estimating
that cost of debt. Thus, the tentative conclusion to rely on the cost
of debt of the surrogate is rejected.
The cost of debt found by Vander Weide for six cable companies was
7.8%. AUS found an 8.5% cost of debt based on 1992 data and notes it
would be lower with more recent data. Several parties suggest higher
debt costs, but provide no supporting documentation. Adelphia's SEC
Form 10K for 1993 states that its floating note interest rates ranged
from LIBOR plus 1.0% to LIBOR plus 1.5%. Its March 31, 1993 average
debt rate was 8.65%. TCI's SEC Form 10K for 1991 states 55% of its debt
was fixed rate, with an average cost of 9.9% and 45% percent was
variable rate, floating at the prime rate. The prime rate on February
18, 1994, was 6% and LIBOR was 3.56% (90 day) and 3.75% (180 day).
The Report and Order computes the range for the average cost of
fixed rate debt established by this information for the most recently
available period (1992-93) as 7.8% to 8.65%. The Report and Order
determines that the reasonable estimate of the cost of debt for cable
is 8.5%. In addition to reflecting historical debt costs, this rate
allows for an increase in the cost of floating rate debt above current
rates.
Capital structure. The Report and Order addresses the
recommendations of commenters that provided analysis of the capital
structure for the cable industry as requested in the Notice. The Report
and Order notes the difficulty encountered in evaluating current cable
industry practices. The Report and Order evaluates the proposals for
establishing a capital structure and discusses in detail the problems
arising with each proposal. The Report and Order further notes that the
long-term average capital structure of the industry is not clear at
this time. Thus, instead of adopting a single capital structure, the
Report and Order finds that a capital structure range, for use in the
determination of the overall cost of capital for regulated cable
operations, is appropriate. Based on the record, the Report and Order
determines that a wide range of capital structures, extending from 40%
debt to 70% debt, is justified, and is consistent with the range for
cost of equity estimates and the cost of debt.
Overall cost of capital. The Report and Order reviews
recommendations for establishing an overall cost of capital, and
reflects on requirements of The Cable Act of 1992 that the cable rate
regulations provide cable operators the opportunity to earn ``a
reasonable profit'' while ``protecting subscribers * * * from rates * *
* that exceed what would be charged * * * if such cable system were
subject to effective competition.'' 46 U.S.C. 623(b)(2)(C)(vii) and
(b)(1), respectively. Companies regulated under this standard must be
allowed an opportunity to earn a return sufficiently high to maintain
financial integrity and attract new capital. At the same time, the
prescribed return must not produce rates that are unreasonable. The
courts have recognized that there is a zone of reasonableness within
which reasonable rates may fall, and that regulatory agencies have
broad discretion to select a return within that zone.
Given this standard, the Report and Order develops its
determination of a reasonable range for the cost of equity for
regulated cable service, cost of debt, and a reasonable range for the
capital structure. The following table combines all these elements and
presents the overall cost of capital implied by these ranges.
Calculation of Overall Rate of Return Debt Portion of Capital Structure
------------------------------------------------------------------------
In percent
---------------------------
40 50 60 70
------------------------------------------------------------------------
Equity estimate (in percent):
12...................................... 10.6 10.3 9.9 9.6
13...................................... 11.2 10.8 10.3 9.9
14...................................... 11.8 11.3 10.7 10.2
15...................................... 12.4 11.8 11.1 10.5
---------------------------
Average............................... 11.5 11.0 10.5 10.0
------------------------------------------------------------------------
Debt Cost: 8.50 percent.
No particular weight is given to any one cell in this table.
Instead, consideration is given to the averages that are produced, as
shown on the last row. Based on these averages, the Report and Order
finds that the overall cost of capital for regulated cable service lies
within a ``zone of reasonableness'' of 10.0% to 11.5%.
The Report and Order notes the concerns in selecting a rate within
this zone, since the record is less than perfect. Also, the risks of
regulated cable operations are not known with certainty, since those
risks are dependent in part on the cost-of-service rules and principles
adopted in this Order and on the revised benchmark methodology.
Additionally, there is a recognized desire to encourage infrastructure
development. Thus, the Report and Order determines that prescribing a
return toward the upper end of the zone of reasonableness will enable
cable operators to attract the capital needed to provide regulated
cable service and to expand their regulated offerings. Based on these
considerations, the Report and Order prescribes an overall cost of
capital of 11.25%.
Interim rate. The Report and Order notes that the rate of return
prescription is an interim one. The FNPRM (published elsewhere in this
Federal Register) seeks information on the relative risks of cable
operations given recent actions by the FCC, and further analysis of S&P
400 companies' costs of capital.
(5) Accounting and Cost Allocation Requirements
Existing requirements. Under existing rules, regulated cable
operators are required to maintain their accounts in accordance with
GAAP. 47 CFR 76.924(b). They are also required to maintain their
accounts in a manner that will allow for identification of appropriate
costs and application of cost assignment and cost allocation procedures
necessary for rate adjustments to reflect changes in external costs and
for cost-of-service showings. 47 CFR 76.924(c). In addition, for
accounting purposes, cable operators are generally required to
aggregate expenses and revenues at either the franchise, system,
regional or company level in a manner consistent with the practices of
the operator as of April 3, 1993. 47 CFR 76.924(d). (The initial rules
erroneously identified this date as April 3, 1992. The rules adopted
with this Report and Order correct this error). Costs associated with
franchise fees, franchise requirements, local taxes, and local
programming must be identified at the franchise level. Id.
Interim summary level accounts. The Report and Order adopts an
interim summary accounting system for use by cable operators that elect
cost of service regulation. This interim summary account system will be
required until a permanent system of accounts is in place. Cable
operators that elect cost of service regulation shall identify costs in
55 summary level accounts contained in FCC Form 1220. This form
requires that cost-of-service showings include a balance of broad
summary level investment, expense, and revenue categories.
The Report and Order expresses concern that even this summary
accounting approach may be burdensome for some small systems. In order
to provide further relief to small systems, the summary level of
accounts that small operators are required to report as a part of the
cost of service filings are aggregated further. The Report and Order
thus, adopts the requirement that small cable system operators may
identify their costs in FCC Form 1225, which contains 32 summary level
accounts.
Filing instructions. With regard to the level at which these
accounting requirements apply, the Report and Order requires that cable
operators electing cost-of-service regulation identify all amounts
associated with each revenue and cost category, as provided for in FCC
Forms 1220 and 1225, at the franchise, system, regional and/or company
level, depending upon the organizational level at which the operator
identified revenues and costs for accounting purposes as of April 3,
1993. (Sec. 76.924(c)). The FNPRM (published elsewhere in this Federal
Register) will provide for cost studies to explore the extent to which
operators should be permitted or required to report average costs at
levels different than those in effect on April 3, 1993.
