Cable Television Rate Regulation; Cost of Service Rules

FEDERAL COMMUNICATIONS COMMISSION

47 CFR Part 76

[MM Docket No. 93-215; FCC 95-502]

Cable Television Rate Regulation; Cost of Service Rules

AGENCY: Federal Communications Commission.

ACTION: Final rule.

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SUMMARY: The Commission has adopted the Second Report and Order and

First Order on Reconsideration in MM Docket 93-215 to refine existing

cost of service rules and to create final rules governing standard cost

of service showings filed by cable operators seeking to justify rates

for regulated cable services. By refining these rules, the Commission

brings greater practicality to cost of service filing procedures and

allows operators and regulatory officials increased flexibility in

defining the actual costs of providing regulated cable services.

EFFECTIVE DATE: This final rule contains information collection

requirements and will not become effective until approval by the Office

of Management and Budget, but no sooner than 30 days after publication

in the Federal Register. The Commission will publish a document

specifying the effective date.

FOR FURTHER INFORMATION CONTACT: Tom Power, Cable Services Bureau,

(202) 416-0800.

SUPPLEMENTARY INFORMATION: This is a synopsis of the Second Report and

Order, First Order on Reconsideration and Further Notice of Proposed

Rulemaking in MM Docket No. 93-215, FCC 95-502, adopted December 15,

1995 and released January 26, 1996.

This Second Report and Order and First Order on Reconsideration

contains modified information collections subject to the Paperwork

Reduction Act of 1995 (``PRA''), Pub. L. No. 104-13. It has been

submitted to the Office of Management and Budget (``OMB'') for review

under Section 3507(d) of the PRA. OMB, the general public, and other

Federal agencies are invited to comment on the modified information

collections contained in this proceeding.

The complete text of this Second Report and Order, First Order on

Reconsideration and Further Notice of Proposed Rulemaking is available

for inspection and copying during normal business hours in the FCC

Reference Center (room 239), 1919 M Street, NW., Washington, DC, and

also may be purchased from the Commission's copy contractor,

International Transcription Services, Inc. (``ITS Inc.'') at (202) 587-

3800, 2100 M Street, NW., Suite 140, Washington, DC 20017.

I. Second Report and Order and First Order on Reconsideration

A. Ratebase--Used and Useful Plant and Excess Capacity

1. In general, except as described below, we make permanent our

interim rules regarding ratebase issues. We clarify that used and

useful plant is plant that is actually used to send signals to

customers. Plant which is not currently used and useful, however, is

excess capacity, and operators may include this excess capacity in the

ratebase only if it is fully constructed plant that will be used to

provide regulated service within 12 months. The Commission clarifies

that there are two types of excess capacity. First, where plant is

being used but not to its full capacity, the portion of the plant

allocated to the unused channels is excess capacity. For example, where

a system provides programming over 36 channels but is capable of

transmitting 48 channels of programming, the plant associated with the

12 channels not currently being used is excess capacity. In other

words, in this example, the operator may only include 75% of the cost

of the plant in the ratebase as used and useful plant, and may include

the other 25% as excess capacity only if the 12 channels will be

activated within one year. Second, excess capacity is fully constructed

plant that is not being used at all, such as where the cable operator

has extended its distribution line into an unserved portion of the

franchise area, is ready and able to provide service to that area, but

is not yet providing such service. The operator may include such plant

in its ratebase to the extent it intends to place the plant into

service within 12 months. However, the operator must make a

corresponding adjustment to its subscriber count to include a

reasonable estimate of the number of subscribers it expects to serve

with that plant by the end of the 12 month period.

2. The Commission also clarifies that plant in service must be

allocated between regulated and unregulated services based on a

reasonable measure of the current usage of that plant. Section

76.922(g)(6)(i) of our rules currently uses the phrase ``used and

useful in the provision of cable services,'' but does not specify that

such cable services must be regulated cable services. Since our

authority to determine cable rates extends only to regulated services

as defined by the Communications Act, only plant used and useful in the

provision of regulated services should be included in the ratebase.

Accordingly, for our final rules, we will make this point explicit

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and will amend the interim rule to specify that tangible plant must be

used and useful in the provision of regulated cable services in order

to be included in the ratebase. This will ensure that the ratebase for

regulated cable service only includes plant used for such regulated

cable service, and that subscribers to regulated tiers are not forced

to subsidize plant that is used solely for premium services.

3. In addition, we recognize that what constitutes a reasonable

measure of the current usage of the tangible plant depends on the

circumstances. We believe that in many cases a reasonable measure would

be a straight channel ratio. In other words, if an operator provides

programming over a total of 40 channels, 32 of which are BST and CPST

channels and eight of which are premium and pay-per-view channels, the

operator must allocate 80% of its plant in service to regulated cable

service and 20% to unregulated service. We do not believe, however,

that the channel ratio should be weighted by customer. The cost of

physical plant is directly related to the provision of cable channels

and the amount of channel capacity which exists on a particular cable

system. The cost of that plant does not vary depending on how many

subscribers receive each channel. It would be inappropriate to weight

the channel ratio by subscriber use when such use does not affect the

cost of the plant.

