ÿWPCP ûÿ2BVJ Z ÿÿ úCourierTÿÿ‰?xxx°p£Ûxþ6X@ÉüKX@þþþþþþþÿþÿÿÿþÿÿþÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿHP LaserJet 4 PostScriptHPLA4POS.PRSÛx Œ @ɇÏhhhhð' CX@ÐÐûÿ2ÿÿ6>N|x3|xÐÐ Before the FEDERAL COMMUNICATIONS COMMISSION Washington, D.C. 20554 FCC 94-39 In the Matter of ) ) Implementation of Sections of ) the Cable Television Consumer ) MM Docket No. 93-215 Protection and Competition Act ) of 1992: Rate Regulation ) ) and ) ) Adoption of a Uniform Accounting ) CS Docket No. 94-28 System for Provision of Regulated ) Cable Service ) REPORT AND ORDER AND FURTHER NOTICE OF PROPOSED RULEMAKING Adopted: February 22, 1994 Released: March 30, 1994 By the Commission: Commissioner Barrett issuing a statement. Comment Date: July 1, 1994 Reply Comment Date: August 1, 1994 Table of Contents Paragraphs: I. Introduction 1 Report and Order II. Cost-Based Cable Rate Regulation 10 A. Regulatory Goals B. Regulatory Model C. Procedural Issues III. Required Cost Showing 37 A. Ratebase Ô"h)0*0*0*°°°1ð"ÔŒ 1. Used and Useful, Prudent Investment Standards 2. Valuation of Plant in Service 3. Additions to Ratebase a. Accumulated Start-up Losses b. Excess Acquisition Costs and Intangibles 4. Plant Under Construction 5. Cash Working Capital 6. Other Costs - Excess Capacity, Cost Overruns, and Premature Abandonment B. Expenses 120 1. Operating Expenses 2. Depreciation 3. Taxes C. Test Year Methodology 142 IV. Rate of Return 147 A. Uniform Rate of Return B. General Methodology C. Cost of Equity D. Debt E. Capital Structure F. Overall Cost of Capital V. Accounting Requirements 209 VI. Cost Allocation Requirements 226 VII. Accounting and Cost Allocation Requirements 242 for External Costs VIII. Affiliate Transactions 249 IX. Streamlined Filing and Review 272 A. Small Systems B. Network Upgrades X. Hardship Rate Relief for Operators 292 XI. Upgrade Incentive Plan 295 Further Notice of Proposed Rulemaking XII. Cost-based Cable Rate Regulation 305 A. Cost-of-Service Requirements B. Cable Accounting System C. Affiliate Transactions D. Productivity Offset E. Upgrade Incentive Plan F. Average Cost Schedules XIII. Initiation of Cost Studies 334 Conclusion XIV. Regulatory Flexibility 335 XV. Paperwork Reduction 353 XVI. Procedural Provisions 354 XVII. Ordering Clauses 356 Attachments Attachment A - Parties Attachment B - Rules Attachment C - Proposed Accounting Rules Attachment D - Cost of Equity Studies I. Introduction 1. The Cable Act of 1992 was adopted by Congress based on findings that most cable television systems do not face effective competition within their geographic areas and that, in the absence of regulation, cable operators have undue market power. The Act sets out specific policy objectives for this Commission, including promotion of a diversity of views and information, reliance on marketplace forces, encouraging expansion of cable system capacity and programming where economically justified, and protection of customer interests where cable systems are not subject to effective competition. 2. Rate regulation under the Cable Act of 1992 applies only to cable systems not subject to effective competition. For these systems, the Act directs the Commission to prescribe regulations for ensuring that cable rates are reasonable, taking into account criteria such as the rates for cable systems subject to effective competition, system capital and operating costs, and advertising revenues. Rate regulation authority is divided between the FCC and local franchising authorities: certified franchising authorities have primary authority to regulate rates for the basic cable service tier, and the FCC has authority, pursuant to a validly-filed complaint, to regulate other tiers of cable programming service. Per-channel, per-program, and certain other offerings are generally not subject to rate regulation. 3. The Commission began its implementation of the 1992 Cable Act with an initial Notice of Proposed Rulemaking, and established initial rules to implement the Cable Act of 1992 in the Rate Order. 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. 4. In the Rate Order we discussed the relevant statutory provisions and legislative history, and 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. We found, however, that the record in Docket 92-266 did not provide sufficient information to enable us to develop detailed cost-of- service rules for the cable industry. We accordingly indicated that general cost-of-service principles would apply for cost-of- service showings for the time being, and we initiated this separate proceeding 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. 5. We adopt today both a Report and Order and a Further Notice of Proposed Rulemaking. In the Report and Order, we establish rules implementing a cost-of-service alternative to our primary benchmark and price cap approach to setting regulated cable service rates. We set forth regulatory requirements to govern cost-of-service showings to justify rates above levels determined under our benchmarks and price cap requirements. We adopt these regulatory requirements on an interim basis, pending completion of cost studies of the cable industry. These 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 these rules; as we indicated in the Rate Order, 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. 