Further, the Report and Order requires cable operators to provide
any additional financial data and explanations reasonably requested by
franchising authorities and the FCC to substantiate cost-of-service
showings or other related proceedings. Where a reasonable response is
not forthcoming, franchising authorities and the Commission are
authorized to make such disallowance as are appropriate, pending the
presentation of convincing evidence by cable operators.
Cost allocation requirements. The Report and Order finds that it is
necessary to require allocation of costs to nonregulated service
categories to help ensure that the allocation of costs to regulated
services is fair and reasonable in relation to the allocation of costs
to nonregulated services. The current rules require that costs be
allocated among the basic service tier and each tier of cable
programming service. 47 CFR 76.924(e)(2). The Report and Order amends
the rule to require that, in addition to the basic and cable
programming service tiers, cable operators shall allocate costs to
nonregulated programming service activities, other cable activities,
and non-cable activities.
The Report and Order requires that, after revenues and costs are
identified at the appropriate organizational level(s), cable operators
shall allocate costs among the equipment basket (47 CFR 76.923(d)) and
the following service cost categories: Basic service, cable programming
services, nonregulated cable programming services, other cable
activities and non-cable activities. These allocations shall be used
for cost-of-service showings and for allocating external costs. For the
purpose of allocating their costs and revenues among the service cost
categories and the equipment basket in cost-of-service proceedings,
cable operators shall use FCC Form 1220 or FCC Form 1225 (for use by
small cable system operators).
The Report and Order also requires direct assignment of all costs,
to the extent possible, among the equipment basket and the service cost
categories. Direct assignment applies when costs are incurred
exclusively to support the equipment basket or a specific service cost
category. For example, most programming charges from program suppliers
relate to specific programming. Those charges should therefore be
directly assigned to the tier on which the programming is offered. In
making this determination, the Report and Order modifies the existing
requirement that, with a few exceptions, cost categories identified at
the franchise level be generally allocated to the basic tier based on
the ratio of channels in the basic tier to the total number of channels
offered in the franchise area, and that costs allocated to each tier of
cable programming be based on the ratio of channels in each cable
programming services tier to the total number of channels offered in
the franchise area. The Report and Order finds that when direct
assignment is possible, it is preferable to a standard allocator
because, while cost allocation provides an estimate of the origination
of certain costs, direct assignment is simpler to apply, and more
accurately reflects cost causality.
The Report and Order requires that cable operators allocate among
the service cost categories and the equipment basket any costs that
cannot be directly assigned, using methodologies that are consistent
with the procedures in Sec. 76.924(f)(5). These procedures require
that, when direct assignment is not possible, operators must first
attempt to allocate costs through direct analysis of their origin. 47
CFR 76.924(f)(5)(i). Where direct analysis is not possible, operators
must attempt to establish cost-causative linkage to other costs
directly assigned or allocated by direct analysis. 47 CFR
76.924(f)(5)(ii). Finally, where no direct or indirect linkage can be
made, operators are required to allocated on the basis of the totals of
all costs directly assigned and allocated using direct assignment,
direct analysis and indirect linkage. 47 CFR 76.924(f)(5)(iii). The
Report and Order requires the Commission and local franchising
authorities to review the allocators proposed by cable operators on a
case-by-case basis to determine whether the allocators achieve
reasonable results.
The Report and Order maintains the current requirement that cable
operators allocate costs that were identified at higher levels to the
franchise level on the ratio of the total number of subscribers at the
franchise level to the total number of subscribers served at the higher
level. 47 CFR 924(e)(1). The Report and Order amends the rule, however,
to specify the particular procedures that must be followed for
allocating costs to the franchise level. First, recoverable costs that
have been aggregated at the highest organizational level at which costs
have been identified are allocated to the next (lower) organizational
level at which recoverable costs have been identified on the basis of
the ratio of the total number of subscribers served at the lower level
to the total number of subscribers served at the higher level. Second,
this procedure is repeated at every organizational level at which
recoverable costs have been identified, until all costs have been
allocated to the franchise level.
(6) Accounting and Cost Allocation Requirements for External Costs
Definition. External costs are categories of costs that cable
operators may pass through to subscribers without a cost-of-service
showing under our price cap rules. Such costs include retransmission
consent fees, other programming costs, taxes, franchise fees, and costs
of other franchise requirements. See Sec. 76.922(d)(3).
Treatment for rate adjustments. To provide for a readily
ascertainable basis for proposed external cost adjustments, the
accounting and cost allocation rules adopted in this Report and Order
will apply to external cost calculations. The Report and Order requires
that the following external costs be identified at the franchise level:
Franchise requirements, franchise fees, local taxes and local
programming. Cable operators are required to identify all other
external costs at the franchise, system, regional and/or company level,
depending upon the organizational level at which they identified costs
for accounting purposes as of April 3, 1993. These costs shall be
identified on FCC Form 1210. After external costs have been identified
at the appropriate organizational level(s), cable operators are
required to allocate such costs among the service cost categories and
the equipment basket in the manner specified for cost-of-service
showings.
With respect to the specific requirements for allocating certain
external costs, the Report and Order requires that the costs of
programming and retransmission consent be allocated to the service cost
category on which the signal or programming is offered. The phrase
``tier'' on which the programming or broadcast signal at issue is
offered'' is replaced with the phrase ``service cost category in which
the programming or broadcast signal at issue is offered.'' See
Sec. 76.924(f)(1) (emphasis added). The Report and Order also requires
that the costs of public, educational, and governmental access channels
carried on the basic tier be directly assigned to basic service cost
category where possible. The Report and Order modifies the allocation
requirements for franchise fees. Under the current rule, ``franchise
fees shall be allocated among equipment and installations, program
service tiers and subscribers in a manner that is most consistent with
the methodology of assessment of franchise fees by local authorities.''
Consistent with the treatment of Sec. 76.924(f)(1), the phrase
``program service tiers'' is replaced with the phrase ``service cost
categories.'' See Sec. 76.924(f)(2). While the franchise fee should be
allocated among the equipment basket and the service cost categories as
the rules currently require, the rules should not list subscribers as a
category to which such costs should be allocated. The equipment basket
and the service cost categories are the only appropriate categories for
allocation purposes. As already noted, the cost of franchise fees must
be identified at the franchise level.
The Report and Order also modifies existing rules to require that,
to the extent possible, all external costs be directly assigned among
the service cost categories. When direct assignment is possible, it is
preferable to a standard allocator because it is simpler to apply and
it more accurately reflects cost causality. For those external costs
that cannot be directly assigned, the Commission requires that cable
operators propose specific allocators that reasonably allocate costs
among the service cost categories and the equipment basket. The
Commission and franchising authorities shall review the allocators
proposed by cable operators on a case-by-case basis and determine
whether the allocators achieve reasonable results.