4. With regard to the time period within which excess capacity must

be used and useful in order to be included in ratebase, we adopt the

interim rule of one year as our final rule. For business purposes,

operators commonly project how much capacity will be used within the

given year as part of their annual operating budgets. We believe that

the 12 month period therefore permits plant associated with all

reasonably foreseeable improvements in or additions to service to be

included in ratebase.

B. Ratebase--Intangibles

5. Previously, we had concluded that one reason we should not rely

on acquisition prices for ratemaking was that it appeared that those

prices often include an expectation of supra-competitive profits that

market power of cable systems not operating in a fully competitive

market might expect to generate.

6. We continue to reject the argument that operators are entitled

to include 100% of their intangible costs in the ratebase. Exclusion of

some amount of these costs from the ratebase does not result in an

impermissible taking without just compensation in violation of the

Fifth Amendment. We have no constitutional duty to ensure full recovery

of these acquisition costs, we must only ensure that the end result of

our ratemaking decisions here is reasonable.

7. We continue to believe that the ratebase should not include

costs resulting from any expectation of monopoly profits or expectation

of a return on emerging and unregulated services, which we believe the

presumptive exclusion of such acquisition costs ensures. However, upon

further reflection and based upon our review of cost of service

filings, we believe this presumption can be modified, without

sacrificing this conclusion.

8. Therefore, we have created a new rule, applicable to systems

conveyed prior to the effective date of the interim cost rules, with

respect to the treatment of intangible assets. We find the model in

which 34% of the purchase price of a system is presumed to be

attributable to monopoly expectations, to be the one best suited to

these goals.

9. Our final rule presumes, rebuttably, that 34% of the purchase

price associated with regulated services of systems purchased prior to

regulation represents monopoly expectations and must be removed from

the regulated ratebase. Put differently, the ratebase presumptively

shall not exceed 66% of that portion of the system price allocable to

assets used to provide regulated services. The 34% adjustment must be

applied to the entire purchase price associated with regulated

services, not just the portion of the price allocable to intangibles,

because cable operators derive revenues, including monopoly revenues,

from the employment of both tangible and intangible assets. Applying

the 34% adjustment to all assets associated with regulated services,

rather than only to the associated intangibles, should remove all

expectations of monopoly profits.

10. As noted, we recognize that this approach necessarily involves

the use of industry-wide averages with respect to certain variables

that, while reasonable, will not always reflect with perfect accuracy

the circumstances of particular operators. To the extent the 34%

adjustment is inexact for certain operators, we are particularly

concerned that this adjustment could be used to raise rates

unreasonably, given our statutory mandate to guard against unreasonable

rates. Therefore, we will allow use of the 34% adjustment only for the

purpose of justifying rates in effect as of the effective date of these

rules. We believe that this represents a reasonable compromise between

the overall integrity of the analysis used to arrive at the 34%

adjustment and the concern we have that in some cases this adjustment

could prove overly generous to operators. Accordingly, in cost of

service cases to which the 34% adjustment is applicable, the operator

may include in the ratebase up to 66% of the purchase price allocable

to assets used to provide regulated services, but only to the extent

necessary to justify rates in effect as of the effective date of these

rules. If the current rate can be justified by including in the

ratebase less than the 66% amount, then in no event shall the operator

seek to use a higher percentage for purposes of any cost of service

showing.

11. This adjustment shall be applied only to the purchase price of

systems sold prior to May 15, 1994, the effective date of the Report

and Order and Further Notice of Proposed Rulemaking, MM Docket 93-215,

9 FCC Rcd 4527 (1994) (``Cost Order'' or ``Further Notice''). The

interim rule is made permanent with respect to systems sold after this

date. Operators who acquired systems after May 15, 1994 were aware of

the interim rule strictly limiting the ability to recover the cost of

intangible assets. Thus, to the extent such operators recorded

substantial intangibles, we presume those intangibles are associated

with investment in unregulated services. As such, they cannot be

included in the regulated ratebase.

12. Generally, operators using the cost of service to justify

current rates for the first time, will be able to do so using the 34%

adjustment. In some rare cases, however, this adjustment may not be

adequate. For instance, if an operator acquired a system with tangible

assets equal to 70% of the purchase price, obviously allowing a

ratebase equal to 66% of the purchase price may not allow the operator

to recover reasonably incurred costs. Similarly, if the tangible assets

represent 64% of the purchase price, the remaining 2% may not

adequately compensate the operator for reasonably incurred intangible

assets. Therefore, where the tangible assets approach 66% of the

purchase price, the operator may justify rates using 100% of the

tangible assets and such intangible assets as are permissible using the

interim rules.