6. We adopt today accounting and allocation requirements that will govern cost-of-service showings. In the Report and Order we also adopt procedures for emergency rate review based on a showing of special circumstances, and we adopt an Upgrade Incentive Plan on an experimental basis. Under this Upgrade Incentive Plan, operators will be given pricing flexibility and profit incentives to introduce new services and operate efficiently, while customers will benefit from greater assurance of reasonable, stable rates for existing services. 7. In the Further Notice of Proposed Rulemaking, we propose that these interim requirements become permanent; we propose a productivity factor that could be incorporated into the price cap mechanism governing cable service rates; and we solicit comment on a permanent upgrade incentive plan for regulated cable service. We also announce initiation of cable industry cost studies that will be used to develop average cost schedules for regulated cable services and equipment, and to evaluate whether we should require full competitive rate reductions for systems currently eligible for transition relief. We solicit comment on rate of return prescription methodologies, and on proposed rules for an accounting system and for affiliate transactions. 8. The rate set in a cost-of-service proceeding will be the permitted rate, even if it is lower than the rate that would have been determined under the benchmark/price cap approach. Our requirements seek to assure that, in any individual case, rates based on costs will be reasonable for both operators and subscribers. Once a rate is established through a cost-of- service proceeding, the price cap mechanism will govern. Although the rules we are adopting here 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. 9. We have been mindful of the Congressional concern that we not replicate Title II common carrier regulation in regulating rates for cable operators. The primary benchmark/price cap approach does not impose the tariff filing, accounting, and cost support obligations accompanying the Title II regulation this Commission has applied to telephone companies. We also are permitting abbreviated cost showings for rate increases needed to support capital improvements such as network upgrades and rebuilds. II. Cost-Based Cable Rate Regulation A. Regulatory Goals i. Notice 10. In the Notice, the Commission sought comment on what regulatory goals should guide our development of cost-based rates for regulated cable service. We reiterated our belief that the benchmark/price cap approach is the primary tool for regulating cable rates, and that cost of service should serve as a 'backstop' method of rate regulation to meet the needs of cable operators with unusually high costs. We stated that our regulatory requirements for determining cost-based rates should fairly balance the interests of cable operators and consumers, permitting cable operators to recover the reasonable costs of providing cable service and attracting capital, including the opportunity for reasonable earnings, while protecting consumers from paying inappropriate costs and unreasonable charges, and should produce rates that are fair and reasonable to both. 11. We tentatively concluded in the Notice that our cost- of-service regulations should offer cable operators an opportunity to recover their legitimate costs of providing service in high cost areas. We stated that we would endeavor to fashion requirements that give ratemaking recognition to all legitimate costs while preventing recovery in rates of costs that subscribers should not be required to pay. We sought comment on, and stated that we would consider, the present economic and financial performance and practices of the cable industry, to allow us to assess the financial and economic impact of our cost rules on the cable industry. 12. In the Notice, the Commission observed that the benchmark approach was designed to produce rates at or near competitive levels; we solicited comment on whether cost requirements should also be designed to serve that goal. We also stated in the Notice that cost requirements should be based as much as possible on a pragmatic approach geared to a practical implementation by local authorities and the Commission, and that they should, to the extent possible, reduce administrative burdens on cable operators and regulators. 13. Finally, we tentatively concluded in the Notice that our cost requirements should be tier neutral, in consonance with the finding in the Rate Order that a regulatory approach that produced a low-priced basic service but created incentives for cable operators to move programming to higher tiers was not desirable, and presented no advantages over an approach that was tier-neutral. ii. Comments 14. Most commenters agree with the Commission that cost-of- service regulation should serve as a backstop to the benchmark/ price cap standard. 15. Cable operators generally argue that the cost-of- service framework should not be guided by the goal of producing rates that approximate competitive levels, given that the cable industry has not been rate regulated since 1986 and that many operators have incurred costs that would not be recoverable under our proposed interim cost standards. Michigan Committee and Municipals support the goal of approximating competitive rates, but Connecticut does not believe it is possible to set "a priori rate levels" in a cost-of-service proceeding. 