For the purpose of establishing external costs at the franchise
level, the Report and Order retains the current requirement that cable
operators allocate costs that were identified at higher levels to the
franchise level on the ratio of the total number of subscribers at the
franchise level to the total number of subscribers served at the higher
level. However, the Report and Order amends the rules to specify the
particular procedures that must be followed for allocating costs to the
franchise level in the case of adjustments to external costs as well as
cost of service regulation.
(7) Requirements for Affiliate Transactions
The report and Order adopts rules for affiliate transactions that
will apply to cable operators who either elect cost-of-service
regulation or seek to adjust benchmark/price cap rates for affiliated
programming costs. For those operators electing to use the benchmark/
price cap approach, the affiliate transaction rules will only be
applicable to affiliate transactions involving programming. In Docket
No. 92-266, under price caps, cable operators may pass-through
affiliated programming costs that exceed inflation as long as the
prices charged to the affiliated cable system operators reflect either
prevailing company prices offered in the marketplace to third parties
(where the affiliated program supplier has established such prices) or
the fair market value of programming. First Order on Reconsideration at
114.
Under the rules adopted in the Report and Order, cable operators
that elect cost-of-service regulation or who seek to adjust benchmark/
price cap rates for affiliated programming costs shall be required to
apply valuation methods that are similar to those telephone companies
are now required to apply. Although the rules for telephone companies
specify the manner of accounting for affiliates transactions, the
affiliate transaction rules adopted for cable operators in this Report
and Order do not impose accounting requirements. The affiliate
transaction rules adopted with this Report and Order merely set the
limits for inclusion of investment and expense in rates set on a cost-
of-service basis. They will also govern external cost treatment of
programming cable operators purchase from affiliates. These methods
distinguish between asset transfers and the provision of services.
When a cable operator sells assets to an affiliate or buys assets
from an affiliate, the assets shall be valued at the asset provider's
prevailing company price, if the provider has sold the same kind of
asset to a substantial number of third parties at a generally available
price. Absent a prevailing company price, the cable operator shall
value the asset at the higher of net book cost and estimated fair
market value when the regulated cable system is the seller, and at the
lower of net book cost and estimated fair market value when the
regulated cable system is the buyer.
When a cable operator sells services to an affiliate or buys
services from an affiliate, the services shall be valued at the
provider's prevailing company price, if the provider has sold the same
kind of service to a substantial number of third parties at a generally
available price. When the provider has established no prevailing
company price, the cable operator must value the service at the service
provider's cost.
In determining the prevailing company price, the Report and Order
requires that it be based on the price at which the provider has sold
the same kind of asset or service to a substantial number of third
parties at a generally available price. In determining the cost of both
assets and services, cable operators shall apply the costing methods
and the rate of return adopted in the Report and Order for cable cost-
of-service showings, to the extent applicable, and shall otherwise use
reasonable costing methods. Where there is no prevailing company price,
affiliate transactions must be carefully scrutinized to ensure that
costs are calculated accurately and, for asset transfers, that fair
market value is estimated properly. Therefore, cable operators must be
prepared to demonstrate that any affiliated transactions costs they
claim as regulated costs reflect the cost-of-service methodologies
adopt with the Report and Order.
For the purpose of evaluating affiliate transactions that involve
programming, the Report and Order determines to classify programming as
an asset. Hence, for the purpose of establishing initial costs for
programming purchased by a cable operator from an affiliate, the cost
of the programming shall equal the provider's prevailing company price,
if the provider has sold the same kind of programming to a substantial
number of third parties at a generally available price. Absent a
prevailing company price, the cost of the programming shall equal the
lower of the provider's net book cost and the programming's estimated
fair market value. Except to the extent that they are relevant for
estimating fair market value, the Report and Order does not allow for
the establishment of affiliate prices by reference to the prices
independent suppliers charge third parties for the same or similar
products.
The Report and Order applies the rules adopted in the program
access proceeding to define affiliated programmers. Rate Order, 8 FCC
Rcd at 5788, n.601, citing Implementation of Sections 12 and 19 of the
Cable Television Consumer Protection and Competition and Diversity Act
of 1992--Development of Competition and Diversity in Video Programming
Distribution and Carriage, Report and Order, FCC 93-178, 58 FR 27658,
released May 11, 1993. Under those rules, an affiliated programmer is a
programmer with an ownership interest of five percent or more,
including general partnership interests, direct ownership interests,
and stock interests in a corporation where such stockholders are
officers or directors or who directly or indirectly own five percent or
more of the outstanding stock, whether voting or nonvoting. Such
interests include limited partnership interests of five percent.
The Report and Order requires cable operators to provide detailed
disclosure of affiliate transactions so that the Commission and
franchising authorities can ensure that affiliate transactions are
treated consistent with the limits of this Report and Order. Where
cable operators have not demonstrated that their affiliate transactions
meet the requirements of the affiliate transaction rules, disallowances
shall be made by the Commission and franchising authorities.
(8) Streamlined Filing and Review for Small Systems
The Report and Order acknowledges Congress' directive under the
Cable Act of 1992 to reduce the administrative burdens of, and costs of
compliance with, cable regulations for small cable systems. 47 U.S.C.
623(i). The Report and Order adopts an abbreviated cost of service form
for use by small systems, Form 1225. This will reduce the
administrative burdens of cost showings for small system operators,
while retaining the necessary regulatory oversight and assurance of
reasonable rates. The Report and Order further requires that
information provided on the abbreviated cost of service form be
certified by the operator as correct; it will be subject to audit by
the local franchising authority and by the Commission.
Independent small systems and small systems operated by small MSO's
may use Form 1225. Small MSO's are those multiple system operators that
(1) Serve 250,000 subscribers or less, (2) own only small systems with
less than 10,000 subscribers, and (3) have an average system size of
1,000 or fewer subscribers. This is the same standard of eligibility
that the Commission adopts for other small system administrative relief
in the Benchmark/price cap Order, which is summarized elsewhere in the
Federal Register.
However, The Report and Order does not allow use of this form for
small operators affiliated with larger systems. The Report and Order
adopts the same affiliation standards employed for small system
administrative relief generally. Use of the small system relief form
(Form 1225) is not permitted by companies in which a larger company
holds more than a 20 percent equity interest (active or passive) or
over which a larger company exercises actual working control (such as
through a general partnership or majority voting shareholder interest).
This affiliated standard also governs eligibility for the use of the
abbreviated summary level accounts for small systems.
Finally, the Report and Order notes that while all cable companies
that choose to make cost-of-service filings should be subject to the
uniform accounting requirements as proposed here, at least in
abbreviated form, such accounting requirements may increase the
administrative burden on small operators to the point of hardship, and
small operators may be unlikely to require the same level of regulatory
oversight as larger entities. Thus, in our Further Notice, comment is
sought on whether to exempt small systems and/or small operators from
these requirements entirely. The Commission also is adopting reduced
accounting requirements for small systems.