13. We further believe it appropriate to adjust our interim rule

concerning deferred income taxes. We will now require operators to

deduct deferred income taxes from the ratebase only to the extent that

such taxes accrued after

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the date the operator became subject to rate regulation.

C. Ratebase-Start-Up Losses

14. We are persuaded that the treatment of prior year losses in the

Cost Order should be amended. We find that we should not prescribe a

specific prematurity phase, rather we find that we should define the

prematurity phase as the actual period during which expenses exceed

revenues. Although we find that the interim rule should be modified, we

continue to reject the claims of commenters who argue that the

wholesale inclusion of start-up losses in the ratebase is warranted. We

also reject the assertion that we should allow deferred earnings into

ratebase. To do so would artificially inflate the ratebase.

15. Thus, we find it appropriate to redefine our current definition

of prematurity so as to account for the specific circumstances

experienced by individual operators rather than continuing to use the

FASB 51 standard. We are persuaded by the arguments that limitations on

start-up losses should be governed by the history of individual

operators. For capitalized start-up losses, build and hold operators

should be permitted to recover reasonably incurred cumulative net

losses, plus any unrecovered interest expenses connected to funding the

regulated ratebase, over the unexpired life of the longest lived asset

in the regulated ratebase, commencing with the end of the loss

accumulation phase. In most cases, acquired systems will have recorded

accumulated start-up losses as goodwill or as some other form of

intangibles. To the extent that purchased systems can demonstrate that

start-up losses have been recorded as goodwill or some other category

of intangibles, these losses shall be allowed just as if they had been

recorded as start-up losses and the system must itemize its assets

instead of using the 66% purchase price allowance methodology described

above. In allowing this however, we must emphasize this should not be

interpreted as authority for the wholesale inclusion of goodwill. The

burden remains on the operator to demonstrate that any portion of a

class of assets is derived from start-up losses.

16. The end of the accumulation phase (i.e., the prematurity phase)

will vary from system to system, depending upon the experience of the

particular system at issue. By allowing the recovery to occur over the

unexpired life of the longest lived asset in the regulated rate base

rather than the remainder of the franchise life, the amortization

period for purchased systems will realistically reflect the expected

period during which the operating losses can be recovered.

D. Ratebase-Tangibles

17. We continue to believe that original cost is a reliable and

fair measure of the value of tangible assets. However, our review of

cost of service filings reveals that in many instances it could be

difficult, if not impossible, to determine the original cost of a

tangible asset. To accomodate this reality, for cable systems

constructed before May 15, 1994, we will allow operators to use the

book value that was recorded as of May 15, 1994, regardless of whether

the system was built or acquired by the current operator. We will

continue to require that original cost be used for cable systems

constructed after May 15, 1994. Also, an operator that acquires

individual cable assets, such as converters or remotes, at arms' length

after May 15, 1994 may use its original cost for those items, rather

than its seller's original cost.

18. An exception may apply to the original cost rule in the case of

assets acquired in an arms-length transaction and without

subscribership. In such instances, assets may be recorded at fair

market value. Thus, where a cable operator sells converters, for

example, to an unaffiliated operator to be used in a different

franchise location, it is acceptable for the acquiring operator to

record such converters at fair market value, that is, at the price the

acquiring operator paid for them.

E. Rate of Return

19. In the Cost Order, we established a single overall rate of

return for cable cost of service proceedings. The presumptive rate was

set at 11.25% after taxes, although operators could seek different

rates if they believed their circumstances justified different rates.

The burden of such justification is high, however, and local

authorities may counter an operator's effort to obtain a higher rate

with evidence to justify a rate below 11.25%. The presumptive 11.25%

rate was selected over individualized rates of return to avoid the

imposition of undue administrative burdens.

20. The Commission will retain this 11.25% presumptive rate. We are

guided to this conclusion by the general absence of challenges to the

presumptive rate and our continued concern that the effort to set an

appropriate rate of return not be overwhelmed by administrative

difficulties that individualized rate estimations could entail. We

recognize, however, that a unitary presumptive rate does not provide

the most accurate estimation of capital costs for the full range of

operators seeking to set cable rates in a cost of service filing. The

Commission is interested in developing a rate of return formula that

better accommodates capital cost differences among cable operators

without imposing unreasonable administrative burdens on operators,

franchise officials and the Commission. We will therefore proceed with

a further notice of proposed rulemaking to solicit input regarding the

development of an alternative rate of return formula. An alternative

formula, if adopted, would serve as an alternative to the current

presumptive rate method. It would not replace it.