16. Finally, cable operators generally oppose tier neutrality as a regulatory goal because they believe inter-tier inefficiencies would be created by the varying costs of programming. Local authorities generally support the concept of tier-neutral regulation in the cost-of-service formulation because they believe it will prevent channel shifting from basic to higher tiers. iii. Discussion 17. Our cost-of-service requirements are designed to assure that operators are able to recover the costs of providing regulated cable service by giving ratemaking recognition to all reasonable costs while preventing recovery in rates of unreasonable costs. Thus they achieve the goal of assuring that cable operators can recover their reasonable costs of providing service in high cost areas; our cost-of-service regulations provide for streamlined cost showings, opportunities to challenge presumptive disallowances, and special procedures for operators facing financial hardship. 18. Our cost-of-service requirements are also designed to produce rates that approach as closely as possible those that would evolve in a competitive market, while still allowing the operator of a high-cost system adequate recovery. Rates set under the benchmark approach are designed to produce competitive rates based on an evaluation of the observed rates of systems subject, and not subject, to effective competition. Our cost-of- service requirements seek to exclude from rates any costs that exceed what would have been incurred in a competitive environment or that are not related to regulated services. Our analysis of allowable costs, together with options for operators to challenge presumptive disallowances, will allow into regulated rates all reasonable costs, and will disallow costs that would not be reflected in rates in a competitive market. Thus, the benchmark and cost approaches both seek to achieve competitive rates by different approaches -- one based on observed prices of cable systems, one based on actual costs. 19. Our regulatory framework gorverning cost-based rates for cable service is designed to assure that we can carefully guage the impact of the application of our cost requirements in individual cases. Our cost requirements are presumptive, and operators can present evidence seeking to justify higher rates than would otherwise be permitted under our cost rules. We also provide for hardship showings. Thus, we can assure that application of our cost rules will not adversely impact the cable industry. Further, our cost and rate of return studies will help us determine whether we should modify our general rules to avoid any undue impact on the industry. Thus, as stated, the cost-of- service option provides a safeguard for the industry from possible adverse effects in individual cases of the primary, benchmark/price cap approach. 20. We adopt our goal of creating a pragmatic cost-of- service system geared to implementation by local authorities, this Commission, and cable operators. We have streamlined and simplified our cost requirements to the extent possible, including adopting a uniform reporting form and a streamlined form for small systems, and proposing a uniform accounting system for cost-based regulated cable service. We have also provided for streamlined filing and review for rate changes due to network upgrades. These actions serve our goal of reducing administrative burdens on cable operators and regulators. 21. We adopt the goal of encouraging infrastructure investment and development. The cost-of-service principles and requirements we adopt here should allow and encourage cable operators to invest in technology, achieve efficiencies, broaden their service offerings, and extend penetration. Further, we are adopting an Upgrade Incentive Plan on an experimental basis to encourage development and deployment of new technologies and new services. Finally, we adopt our tentative conclusion that tier neutrality should be maintained. Thus, we adopt the same cost- of-service requirements for both the basic and cable programming services tiers. B. Regulatory Model i. Notice 22. We sought comment in the Notice on what general standard should be used to set rates based on costs for regulated cable service; we proposed using traditional cost-of-service principles to determine cost-based rates for regulated cable service. We noted that under traditional cost-of-service regulation, rates are set at a level to provide the company with a recovery of its expenses and a reasonable opportunity to earn a fair return on its invested capital. At the same time, recognizing some differences between the cable industry and other rate-regulated industries, we sought comment on alternatives or modifications to cost-of-service regulation that might be appropriate for determination of cost-based rates for regulated cable service. We also sought comment on what transition elements, if any, we should establish to permit cable operators to adapt to a rate-regulated environment. ii. Comments 23. Commenters other than cable operators generally agree that the traditional cost-of-service model we proposed is appropriate. Utah and CFA explicitly support the Commission's proposal. Bell Atlantic also supports traditional ratebase/ rate of return regulation because it believes this approach places cable operators on comparable regulatory footing with the local