(9) Streamlined Filing Requirements for Network Upgrades
The Report and Order concludes that an abbreviated cost-of-service
showing for network upgrades, with safeguards, provides an appropriate
way to implement the goals of the Cable Act of 1992, to promote the
availability of diverse cable services and facilities, encourage
economically justified upgrades, and reduce regulatory burdens, while
ensuring reasonable rates for regulated services.
The Report and Order notes that for many systems, this option will
be unnecessary or inapplicable. The benchmark/price cap mechanism is
already based on the rates of competitive systems, including those with
upgraded networks. The rates charged by those systems presumably
recover their capital costs. The benchmark also includes factors
reflecting the number of channels a system furnishes to customers.
Nevertheless, there may be cases where the benchmark rates do not
provide sufficient revenue to attract capital for upgrades because of
unusual costs associated with capital improvements. For these cases the
abbreviated cost-of-service showing should provide the ability to
attract the capital needed for the upgrade.
The abbreviated cost of service showing for network upgrades is
available only for significant upgrades requiring added capital
investment, such as expansion of band width capability and conversion
to fiber optics, and for system rebuilds. Normal improvements and
expansions of service will remain subject to the usual rate review
process. The Report and Order finds that to justify an increase in the
rates for regulated services, the operator will be required to
demonstrate that the capital investment actually will benefit
subscribers through improvements in the regulated services subject to
the rate increase. The Report and Order also holds that, except to the
extent provided by our AFUDC policy, the upgrade rate increase should
not be assessed on customers until the upgrade is complete and
providing these benefits to customers of the regulated services. This
is consistent with the general cost-of-service standard that only used
and useful property should be included in the ratebase. Any costs that
are not used and useful, will be deducted from total cost. Issues of
allowable costs can be resolved if raised by comparison with costs of
similar systems and, in particular, systems subject to competition.
To assure that the upgrade rate increase is justified by higher
costs, the Report and Order requires that the operator bear the burden
of demonstrating the amount of the net increase in costs, taking into
account current depreciation expense, likely changes in maintenance and
other costs, changes in revenues, and expected economies of scale. The
Report and Order requires that the operator must also allocate the net
increase in costs in conformance with the cost allocation rules for
cost-of-service showings, to assure that only costs allocable to
regulated services are imposed on subscribers to those services.
The Report and Order explains that the permitted rate (based upon
the showing of the net increase in allowable costs associated with the
capital improvement) would be provided in two elements. The first
element is the benchmark rate, as governed by the Rate Order and the
price cap. The second element is the capital improvement add-on. The
sum of these two elements yield the maximum allowable rate that might
be charged to subscribers. The capital improvement add-on is not
adjusted for inflation but is a fee charged over the useful life of the
improvement determined in accordance with our cost-of-service
requirements.
The Report and Order delegates to the Cable Services Bureau the
development of appropriate forms for these abbreviated showings.
(10) Hardship Rate Relief for Operators
The Report and Order recognizes that, in extraordinary cases, the
cable industry may face special problems as it moves into a regulated
environment, and that it is conceivable that the particular
circumstances of an operator could be such that the practical result of
applying any of these rate options could still be to threaten the
financial health of the operator and its continued ability to provide
cable service.
The Report and Order addresses this possibility, and notes that the
Commission will consider the need for special rate relief for operators
in individual cases. To demonstrate eligibility for such extraordinary
relief, the operator should establish that the rates permitted by the
benchmark/price cap and cost-of-service mechanisms undermine the
financial health of the operator so that it is unable to attract
capital and maintain credit necessary to operate, despite prudent and
efficient management. The operator should also establish that the
resulting rates, though higher than those justified by the operator's
costs, will nevertheless not be unreasonable or exploitative of
customers. For example, the operator should demonstrate that the rates
are not excessive in comparison with similarly situated systems,
particularly systems subject to competition.
The Report and Order requires that this hardship showing must be
made for the MSO level, or in any event at the highest level of the
operator's cable system organization. The operator should provide all
information and legal authority on which it seeks to rely, and all
factors it believes the Commission should consider, to demonstrate that
the end result of the other ratesetting options available to it would
place the operator in financial difficulty warranting rate relief, and
that on balance this relief would not result in unreasonable rates for
customers. If the operator makes an adequate initial showing of facts
which, if proved, might warrant rate relief, the Commission will
subsequently provide the operator with an opportunity to prove the
facts alleged and demonstrate that, balancing the relevant interests of
investors and ratepayers, rate relief is warranted.
(11) Experimental Upgrade Incentive Plan
The Report and Order determines that the goal of promoting
economically justified system upgrades, as well as the goals of the
Cable Act and of this proceeding, would be furthered by development of
an incentive regulation approach to upgrading cable services, similar
to the incentive plans implemented for telephone carriers. The Report
and Order outlines the incentive approach as follows. Basically, an
operator would be permitted to enter into a ``social contract'' with
its customers under which the operator would be given substantial
flexibility in setting rates for new regulated services it introduces,
such as new service tiers offering additional program channels. In
exchange, customers would be guaranteed that rates for current services
would be kept stable and reasonable, no higher than rates before the
contract takes effect or the benchmark/price cap rate (which might
include adjustments for inflation and external cost changes), and that
this would purchase at least the same program channels, or channels of
equivalent value to customers. The operator would also commit to
otherwise maintaining or improving its service quality. The contract
would be effective for a term of years and would be overseen by this
Commission, and reviewed before the end of the term.
The Report and Order notes that a plan such as this, which protects
the rates and quality of current cable service tiers, while providing
profit incentives for operators to introduce new and improved regulated
services, may help carry out the purposes of the Cable Act while also
being fair to customers of current services, less burdensome on cable
operators and those responsible for their regulation, and more likely
to encourage worthwhile investments to upgrade cable service.
The Report and Order contemplates that this plan will generate a
strong incentive for the operator to undertake only upgrades that are
economically justified and that best meet customer needs, and to make
such upgrades in the most efficient manner possible. In order to profit
from the planned upgrade, an operator must provide customers with
additional or upgraded services they want to buy. Marketplace forces,
not this Commission, will determine which services succeed. A properly
designed incentive plan for system upgrades should help achieve other
goals. It should, for example, help encourage operators to provide
additional tiers of services. An incentive regulation plan should also
reduce regulatory burdens, even below those likely under the add-on
rate proposal. Regulatory review should only encompass whether the
operator is continuing to offer existing services at rates no higher
and quality no lower than the operator contracted to provide. The
Commission would not expect to investigate complaints regarding rates
for additional regulated services unless they were clearly outside a
wide range of reasonable rates, as evidenced, for example, by similar
systems.