F. Depreciation

21. We indicated in the Further Notice that industry practices with

respect to depreciation would shape our ultimate resolution of the

issue. Since release of the Further Notice, we have had the opportunity

to review numerous cost of service filings. These filings demonstrate

that some operators often do not follow any industry standards or other

specific guidelines in establishing the useful lives of their assets

for purposes of depreciation, or with respect to other aspects of their

cost of service filings. As a result, the claimed useful life of a

particular asset category can vary significantly among cable operators,

even though they all use the same type of equipment and hence should be

claiming roughly the same useful life in most instances. Some variation

in the claimed useful lives is to be expected since, for example,

management plans to replace equipment will affect its useful life and

will vary among operators. Thus, when we adopted the interim rules with

respect to depreciation, we expressly provided for case-by-case review

of filings. However, we neither intended nor expected the substantial

variations that the Form 1220s reveal. Our experience since adoption of

the Cost Order now convinces us that the benefits of standardizing the

useful lives of assets underlying depreciation rates outweigh any

resulting burdens.

22. The absence of specific standards or guidelines with respect to

useful lives creates uncertainty for operators and regulators alike

and, at the local level, creates the risk of inconsistent treatment of

similarly situated operators, given the varying practices of the

operators and the discretion given to franchising authorities. These

factors necessitate heightened scrutiny of cost of service cases before

the Commission, as our

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staff endeavors to ensure that the rates charged for regulated services

are the product of reasonable estimations of useful lives. To provide

for consistent treatment of these issues and to ease burdens on

operators and regulators, we believe it prudent to establish some

certainty and uniformity with respect to several issues.

23. Depreciation schedules. A staff survey of cost of service

filings reveals significant disparities in the useful lives claimed by

cable operators with respect to specific assets. Although for each

particular asset category there are a substantial number of filers

claiming useful lives within a relatively small range, there are also a

significant number of outliers whose claimed useful lives appear to be

inappropriate. With respect to headends, for example, 22% of filers

claimed a useful life of between seven and nine years while 18% claimed

between 15 and 16 years. For transmission facilities, 33% of filers set

the useful life at five to six years, while 23% claimed lives of

between 15 and 16 years.

24. The variations in the useful lives of various assets, as

claimed by cable operators, are due in part to the absence of

depreciation schedules in the interim cost rules, which forces

operators to establish the useful lives of their assets on some other

basis. Thus, it appears that operators do not have a great deal of

specific guidance from any source in this regard, resulting in the

variations described above.

25. Local franchising authorities face a similar lack of guidance

when they attempt to determine the reasonableness of the useful lives

that their cable operators claim. And the Commission staff that reviews

the cost of service filings, in an effort to ensure equal treatment of

similarly situated cable operators, must attempt to reconcile the

substantial differences reflected in the individual filings.

26. To eliminate the uncertainty described above, and to facilitate

more uniform depreciation practice for use in computing rates for

regulated cable services, we will adopt a flexible range of useful

lives for use by cable operators seeking to justify depreciation rates

in cost of service filings. In general, we have used the data available

from these filings to develop a range of years defining the useful life

of each of the relevant asset categories identified in Section C, Item

9 of Form 1220, as follows:

------------------------------------------------------------------------

Useful life

Category (years)

------------------------------------------------------------------------

a. Headend................................................ 8-13

b. Transmission Facilities and Equipment.................. 6-14

c. Distribution Facilities................................ 10-15

d. Circuit Equipment...................................... 7-14

e. Maintenance Facilities................................. 17-35

f. Maintenance Vehicles and Equipment..................... 3-7

g. Buildings.............................................. 18-33

h. Office Furniture and Equipment......................... 9-11

------------------------------------------------------------------------

27. These figures are derived from 600 cost of service filings.

Such filings, including the depreciation data, are required to be made

in accordance with generally accepted accounting principles (``GAAP'').

GAAP does not dictate specific useful lives, but rather provides

general guidelines. Thus, the useful lives reported on the cost-of-

service filings reflect, to some extent, the subjective judgments of

the operators making the filings. To the extent certain aspects of

particular filings raise concerns, we have made adjustments

accordingly. For example, we excluded from the observation pool as

facially unreasonable the filings of a number of systems that claimed a

useful life of one year for all of their assets.

28. Having made such adjustments, staff arrived at an average

useful life for each asset category. Staff then established a range, by

taking one standard deviation from the average useful life for each

asset category. Each end of the range was then rounded to the nearest

whole number. We have chosen a range of years, rather than dictating

the use of a unitary figure, to provide operators with flexibility in

determining depreciation rates for their particular systems, although

still within reasonable bounds. By prescribing a range of years, we

will permit operators to take into account factors that reflect

characteristics of their individual systems. For example, the useful

life of a cable distribution system might vary depending upon the

presence and nature of a competing multichannel video programming

distributor (``MVPD''). Depending upon whether the competing MVPD

offers interactivity and other advanced features, the cable operator

reasonably might determine that these factors will alter the

obsolescence, and hence change the depreciation period, of the

operator's assets that do have such features. Thus, while the ranges we

have prescribed will provide for more consistent depreciation practices

between cable operators, we do not believe it is necessary or prudent

to deprive cable operators of all discretion to judge the appropriate

useful life of their own property. However, operators seeking to

establish useful lives that fall outside the prescribed ranges will

have to justify such claims on a case-by-case basis.