exchange companies while utilizing the Commission's expertise. Georgia Cable disagrees, stating that the cable industry should not be subject to telco-like regulation merely for the sake of "regulatory parity." Several parties argue that the proposed ratebase/rate of return formula contravenes the Congressional directive to avoid replicating Title II regulation. GTE contends, however, that Congress did not intend to prohibit the Commission from using any regulatory tools currently used by the Commission in its regulation of telephone companies. TMC supports the ratebase/rate of return standard as long as it is tailored to the cable industry's particular cost and financial structures. iii. Discussion 24. After careful consideration of the record, we adopt the cost-of-service formulation specified in the Notice. This formulation permits the regulated entity to recover its operating expenses and a fair return on investment, while protecting consumers from unreasonably high rates. In addition, while we are adopting in this proceeding rules of general applicability as part of our cost-of-service formulation, in individual cost proceedings, we can and will tailor our requirements to accommodate the special circumstances of individual cable operators. Thus, the requirements we adopt governing costs operators may recover in rates for regulated cable service establish presumptive standards that operators may seek to overcome in individual proceedings. In addition, although the cost-of-service requirements we are adopting are designed to be consistent with the ratebase/rate of return formula that has traditionally been used in public utility regulation, we plan to implement that formula in a manner that is simpler and easier to administer than the telephone model. We have also provided for streamlined cost showings for network upgrades, and have established provisions to address any extraordinary situations where our cost standards could create severe economic hardship. Our cost-of-service requirements will therefore permit us to address in individual cases any special circumstances cable operators may face in moving to a rate-regulated environment. 25. Commenters provide no feasible alternative model, nor any persuasive arguments against the ratebase/rate of return model. We disagree with commenters who contend that the ratebase/rate of return model contravenes congressional intent that we not replicate Title II regulation. Our primary approach to rate regulation of cable service, the benchmark/price cap approach, is not cost-based, and does not impose the concomitant regulatory burdens such as tariff and cost support obligations. The cost-of-service regulation adopted here is only a secondary approach. It is also a more streamlined approach than Title II regulation, requiring less detailed cost support and accounting, and imposing no annual or biannual filing requirements. Moreover, the Cable Act of 1992 requires that the Commission consider such factors as the cost of obtaining and transmitting certain types of programming, franchise fees, taxes, and a reasonable profit for cable operators. Our ratebase/rate of return standard includes these factors, and thus implements, rather than violates, the statute. 26. While Congress was concerned that we not replicate Title II regulation, it did not intend that we produce a system that is far more generous to operators, and less generous to customers, than the result produced by the telephone model. The purpose of regulation in each case is to ensure reasonable recovery for the service provider, while protecting the interests of the consumer. We believe that the cost-of-service standards we are adopting will approximate the costs and rates of cable systems subject to competition. Inasmuch as cost-of-service ratemaking is a safety valve for cable operators who believe that rates set under the benchmark approach are insufficient for them, fair, traditional cost-of-service standards are appropriate. C. Procedural Issues 1. Frequency of Filing 27. We proposed in the Notice to limit the frequency with which cable operators could submit cost-of-service showings for the basic or cable programming services tiers, so that after a pending cost-of-service showing has been evaluated by the local franchising authority or the Commission, an operator could not present a new cost-of-service showing for some period of time. 28. Virtually all commenting parties agree that it is reasonable to set limitations on the frequency with which cable operators can submit cost-of-service showings for ratemaking purposes. Some local franchising authorities favor periods of two to three years, while cable operators generally agree that a one-year period is sufficient. Some parties endorse a waiver mechanism for mid-period filings if economic circumstances justify. 29. We conclude that a period of two years is a reasonable frequency limitation. We believe that changes in both cost and revenue will be adequately reflected on this schedule. A two- year period also allows for the development of regulatory stability, and the reduction of regulatory burdens. 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. We are also adopting rate-setting procedures that will be available to an operator in emergency situations, described more fully herein. 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. 