Offering substantial rate flexibility may also be appropriate to
encourage operators to take the entrepreneurial risk of investing in
the upgrades needed to offer such services, while replicating
competitive marketplace forces. In competitive markets, entrepreneurs
offering new and improved services can hope to reap above-market
profits for some period, at least until competitors catch up, but also
take the risk that the services will not succeed in the marketplace.
Permitting cable operators to take the risks and to keep the rewards of
introducing new and improved services, at least for a reasonable
period, should have similar benefits when applied to cable operators.
The Report and Order notes that additional services will be
indirectly regulated by the price cap on current regulated services.
The added services and capabilities must effectively compete with the
other regulated services, whose rates are limited by regulation.
Customers are likely to subscribe to and pay for the added services and
capabilities only if they offer additional value at a reasonable price,
in comparison to those offered by current tiers.
The Report and Order observes that to generate an incentive plan
that is effective in encouraging operators to invest in worthwhile
upgrades, but also fair to customers, the rate limits on existing
services and the rate flexibility for new services would apply for a
substantial period, but would be subject to eventual review. For
instance, in the case of telephone companies, an initial review is made
during the fourth year of the price cap incentive plan. In view of the
initial start-up issues for any incentive plan for cable operators, a
longer period is probably desirable, both to permit operators to
understand and respond to the plan and to assure strong efficiency
incentives. Thus, the Report and Order proposes that the Commission
review the plan in the fifth year of operation.
The Report and Order adopts the Upgrade Incentive Plan on an
experimental basis. Cable systems that commit to meet the basic
obligations of freezing rates for current services that have been
adjusted to benchmark/price cap or cost of service levels, or
conforming their rates to the price cap, and maintaining programming
and service quality that is at least as valued by customers as that
offered currently, will be permitted substantial rate flexibility in
the rates they might wish to introduce for additional regulated
services and capabilities for a term of years, up to five years, from
the acceptance of the plan. These experimental plans will then be
monitored and reviewed no later than the fifth year to evaluate their
performance.
To gain experience with this approach, the Report and Order states
that the Commission will consider proposals from cable operators that
will implement the Upgrade Incentive Plan on an experimental case-by-
case basis, for a limited term of years. Cable operators wishing to
participate should submit a proposal to the Commission's Cable Services
Bureau outlining a proposal and explaining how it would implement the
objectives outlined here. The proposal should also be accompanied by a
written statement by any certified franchising authority with
jurisdiction over cable systems affected by the plan of its views
concerning the proposed agreement.
Regulatory Flexibility Analysis
Final Regulatory Flexibility Analysis for the Report and Order
Pursuant to the Regulatory Flexibility Act of 1980, 5 U.S.C.
Sections 601-12, the Commission's final analysis with respect to the
Report and Order is as follows:
Need and purpose of this action: The Commission, in compliance with
sections 3 and 14 and those portions of section 9 of the Cable
Television Protection and Compliance Act of 1992 (the Act) pertaining
to rate regulation, adopts rules and procedures intended to ensure
cable subscribers of reasonable rates for cable services with minimum
regulatory and administrative burdens on cable entities.
Summary of issues raised by the public comments in response to the
Initial Regulatory Flexibility Analysis (IRFA): The Chief Counsel for
Advocacy of the United States Small Business Administration (``Office
of Advocacy'') offers several remarks in response to the IRFA. The
Office Advocacy expresses concern that numerous small cable operators
cannot operate profitably, if at all, under the constraints imposed by
the benchmark. It agrees with the Commission that some other process
must be developed to permit small cable operators to demonstrate the
reasonableness of rates. The Office of Advocacy believes the
Commission's experience with regulation of common carriers may prove
beneficial in developing mechanisms that balance the need for
exactitude with administrative simplicity.
First, the Office of Advocacy opines that the 1,000 subscriber
standard in the 1992 Act does not provide an adequate definition of
small operator. It recommends defining small cable operators at those
with less than $7.5 million in gross revenues, a standard roughly
equivalent to 20-25,000 subscribers. Within this category it recommends
separate tiers at 1,000, 3,500, and 10,000 subscribers.
Second, the Office of Advocacy commends the Commission for its
compliance with the Regulatory Flexibility Act and its extensive
examination of alternative regulatory regimes. It supports the
Commission's proposal to streamline cost of service showings for
smaller firms, if a relatively simple form can be developed to show
what these costs are. It also supports the Commission's proposal of an
abbreviated cost showing for significant capital expenditures. The
Office of Advocacy also suggests that the Commission consider use of
average cost schedules, maintained by an organization of cable
operators to provide the same functions for the cable industry that the
National Exchange Carrier Association performs for local telephone
companies. It opposes use of 1986 rates adjusted for inflation and
productivity as an alternative.
Third, the Office of Advocacy also supports considering exemptions
for small cable operators, provided certain principles are maintained,
including a Commission finding that exempt operators' rates are
reasonable.
The Commission also is adopting its proposals for streamlined cost
of service studies for small companies, based on a simplified form, and
abbreviated cost of service showings for significant capital
expenditures. The Commission is also seeking the information needed to
consider development of average cost schedules. The Upgrade Incentive
Plan that the Commission is adopting on an experimental basis, and
seeking comment on, may also be an attractive alternative form of
regulation, with substantially reduced administrative burdens, for
small operators.
The Commission agrees with the Office of Advocacy that we must
ensure that rates for regulated services are reasonable for all cable
operators. We are also willing to consider proposals for pooling cable
system costs and revenues in a manner similar to that employed for
small telephone companies. It is unclear to us, however, that cable
operators are sufficiently interested in such an approach to make its
adoption worthwhile. Our consideration of average cost schedule
approaches in the Further Notice may provide insight on this matter.
The Commission has also considered the other comments and proposals
regarding small cable operators, as we discuss in more detail in the
body of the Report and Order. For example, in response to a proposal in
comments from Small Systems, we have broadened the definition of small
systems for purposes of the cost of service mechanisms to include MSOs
with 250,000 or fewer subscribers, who do not own any system with more
than 10,000 subscribers, and whose average system size is 1,000
subscribers or less. Interested persons will also have the opportunity
to submit further comments on these interim rules in the Further Notice
so that we may consider appropriate revisions before these rules become
final.
Paperwork Reduction Act
The proposal contained herein has been analyzed with respect to the
Paperwork Reduction Act of 1980 and found to impose a new or modified
information collection requirement on the public. Implementation of any
new or modified requirement will be subject to approval by the Office
of Management and Budget as prescribed by the Act.
Ordering Clauses
Accordingly, It is ordered That, pursuant to sections 4(i), 4(j),
612, 622(c) and 623 of the Communications Act of 1934, as amended, 47
U.S.C. 154(i), 154(j), 532, 542(c) and 543, the rules, requirements,
and policies discussed in the foregoing Report & Order are adopted, and
that part 76 of the Commission's rules, 47 CFR part 76, is amended as
set forth below.