29. Given the number of filings, the requirements of GAAP, the

ability of operators to adjust for their individual circumstances, and

the refinements and adjustments made by the staff, we are confident

that the survey captures a representative sampling of data and produces

a fair and reasonable range of years for each asset category.

30. For any asset category, we will presume the reasonableness of

the useful life claimed by an operator if it falls within the range

prescribed above. An operator may seek to depreciate assets over a

period of time other than that which we have prescribed, but in that

case the operator will have the burden of establishing the

reasonableness of the period it has chosen. Thus, while furthering the

goals of certainty and uniformity in the area of depreciation rates,

our approach will be flexible enough to account for those unique

circumstances in which an operator can demonstrate the reasonableness

of a rate that falls outside of the prescribed range.

31. In addition, we will require the operator to depreciate its

assets in accordance with the straight-line methodology. Our review of

the Form 1220s on file with the Commission suggests that some operators

are using accelerated depreciation methodologies to increase the amount

of their depreciation expense and thus to increase rates. While there

are contexts in which accelerated deprecation is a legitimate practice,

we have been presented with insufficient justification to show that it

would be appropriate for purposes of establishing rates under our cable

cost of service rules.

32. Test-year data. Our cost of service rules establish a maximum

permitted rate based on the operator's costs and ratebase as

established during the test year, which is the operator's most recent

fiscal year. In some instances, an operator will be able to time the

filing of its 1220 such that the test year will be one in which

unusually high depreciation write-offs were taken. Higher depreciation

expenses translate into higher permitted rates, since rates must cover

expenses. Thus, to the extent the operator can control the timing of

its filing, it can justify rates that are higher than would be

permitted were the operator to use data from a more representative 12

month period. The staff review of the Form 1220s suggests that some

operators are pursuing precisely this strategy and thus artificially

inflating rates.

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33. Our new rules prescribing depreciation schedules and requiring

straight-line depreciation should help to curb this practice. Where it

nevertheless appears that the test-year data include unreasonably high

depreciation write-offs, the operator should determine the extent to

which the depreciation claimed for the test year exceeds normal

depreciation and exclude the excess from the ratebase.

34. Relevance of Franchise Life in Defining Useful Life of Assets.

The cost of service filings indicate that operators often claim that

the useful life of cable system assets cannot exceed the term of the

cable franchise, based on the proposition that the termination of the

franchise renders the assets useless. However, this presumes that

operators generally are unsuccessful at renewing the franchise, a

premise for which there is no evidence and which conflicts with the

general experience of the industry. Even in the event of a non-renewal,

the operator might sell its asset to the new cable franchisee and

thereby realize the value associated with its actual remaining life.

For these reasons, we will presume that the term of the franchise is

not relevant for purposes of determining the useful life of cable

system assets, again subject to rebuttal by the operator if it can

show, for example, some threat that its franchise will not be renewed

and that in the event of non-renewal the operator will not be able to

recover the value of its assets.

G. Taxes

35. In the Cost Order, we provided for the recovery in income taxes

as an expense incurred by operators as a consequence of providing

regulated cable services. Commenters have argued that capital structure

assumptions used to calculate the tax expense should parallel the

capital structure assumptions used to estimate the rate of return.

36. We agree that use of actual capital structures is the

appropriate method of estimating the equity portion subject to tax

recovery when the actual, or individualized, capital structure of an

operator is used to establish the rate of return. Accordingly, if we

adopt the proposed alternative to use actual capital structures when

calculating the rate of return, we will rely on actual capital

structures derived from the rate of return analysis to determine the

amount of tax recovery for operators using the alternative to the

presumptive 11.25% rate. However, when hypothetical structures are used

to set the rate of return under the initial Cost Order method, we will

employ the same capital structure assumptions used in such analysis to

the tax calculation.

37. With respect to distributions to individual owners of non-

Chapter C entities, we will continue to adjust the income calculation

for estimating allowed taxes. We recognize that entities other than

Chapter C corporations may pass through income directly to the

individual owners and that this income may have been derived from the

provision of regulated cable services. Nevertheless, we will continue

to adhere to the traditional principle of adjusting the income tax

amount to ensure that ratepayers do not pay the taxes of individuals

who are structurally separate from the entity providing the regulated

service.