2. Procedural Limitations 30. In the Notice we solicited comment on whether we should establish procedural as well as frequency limitations on the submission of cost-of-service showings to justify rates higher than existing rates; we asked, for instance, whether we should require a demonstration of special circumstances or extraordinary costs before we would allow a cost-of-service showing. We also sought comment on whether it was reasonable to assume that operators set rates in an unregulated environment at levels that are fully compensatory, and whether we should therefore limit operators' ability to choose cost of service to set initial regulated rates at levels above pre-regulation levels. 31. Cable operators uniformly oppose any obstacles to their electing cost-of-service regulation, and dispute the presumption that existing rates are fully compensatory. These commenters believe that cost-of-service regulation should be freely electable as a full alternative to our primary benchmark/price cap approach. NCTA argues that the Commission may not, consistent with due process, establish cost-of-service rules that are designed to discourage operators from seeking to establish cost-based rates. CATA states that cost-based regulation should be an option for all operators, not just those with the resources to conduct such a proceeding. 32. Several commenters state that the Commission should make this option available only in extraordinary circumstances because of the burden it would place on regulators. Local franchising authorities generally believe that cost-of-service showings should be permitted only if: (1) existing rates prevent the operator from earning a reasonable rate of return on revenues from all services taken together; (2) the operator has made a capital improvement of benefit to all subscribers; or (3) the operator has experienced unanticipated special costs not arising from operational or financial mismanagement. 33. We conclude that no "threshold" or further procedural limitation on the ability of cable operators to file cost-of- service showings is needed. We believe that the threshold created by the requirements we adopt today -- that operators may not, absent extraordinary circumstances, file more frequently than every two years, and that operators will be bound by the findings of the cost-of-service showing even if those findings result in a rate reduction and in refund liability -- will serve as an adequate safeguard against the filing of frivolous or unneeded cost-of-service proceedings. 3. Initiation of Cost-of-service Regulation by Local Authorities 34. Some local authorities urge the Commission to permit them to require further information of operators, and to initiate cost-of-service showings, if appropriate. While franchising authorities are of course free to require supplemental information in the course of a cost-of-service proceeding, we will not adopt a provision that local franchising authorities can initiate cost-of-service proceedings or general data collections, because we believe 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 administrative burdens of rate regulation. Moreover, we believe that our primary benchmark/price cap approach to setting rates will assure that rates for regulated cable service are reasonable. Accordingly, we will not provide that local authorities may initiate cost-of- service regulation. 4. Cost of Service Form 35. In order to reduce the administrative burdens of cost- of-service regulation, we proposed in the Notice to require that cable operators electing cost-of-service regulation present cost- of-service showings for both the basic service tier and cable programming services tier on a uniform FCC-prescribed form and associated worksheets. Cable operators and local franchising authorities generally support our proposal, although Time Warner argues that the Commission lacks the required experience to design a suitable form. 36. We believe that use of a uniform cost of service form holds several advantages. 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. Accordingly, we adopt a form that operators seeking to justify rates based on cost of service are required to use. We also adopt a simplified version of this form, for use by small cable systems. The requirements for these forms are provided with particularity in the instructions for each form. See also parts V. and VI., infra. III. Required Cost Showing A. Ratebase 37. Under traditional ratebase/rate of return principles, it is necessary to determine the allowable ratebase both to calculate the return or profit component of the revenue requirement and to compute the earned rate of return. In this section we adopt an interim approach to valuation of ratebase for purposes of determining rates based on cost of service showings. Specifically, we adopt the used and useful and prudent investment standards to govern amounts that may be included in ratebase. We determine that tangible plant in service shall be valued at original cost, but that, where records of original cost are not available, we will permit valuation of tangible plant at the book value assigned by the acquirer of the system provided that the operator shows that book value reasonably approximates original cost. We also permit certain intangible costs to be included in the ratebase as described below: accumulated start-up losses, customer lists, and franchise rights. To the extent that a certain cost is excluded from the ratebase under these standards, the operator is permitted to present evidence to overcome some or all of the disallowance by showing that these costs benefit subscribers. 