It is further ordered that, the rules, policies, and requirements
adopted herein shall be effective May 15, 1994.
It is further ordered That, the Secretary shall send a copy of this
Report and Order, including the certification, to the Chief Counsel for
Advocacy of the Small Business Administration in accordance with
paragraph 603(a) of the Regulatory Flexibility Act. Public Law 96-354,
94 Stat. 1164, 5 U.S.C. 601 et seq. (1981).
It is further ordered That authority is delegated to the Chief,
Cable Services Bureau to conduct cost studies in conjunction with this
proceeding and to develop forms necessary and appropriate to implement
this Order.
It is further ordered Pursuant to sections 4(i) 4(j), 623(b), and
623(c) of the Communications Act, 47 U.S.C. 154(i), 154(j), 543 (b) and
(c), that the Upgrade Incentive Plan described herein is adopted on an
experimental basis. Authority is delegated to the Chief, Cable Services
Bureau to implement this plan.
List of Subjects in 47 CFR Part 76
Cable television.
Federal Communications Commission.
William F. Caton,
Acting Secretary.
Rule Changes
Part 76 of title 47 of the CFR is amended as follows:
PART 76--CABLE TELEVISION SERVICE
1. The authority citation for part 76 continues to read as follows:
Authority: Secs. 2, 3, 4, 301, 303, 307, 308, 309, 48 Stat., as
amended, 1064, 1065, 1066, 1081, 1082, 1083, 1084, 1085, 1101: 47
U.S.C. 152, 153, 154, 301, 303, 307, 308, 309, 532, 533, 535, 542,
543, 552, as amended, 106 Stat. 1460.
2. Section 76.922 is amended by adding paragraphs (g) through (k)
to read as follows:
Sec. 76.922 Rates for the basic service tier and cable programming
services tiers.
* * * * *
(g) Cost of service charge. (1) For purpose of this section, a
monthly cost-of-service charge for a basic service tier or a cable
programming service tier is an amount equal to the annual revenue
requirement for that their divided by a number that is equal to 12
times the average number of subscribers to that tier during the test
year, except that a monthly charge for a system or tier in service less
than one year shall be equal to the projected annual revenue
requirement for the first 12 months of operation or service divided by
a number that is equal to 12 times the projected average number of
subscribers during the first 12 months of operation or service. The
calculation of the average number of subscribers shall include all
subscribers, regardless of whether they receive service at full rates
or at discounts.
(2) A test year for an initial regulated charge is the cable
operator's fiscal year preceding the initial date of regulation. A test
year for a change in the basic service charge that is after the initial
date of regulation is the cable operator's fiscal year preceding the
mailing or other delivery of written notice pursuant to Sec. 76.932. A
test year for a change in a cable programming service charge after the
initial rate of regulation is the cable operator's fiscal year
preceding the filing of a complaint regarding the increase.
(3) The annual revenue requirement for a tier is the sum of the
return component and the expense component for that tier.
(4) The return component for a tier is the average allowable test
year ratebase allocable to the tier adjusted for known and measurable
changes occurring between the end of the test year and the effective
date of the rate multiplied by the rate of return specified by the
Commission or franchising authority.
(5) The expense component for a tier is the sum of allowable test
year expenses allocable to the tier adjusted for known and measurable
changes occurring between the end of the test year and the effective
date of the rate.
(6) The ratebase may include the following:
(i) Prudent investment by a cable operator in tangible plant that
is used and useful in the provision of cable services less accumulated
depreciation. Tangible plant in service shall be valued at the actual
money cost (or the money value of any consideration other than money)
of property at the time it was first used to provide cable service. The
actual money cost of plant may include an allowance for funds used
during construction at the prime rate or at the operator's actual cost
of funds used during construction. Cost overruns are presumed to be
imprudent investment in the absence of a showing that the overrun
occurred through no fault of the operator.
(ii) An allowance for start-up losses, if any, that is equal to the
lesser of the first two years of operating costs or accumulated losses
incurred until the system reached the end of its prematurity stage as
defined in Financial Accounting Standards Board Standard 51 (``FASB
51'') less straight-line amortization over a reasonable period not
exceeding 15 years that commences at the end of the prematurity phase
of operation. FASB 51 is available from: Financial Accounting Standards
Board, 401 Merritt 7, P.O. Box 5116, Norwalk, CT 06856-5116.
(iii) Intangible assets less amortization that reflect the original
costs prudently incurred by a cable operator in organizing and
incorporating a company that provides regulated cable services,
obtaining a government franchise to provide regulated cable services,
or obtaining patents that are used and useful in the provision of cable
services.
(iv) The cost of customer lists if such costs were capitalized
during the prematurity phase of operations less amortization.
(v) An amount for working capital to the extent that an allowance
or disallowance for funds needed to sustain the ongoing operations of
the regulated cable service is demonstrated.
(vi) Other intangible assets to the extent the cable operator
demonstrates that the asset reflects costs incurred in an activity or
transaction that produced concrete benefits or savings for subscribers
to regulated cable services that would not have been realized otherwise
and the cable operator demonstrates that a return on such an asset does
not exceed the value of such a subscriber benefit.
(vii) The portion of the capacity of plant not currently in service
that will be placed in service within twelve months of the end of the
test year.
(7) Deferred income taxes shall be deducted from items included in
the ratebase.
(8) Allowable expenses may include the following:
(i) All regular expenses normally incurred by a cable operator in
the provision of regulated cable service, but not including any
lobbying expense, charitable contributions, penalties and fines paid on
account of violations of statutes or rules, or membership fees in
social, service, recreational or athletic clubs or organizations.
(ii) Reasonable depreciation expense attributable to tangible
assets allowable in the ratebase.
(iii) Reasonable amortization expense for prematurely abandoned
tangible assets formerly includable in the ratebase that are amortized
over the remainder of the original expected life of the asset.
(iv) Reasonable amortization expense for start-up losses and
capitalized intangible assets that are includable in ratebase.
(v) Taxes other than income taxes attributable to the provision of
regulated cable services.
(vi) An income tax allowance.
(h) Network upgrade rate increase. (1) Cable operators that
undertake significant network upgrades requiring added capital
investment may justify an increase in rates for regulated services by
demonstrating that the capital investment will benefit subscribers.
(2) A rate increase on account of upgrades shall not be assessed on
customers until the upgrade is complete and providing benefits to
customers of regulated services.
(3) Cable operators seeking an upgrade rate increase have the
burden of demonstrating the amount of the net increase in costs, taking
into account current depreciation expense, likely changes in
maintenance and other costs, changes in regulated revenues and expected
economies of scale.