H. Cost Allocation

38. While our current cost allocation rules require direct

assignment of costs, the rules also allow for operator flexibility in

determining specific allocators and allocation schemes. Accordingly, we

affirm the Commission's current cost allocation requirements, with the

exception of our rule which requires cost allocation of non regulated

costs to specific non regulated service categories, which we remove. We

also clarifiy that, within our current cost allocation methods which

are affirmed by the Order, revenues must be matched with underlying

expenses between related lines on FCC Form 1220, and that allocators

need to be consistent.

39. The general propositions upon which we continue to base our

cost allocation requirements are as follows: (1) costs shall be

directly assigned among the equipment basket and service cost

categories whenever possible; (2) costs that cannot be directly

assigned and which no allocator has been specified by the Commission

are to be allocated based on direct analysis of the origin of the

costs, and where allocation based on direct analysis is not possible,

operators must attempt to make a cost causative linkage to other costs

directly assigned or allocated to the service cost categories and the

equipment basket; and (3) for costs that cannot be directly assigned

and for which no indirect measures of cost allocation can be found,

such 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.

40. We eliminate cost allocation of non-regulated costs to specific

non-regulated service categories. While the requirement may in some

limited instances enable us to more readily ascertain the bases for

cost allocations to regulated categories, we believe that it would be

overly burdensome to continue to include this requirement in our rules.

Therefore, we amend our rules to remove the requirement that non-

regulated costs must be allocated among the non-regulated programming

service categories, other cable activities, and non-cable activities

categories, and replace these categories with a single ``all other''

service cost category. Accordingly, operators electing cost of service

regulation and cable operators seeking an adjustment to external costs

shall allocate costs among the equipment basket and the following

service cost categories: (1) BST, (2) CPST, and (3) all other. The

``all other'' service cost category shall include all costs not

included in the BST or CPST service cost categories.

41. We decline to adopt a ``weighted channel'' approach to cost

allocation. Generally, incremental increases in plant investment are

driven by the number of channels added, irrespective of subscribership

to BST channels. The number of subscribers does not impact costs in

most cable equipment categories. Accordingly, we believe that in most

cases, a straight channel ratio would be a reasonable approach to the

allocation of plant costs amongst service baskets.

42. We also reject the proposition that advertising revenues and

home shopping services be assigned to the ``other cable services''

category. The allocation approach for cost of service showings

reflected in FCC Form 1220 indicates that revenues received for

advertising and home shopping on a regulated tier should be allocated

to that tier, and used as an offset to providing service on that tier.

We adopted this approach because advertising and home shopping shown on

regulated channels employ regulated assets and, consequently, these

revenues should be distributed as offsets to the regulated tier revenue

requirements.

I. Accounting Requirements

43. In the Cost Order, we stated that we would adopt a uniform

system of accounts for those cable operators that elect cost of service

regulation. We concluded that until a uniform system of accounts could

be finalized, operators electing cost of service regulation should use

an interim summary accounting system. Under the interim system that we

adopted, operators using FCC Form 1220 identify costs in 55 summary

level accounts, and small operators using FCC Form 1225 identify costs

in 32 summary level accounts.

[[Page 9366]]

Operators are required to identify all amounts associated with each

revenue and cost category at the franchise, system, regional and/or

company level, depending on the organizational level at which the

operator identified revenues and costs for accounting purposes as of

April 3, 1993. Local franchising authorities and the Commission may

require operators to provide any additional financial data and

explanations necessary to substantiate a cost of service filing and may

order appropriate disallowances if an operator fails to provide a

reasonable response.

44. We now conclude that a uniform system of accounts would be

unnecessarily burdensome for cable operators at this time. Our review

of the cost of service filings has shown that FCC Forms 1220 and 1225

generally provide a sufficiently detailed basis for evaluating

operators' rates. The additional detail provided by a uniform system of

accounts would be of limited value since most of the filing defects we

have discovered thus far are company-specific and would not have been

prevented by a uniform accounting system. Our practice of issuing

deficiency letters when questions arise has proved to be an adequate

means of clarifying data. Therefore, we agree that investing the time

required to develop a uniform system would be counter-productive to

achieving our objective to process cases as expeditiously as possible.

We are also persuaded that imposing a different accounting system on

the relatively few systems filing cost of service justifications may

create administrative inefficiencies for cable operators. Therefore, we

will not adopt a uniform accounting system but will require operators

electing cost of service regulation to follow the accounting standards

required by FCC Forms 1220 and 1225, thus making permanent our interim

accounting standards.

J. Affiliate Transactions

45. In the Cost Order, we promulgated rules for valuing

transactions between cable operators and affiliated companies. These

rules were designed to prevent favorable self-dealing between

affiliated companies in order to manipulate our rate rules. We defined

an affiliated entity as one that shares a 5% or greater ownership

interest with the cable system operator. The interim rules require an

affiliated transaction to be valued at the ``prevailing company

price,'' if the provider has sold the same kind of asset or services to

a substantial number of third parties at a generally available price.