1. Used and Useful, Prudent Investment Standards 38. In the Notice, the Commission sought comment on costs that should be included in plant in service, the largest portion of the ratebase. We tentatively concluded that we should apply the used and useful and prudent investment standards to the original construction cost of assets dedicated to regulated cable service to determine the costs that may be included in plant in service in the ratebase. 39. Of the parties that commented specifically on the Commission's proposal to adopt the used and useful and prudent investment standards, the majority supported the Commission's tentative conclusion. 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. 40. We believe that adoption of this approach best fulfills our statutory mandate to ensure that regulated cable service rates are reasonable while allowing operators to earn a reasonable return on their investment, and reducing regulatory burdens. The prudent investment standard strikes a fair balance between consumer and cable investor interests in that it protects consumers from subsidizing plant not prudently invested in, while allowing cable operators to recover their costs prudently invested in regulated cable service. The used and useful standard ensures that subscribers pay for only those portions of plant that are used and useful in the provision of regulated cable services. The standard is also familiar to this Commission as the standard we have applied to telephone companies, and should thus be simple to apply and administer. This approach will thus allow us to achieve a fair balance of consumer and investor interests in determining regulated cable service rates under our cable cost of service standards. 2. Valuation of Plant in Service 41. In the Notice the Commission proposed establishing standards to determine the value of plant in service that cable operators may include in the ratebase. We requested comment on various approaches to determining the value of plant included in the ratebase, including: market value, original cost, replacement cost, reproduction cost, or a combination of these approaches. The Commission noted that under applicable judicial precedent, regulators have wide discretion to select a methodology for purposes of valuating ratebase, provided the end result is reasonable, and that we would select the approach that best implements our balancing of goals for cost-based rates of cable service. 42. We also solicited comment on how each methodology would affect systems under original ownership and those that have been refinanced or rebuilt. Furthermore, we sought comment on whether we should adopt one valuation methodology for determining initial regulated rates under a cost-of-service showing and another for assessing proposed increases in rates of regulated cable services under subsequent cost-of-service showings. We tentatively concluded that the Commission should adopt an original cost methodology to determine the value of a cable operator's plant in service for ratebase purposes. a. Market Value 43. In the Notice we said that under the market value approach to valuation of plant, plant in service would be valued at the fair market value of assets at the time they are acquired. Several cable operators argue in favor of a fair market value approach to valuating plant. These operators argue that this approach is administratively easy -- that valuation will be readily ascertainable because cable systems are often sold at market value. It should be noted, however, that operators supporting a market value approach favor differing methods. For example, CATA argues in favor of a current market value approach to ratebase. Others think that valuing cable assets at their actual market value as of the date of regulation might reflect capitalized monopoly profits. As an alternative approach, these parties advocate a competitive market value, under which assets of the cable operator would be valued according to their actual market value, less any quantifiable capitalized monopoly profits. 44. Several parties argue against the market value approach. For example, Bell Atlantic argues that this approach is flawed by its inherent circularity because in a regulated environment market value is the result of regulation, rather than the starting point. Austin argues that one should not rely on the market value of cable systems for determining ratebase because prices paid for systems are based on expected revenues, regardless of whether these expected revenues are based on reasonable rates. b. Original Cost 45. Original cost was defined in the Notice as the initial construction cost of the property, adjusted for all subsequent capital transactions including depreciation, retirements, and improvements. Numerous parties, including local and state governments and telephone companies, support an original cost approach. Bell Atlantic suggests that the Commission use original cost, less depreciation, to determine rates for both the original owner and subsequent purchaser. Some parties support the use of original cost, arguing that using original cost will permit the operator to recover the costs of constructing the plant that is used and useful in the provision of regulated cable service, and will produce the lowest rates for consumers. Bell Atlantic believes that original cost will be the easiest methodology to administer and prove. But New York, which argues in favor of this methodology, warns that original cost may be difficult to determine, because of the frequency of cable system turnover. 