(4) Cable operators seeking a rate increase for network upgrades
shall allocate net cost increases in conformance with the cost
allocation rules as set forth in Sec. 76.924.
(5) Cable operators that undertake significant upgrades shall be
permitted to increase rates by adding the benchmark/price cap rate to
the rate increment necessary to recover the net increase in cost
attributable to the upgrade.
(i) Hardship rate relief. A cable operator may adjust charges by an
amount specified by the Commission for the cable programming service
tier or the franchising authority for the basic service tier if it is
determined that:
(1) Total revenues from cable operations, measured at the highest
level of the cable operator's cable service organization, will not be
sufficient to enable the operator to attract capital or maintain credit
necessary to enable the operator to continue to provide cable service;
(2) The cable operator has prudent and efficient management; and
(3) Adjusted charges on account of hardship will not result in
total charges for regulated cable services that are excessive in
comparison to charges of similarly situated systems.
(j) Cost of service showing. A cable operator that elects to
establish a charge, or to justify an existing or changed charge for
regulated cable service, based on a cost-of-service showing must submit
data to the Commission or the franchising authority in accordance with
forms established by the Commission. The cable operator must also
submit any additional information requested by franchising authorities
or the Commission to resolve questions in cost-of-service proceedings.
(k) Subsequent cost of service charges. No cable operator may use a
cost-of-service showing to justify an increase in any charge
established on a cost-of-service basis for a period of 2 years after
that rate takes effect, except that the Commission or the franchising
authority may waive this prohibition upon a showing of unusual
circumstances that would create undue hardship for a cable operator.
3. Section 76.924 is amended by revising paragraphs (b) (c), (d),
(e), and (f), redesignating paragraph (g) as paragraph (j), and adding
new paragraphs (g) and (i) to read as follows:
Sec. 76.924 Cost accounting and cost allocation requirements.
* * * * *
(b) Accounting requirements. Cable operators electing cost-of-
service regulation or seeking rate adjustments due to changes in
external costs shall maintain their accounts:
(1) in accordance with generally accepted accounting principles;
and
(2) in a manner that will enable identification of appropriate
investments, revenues, and expenses.
(c) Accounts level. Except to the extent indicated below, cable
operators electing cost of service regulation or seeking adjustments
due to changes in external costs shall identify investments, expenses
and revenues at the franchise, system, regional, and/or company
level(s) in a manner consistent with the accounting practices of the
operator on April 3, 1993. However, in all events, cable operators
shall identify at the franchise level their costs of franchise
requirements, franchise fees, local taxes and local programming.
(d) Summary accounts. (1) Cable operators filing for cost-of-
service regulation, other than small operators, as defined by
Sec. 76.922(b)(5)(i), shall report all investments, expenses, and
revenue and income adjustments accounted for at the franchise, system,
regional and/or company level(s) to the summary accounts listed below:
(i) Ratebase:
(A) Net Working Capital.
(B) Headend.
(C) Trunk and Distribution Facilities.
(D) Drops.
(E) Customer Premises Equipment.
(F) Construction/Maintenance Facilities and Equipment.
(G) Programming Production Facilities and Equipment.
(H) Business Offices Facilities and Equipment.
(I) Other Tangible Assets.
(J) Accumulated Depreciation.
(K) Plant Under Construction.
(L) Organizational and Franchise Costs.
(M) Subscriber Lists.
(N) Capitalized Start-up Losses.
(O) Goodwill.
(P) Other Intangibles.
(Q) Accumulated Amortization.
(R) Deferred Taxes.
(ii) Operating Expenses:
(A) Cable Plant Employee Payroll.
(B) Cable Plant Power Expense.
(C) Pole Rental, Duct, Other Rental for Cable Plant.
(D) Cable Plant Depreciation Expense.
(E) Cable Plant Expenses--Other.
(F) Plant Support Employee Payroll Expense.
(G) Plant Support Depreciation Expense.
(H) Plant Support Expense--Other.
(I) Programming Activities Employee Payroll.
(J) Programming Acquisition Expense.
(K) Programming Activities Depreciation Expense.
(L) Programming Expense--Other.
(M) Customer Services Expense.
(N) Advertising Activities Expense.
(O) Management Fees.
(P) General and Administrative Expenses.
(Q) Selling General and Administrative Depreciation Expenses.
(R) Selling General and Administrative Expenses--Other.
(S) Amortization Expense--Franchise and Organizational Costs.
(T) Amortization Expense--Customer Lists.
(U) Amortization Expense--Capitalized Start-up Loss.
(V) Amortization Expense--Goodwill.
(W) Amortization Expense--Other Intangibles.
(X) Operating Taxes.
(Y) Other Expenses (Excluding Franchise Fees).
(Z) Franchise Fees.
(AA) Interest on Funded Debt.
(BB) Interest on Capital Leases.
(CC) Other Interest Expenses.
(iii) Revenue and Income Adjustments:
(A) Advertising Revenues.
(B) Other Cable Revenue Offsets.
(C) Gains and Losses on Sale of Assets.
(D) Extraordinary Items.
(E) Other Adjustments.
(2) Small operators, as defined by Sec. 76.922(b)(5)(i), that file
for cost of service regulation shall report all investments, expenses,
and revenue and income adjustments accounted for at the franchise,
system, regional and/or company level(s) to the following summary
accounts:
(i) Ratebase:
(A) Net Working Capital.
(B) Headend, Trunk and Distribution System and Support Facilities
and Equipment.
(C) Drops.
(D) Customer Premises Equipment.
(E) Production and Office Facilities, Furniture and Equipment.
(F) Other Tangible Assets.
(G) Accumulated Depreciation.
(H) Plant Under Construction.
(I) Goodwill.
(J) Other Intangibles.
(K) Accumulated Amortization.
(L) Deferred Taxes.
(ii) Operating Expenses:
(A) Cable Plant Maintenance, Support and Operations Expense.
(B) Programming Production and Acquisition Expense.
(C) Customer Services Expense.
(D) Advertising Activities Expense.
(E) Management Fees.
(F) Selling, General and Administrative Expenses.
(G) Depreciation Expense.
(H) Amortization Expense--Goodwill.
(I) Amortization Expense--Other Intangibles.
(J) Other Operating Expense (Excluding Franchise Fees).
(K) Franchise Fees.
(L) Interest Expense.
(iii) Revenue and Income Adjustments:
(A) Advertising Revenues.
(B) Other Cable Revenue Offsets.
(C) Gains and Losses on Sale of Assets.
(D) Extraordinary Items.
(E) Other Adjustments.
(3) Cable operators shall not be required to report their
investments, expenses and revenues to the summary accounts listed in
paragraphs (d)(1) and (d)(2) of this section for purposes of adjusting
rates based on changes in their external costs.
(e) Allocation to service cost categories.