If the provider has not been engaged in similar transactions with a

substantial number of third parties, the rules distinguish between the

sale of an asset and the sale of a service (for the purposes of

evaluating affiliate transactions, programming is considered an asset).

If the transaction involves an asset, the cable operator is required to

value the transaction at the higher of cost or fair market value when

the cable operator is the seller and the lower of cost or fair market

value when the cable operator is the purchaser. If the transaction

involves a service and no prevailing company price can be established,

the cable operator is required to value the service at the service

provider's cost.

46. We reject the argument to permit a window for new services,

i.e., until they can market their services to a substantial number of

third parties. In a competitive market, programmers would not be able

to subsidize new services with higher rates for competitive services.

Similarly, in a regulated industry, programmers cannot expect regulated

ratepayers to subsidize new programming ventures.

47. We also requested comment on an appropriate method of valuing

an asset absent a prevailing company price. Ruling that cable operators

are permitted to value services at the provider's cost is consistent

with the current rules for telephone companies and there appears to be

no reason to distinguish the two industries in this particular context.

This is especially true in light of the more liberal definition of

prevailing company price in the cable services regulatory scheme.

48. We also find that the current definition of ``affiliate'' is

consistent with the definition used elsewhere in the cable services

regulatory scheme.

49. Finally, we requested comment as to whether the interim

affiliate transaction rules should be incorporated into a uniform

system of accounts. Since we have found that no need exists at this

time to adopt a uniform system of accounts, this point is moot.

K. Hardship Rate Relief

50. In the Cost Order, we recognized that, in certain extraordinary

cases, rate regulation under either the benchmark or cost of service

mechanisms would threaten an operator's financial health or ability to

provide service. In such situations, an operator may obtain special

rate relief by demonstrating that rate regulation using either of the

two standard rate-setting options would cause such financial harm that

the operator would be unable to attract capital or maintain credit

necessary to operate, despite prudent and efficient management. The

operator must show that the requested rate relief would not be

unreasonable or exploitative of customers. In other words, rates cannot

be excessive compared to competitive rates of similarly situated

systems. Hardship showings must be made for the MSO level, or the

highest level of the operator's cable system organization. Operators

that submit an adequate initial showing of facts which, if proved,

might warrant special relief, are subsequently given the opportunity to

prove the facts alleged in the showing.

51. We now believe that the process could be shortened by

eliminating the requirement of an initial showing. We will therefore

allow operators to combine the requirements of the initial factual

showing and the subsequent evidentiary showing into one pleading.

52. We continue to believe that we are authorized to consider an

operator's unregulated revenues when determining eligibility for

hardship relief. An evaluation of an operator's financial health that

is based on only a portion of the operator's revenues would be

incomplete and inaccurate. Similarly, it is appropriate to consider a

hardship pleading in light of an operator's revenues measured at the

highest level of the operator's organization. Hardship relief is an

extraordinary relief measure reserved for operators whose overall

financial health would be seriously threatened under the standard rate

regulation mechanisms. It is not designed to bail out struggling cable

systems that are owned and operated by prosperous MSOs. Lastly, the

requirement that rates cannot be excessive compared to competitive

rates of similarly situated systems does not mean that rates cannot

exceed competitive rates. Rather, we expect operators to show that

their rates would not exceed competitive rates to a degree that would

be unreasonable.

II. Regulatory Flexibility Analysis

A. Final Regulatory Flexibility Act Analysis for the Second Report and

Order and First Order on Reconsideration

53. Pursuant to the Regulatory Flexibility Act of 1980, 5 U.S.C.

Secs. 601-12, the Commission's final analysis with respect to the

Second Report and Order and First Order on Reconsideration is as

follows:

54. Need and purpose of this action: The Commission, in compliance

with Section 3 (b) and (c) of the Cable Television Consumer Protection

and Competition Act of 1992 pertaining to rate regulation, adopts rules

and procedures intended to ensure cable subscribers of reasonable rates

for cable

[[Page 9367]]

services with minimum regulatory and administrative burden on cable

entities.

55. Summary of issues raised by the public in response to the

Initial Regulatory Flexibility Analysis: There were no comments

submitted in response to the Initial Regulatory Flexibility Analysis.

The Chief Counsel for Advocacy of the United States Small Business

Administration filed comments in the original rulemaking order. The

Commission addressed these comments in the Rate Order ( MM Docket No.

92-266, FCC 93-177, 8 FCC Rcd 5631 (1993)). The Chief Counsel for

Advocacy of the United States Small Business Administration also filed

comments in response to the Further Notice of Proposed Rulemaking.

Those comments are addressed herein.