(1) For cable operators electing cost-of-service regulation,
investments, expenses, and revenues contained in the summary accounts
identified in paragraph (d) of this section shall be allocated among
the Equipment Basket, as specified in Sec. 76.923, and the following
service cost categories:
(i) Basic service cost category. The basic service category, shall
include the cost of providing basic service as defined by
Sec. 76.901(a). The basic service cost category may only include
allowable costs as defined by Secs. 76.922(g) through 76.922(k).
(ii) Cable programming services cost category. The cable
programming services category shall include the cost of providing cable
programming services as defined by Sec. 76.901(b). This service cost
category shall contain subcategories that represent each programming
tier that is offered as a part of the operator's cable programming
services. All costs that are allocated to the cable programming service
cost cateogry shall be further allocated among the programming tiers in
this category. The cable programming service cost category may include
only allowable costs as defined in Sec. 76.922(g) through 76.922(k).
(iii) Nonregulated cable programming services cost category. The
nonregulated cable programming service cost category shall include the
cost of providing video programming that is not carried on either the
basic service tier or a cable programming service tier. It includes
video programming that is offered.
(A) On a pay-per-channel basis;
(B) On a pay-per-program basis; or
(C) As any combination of multiple channels of pay-per-channel or
pay-per-program video programming offered on a multiplexed or time-
shifted basis so long as the combined service consists of commonly-
identified video programming and is not bundled with any regulated tier
of service.
(iv) Other cable activities service cost category. The other cable
activities service cost category shall include the cost of providing
all cable services that are not included in the basic service, cable
programming services, or nonregulated cable programming services
categories. Other cable activities include leased commercial access,
billing and collection services, studio and nonregulated equipment
engineering and rental services, sale of nonregulated equipment, and
maintenance of nonregulated equipment sold to customers.
(v) Non-cable activities service cost category. The noncable
service cost category shall include the cost of providing all
activities of a cable operator that are not related to the provision of
cable services.
(2) Cable operators seeking an adjustment due to changes in
external costs identified in FCC Form 1210 shall allocate such costs
among the equipment basket, as specified in Sec. 76.923, and the
following service cost categories:
(i) The basic service category as defined by paragraph (e)(1)(i) of
this section;
(ii) The cable programming services category as defined by
paragraph (e)(1)(ii) of this section;
(iii) The nonregulated cable programming services cost category as
defined by paragraph (e)(1)(iii) of this section;
(iv) The other cable activities service costs category as defined
by paragraph (e)(1)(iv) of this section; and
(v) The non-cable activities service cost category as defined by
paragraph (e)(1)(v) of this section.
(f) Cost allocation requirements. (1) Allocations of investments,
expenses and revenues among the service cost categories and the
equipment basket shall be made at the organizational level in which
such costs and revenues have been identified for accounting purposes
pursuant to Sec. 76.924(c).
(2) Costs of programming and retransmission consent fees shall be
directly assigned or allocated only to the service cost category in
which the programming or broadcast signal at issue is offered.
(3) Costs of franchise fees shall be allocated among the equipment
basket and the service cost categories in a manner that is most
consistent with the methodology of assessment of franchise fees by
local authorities.
(4) Costs of public, educational, and governmental access channels
carried on the basic tier shall be directly assigned to the basic tier
where possible.
(5) All other costs that are incurred exclusively to support the
equipment basket or a specific service cost category shall be directly
assigned to that service cost category or the equipment basket where
possible.
(6) Costs that are not directly assigned shall be allocated to the
service cost categories in accordance with the following allocation
procedures:
(i) Wherever possible, common costs for which no allocator has been
specified by the Commission are to be allocated among the service cost
categories and the equipment basket based on direct analysis of the
origin of the costs.
(ii) Where allocation based on direct analysis is not possible,
common costs for which no allocator has been specified by the
Commission shall, if possible, be allocated among the service costs
categories and the equipment basket based on indirect, cost-causative
linkage to other costs directly assigned or allocated to the service
cost categories and the equipment basket.
(iii) Where neither direct nor indirect measures of cost allocation
can be found, common costs shall be allocated to each service cost
category based on the ratio of all other costs directly assigned and
attributed to a service cost category over total costs directly or
indirectly assigned and directly or indirectly attributable.
(g) Cost identification at the franchise level. After costs have
been directly assigned to and allocated among the service cost
categories and the equipment basket, cable operators that have
aggregated costs at a higher level than the franchise level must
identify all applicable costs at the franchise level in the following
manner:
(1) Recoverable costs that have been identified at the highest
organizational level at which costs have been identified shall be
allocated to the next (lower) organizational level at which recoverable
costs have been identified on the basis of the ratio of the total
number of subscribers served at the lower level to the total number of
subscribers served at the higher level.
(2) Cable operators shall repeat the procedure specified in
paragraph (g)(1) of this section at every organizational level at which
recoverable costs have been identified until such costs have been
allocated to the franchise level.
* * * * *
(i) Transactions and affiliates. Adjustments on account of external
costs and rates set on a cost-of-service basis shall exclude any
amounts not calculated in accordance with the following:
(1) Charges for assets purchased by or transferred to the regulated
activity of a cable operator from affiliates shall equal the invoice
price if that price is determined by a prevailing company price. The
invoice price is the prevailing company price if the affiliate has sold
a substantial number of like assets to nonaffiliates. If a prevailing
company price for the assets received by the regulated activity is not
available, the changes for such assets shall be the lower of their cost
to the originating activity of the affiliated group less all applicable
valuation reserves, or their fair market value.
(2) The proceeds from assets sold or transferred from the regulated
activity of the cable operator to affiliates shall equal the prevailing
company price if the cable operator has sold a substantial number of
like assets to nonaffiliates. If a prevailing company price is not
available, the proceeds from such sales shall be determined at the
higher of cost less all applicable valuation reserves, or estimated
fair market value of the asset.
(3) Charges for services provided to the regulated activity of a
cable operator by an affiliate shall equal the invoice price if that
price is determined by a prevailing company price. The invoice price is
the prevailing company price if the affiliate has sold like services to
a substantial number of nonaffiliates. If a prevailing company price
for the services received by the regulated activity is not available,
the charges of such services shall be at cost.
(4) The proceeds from services sold or transferred from the
regulated activity of the cable operator to affiliates shall equal the
prevailing company price if the cable operator has sold like services
to a substantial number of nonaffiliates. If a prevailing company price
is not available, the proceeds from such sales shall be determined at
cost.
(5) For purposes of Sec. 76.924(i)(1) through 76.924(i)(4), costs
shall be determined in accordance with the standards and procedures
specified in Sec. 76.922 and paragraphs (b) and (d) of this section.
[FR Doc. 94-9078 Filed 4-14-94; 8:45 am]
BILLING CODE 6712-01-M
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.