56. Significant alternatives considered and rejected. Petitioners

representing cable interests and franchising authorities submitted

several alternatives aimed at minimizing administrative burdens. In

this proceeding, the Commission has attempted to accommodate the

concerns raised by these parties. For example, the revised rules

regarding action on rate complaints within two years of a cost of

service showing are designed to reduce burdens on both industry and

regulators. In addition, the revised rules also reduce burdens on both

industry and regulators by simplifying certain calculations involved in

producing and reviewing a cost of service showing.

III. Paperwork Reduction Act

57. The Requirements adopted herein have 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 perscribed in the

Act.

IV. Ordering Clauses

58. Accordingly, it is ordered that the Petitions for

Reconsideration are granted in part, denied in part, and to the extent

that Petitions raise issues unresolved in this order, they will be

disposed of in future orders.

59. It Is further ordered that, pursuant to Sections 4(i), 4(j),

623 (b) and (c) of the Communications Act of 1934, as amended, 47

U.S.C. 154(i), 154(j), 543(b) and (c) the rules, requirements and

policies discussed in this Second Report and Order and First Order on

Reconsideration are adopted and Sections 76.922 and 76.924 of the

Commission's rules, 47 CFR 76.922 and 76.924, are amended as set forth

below.

60. It is further ordered that the requirements and regulations

established in this decision shall become effective upon approval by

the Office of Management and Budget of the new information collection

requirements adopted herein, but no sooner than thirty (30) days after

publication in the Federal Register.

61. It is further ordered that the Secretary shall send a copy of

this Second Report and Order, First Order on Reconsideration, and

Further Notice of Proposed Rulemaking, including the Initial Regulatory

Flexibility Analysis, to the Chief Counsel for Advocacy of the Small

Business Administration in accordance with paragraph 603(a) of the

Regulatory Flexibility Act, Pub. L. No. 96-354, 94 Stat. 1164, 5 U.S.C.

Secs. 601 et seq. (1981).

List of Subjects in 47 CFR Part 76

Cable television, Reporting and recordkeeping requirements.

Federal Communications Commission.

William F. Caton,

Acting Secretary.

Rule Changes

Part 76 of Title 47 of the Code of Federal Regulations is amended

as follows:

PART 76--CABLE TELEVISION SERVICE

1. The authority citation for Part 76 continues to read as follows:

Authority: Sections 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; 612, 614-615, 623,

632 as amended, 106 Stat. 1460, 47 U.S.C. 532; 623, as amended, 106

Stat. 1460; 47 U.S.C. 532, 533, 535, 543, 552.

2. Section 76.922 is amended by revising paragraphs (i)(6)(i) and

(i)(7), redesignating paragraphs (i)(6)(ii) through (i)(6)(vii) as

paragraphs (i)(6)(iii) through (i)(6)(viii) respectively, and adding a

new paragraph (i)(6)(ii) to read as follows:

Sec. 76.922 Rates for the basic service tier and cable programming

services tiers.

* * * * *

(i) * * *

(6) * * *

(i) Prudent investment by a cable operator in tangible plant that

is used and useful in the provision of regulated 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) at the time it was first used to provide cable service,

except that in the case of systems purchased before May 15, 1994 shall

be presumed to equal 66% of the total purchase price allocable to

assets (including tangible and intangible assets) used to provide

regulated services. The 66% allowance shall not be used to justify any

rate increase taken after the effective date of this rule. The actual

money cost of plant may include an allowance for funds used during

construction at the prime rate or the operator's actual cost of funds

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 including depreciation,

amortization and interest expenses related to assets that are included

in the ratebase. Capitalized start-up losses, may include cumulative

net losses, plus any unrecovered interest expenses connected to funding

the regulated ratebase, amortized over the unexpired life of the

franchise, commencing with the end of the loss accumulation phase.

However, losses attributable to accelerated depreciation methodologies

are not permitted.

* * * * *

(7) Deferred income taxes accrued after the date upon which the

operator became subject to regulation shall be deducted from items

included in the ratebase.

* * * * *

3. Section 76.924 is amended by revising the section heading,

removing paragraphs (e)(1)(iv), (e)(1)(v), (e)(2)(iv) and (e)(2)(v),

and revising paragraphs (e)(1)(iii) and (e)(2)(iii) to read as follows:

Sec. 76.924 Allocation to service cost categories.

* * * * *

(e) * * *

(1) * * *

(iii) All other services cost category. The all other services cost

category shall include the costs of providing all other services that

are not included the basic service or a cable programming services cost

categories as defined in paragraphs (e)(1)(i) and (ii) of this section.

(2) * * *

(iii) The all other services cost category as defined by paragraph

(e)(1)(iii) of this section.

* * * * *

[FR Doc. 96-5427 Filed 3-7-96; 8:45 am]

BILLING CODE 6712-01-P