46. Small Systems argues in favor of original cost if the Commission adopts the definition found in AT&T v. United States, "the actual money cost of (or the current money value of any consideration other than money exchanges for) property at the time when it was first dedicated to public use, whether by the accounting company or by a predecessor public utility." Small Systems states that for an original owner, the original cost of the system should not be difficult to determine, and that where original cost information is not available, the Commission should use reproduction cost. 47. The majority of cable operators argue against the original cost approach. Two operators argue that use of this approach would penalize cable systems that engage in long-term investment; it would provide strong incentives to operators of highly-depreciated systems to abandon serviceable plant and replace it with new, undepreciated plant, and would produce disincentives for investment in infrastructure. Some operators also argue that use of original cost produces rates that are substantially lower than competitive levels. 48. Other operators argue that acquired systems often lack records for ascertaining original cost, or that it is simply impractical to use such an approach. Some argue that use of original cost distorts the ratebase because it fails to include inflation, or operating losses for years prior to rate regulation. Others argue that plant may be fully depreciated, leaving original cost minimal; in that case, they assert, using original cost would not provide an accurate or fair assessment of assets. Several parties assert that courts have held that the additional amount of value over book must be considered in setting rates, and that to fail to do so would be unfair, confiscatory, and contrary to public policy. c. Replacement Cost and Reproduction Cost 49. In the Notice we defined replacement cost valuation as valuing plant at the cost of building a new "state of the art" facility. We defined reproduction cost as the present cost to construct the plant that is in service. 50. TMC recommends use of replacement cost methodology because, TMC argues, it allows plant upgrades and takes advantage of cost efficiencies that result from this development to keep rates reasonable. Other parties, however, oppose the use of replacement cost as burdensome and unreliable. 51. Several parties argue in favor of reproduction cost, depreciated. Others oppose this approach, arguing that determining the cost of reproducing an old system makes no sense in determining the value of the capital committed to the enterprise. d. Other Approaches 52. Several parties advocate a "fair value" approach to valuation of plant in service. Fair value is the current market value of the property placed in service, and may be determined in several ways, including market value and replacement cost. Several parties also advocate other approaches, including an operating ratio analysis to test the reasonableness of rates; ratebase equal to the invested capital on the books with a transition to original cost over a ten-year period; or a current value (trended original cost) approach. e. Discussion 53. We conclude that an original cost approach is most likely to produce fair and reliable valuations of plant in service, and allows us the best opportunity to balance operators' reasonable recovery of costs with consumers' payment of rates that reflect only costs reasonably incurred in providing regulated service. We find that none of the other valuation approaches provides the same reliability and fairness as this approach. 54. For purposes of our cable cost-of-service rules, we define 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. 55. 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 reduced administrative burdens. The practical benefits of original cost valuation in general are that it is less administratively burdensome on all involved, and well understood. 56. 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 this Commission's policy in recent years to bring its regulatory accounting into conformance with GAAP as far as possible. Use of original cost for cable systems will help implement this policy and minimize regulatory accounting burdens. 57. These practical benefits are particularly significant for cable system regulation, where Congress has expressly directed us to reduce administrative burdens. Use of original cost should reduce administrative burdens because it does not require appraisals or other methods of assessing value at a later date, and it is the most familiar method for regulatory cost of service studies. Original costs also are likely to be far less contentious because they can generally be objectively verified by reference to actual construction records and, for many operators, are readily available. On a going forward basis, operators should easily be able to keep track of these costs. To the extent that original costs may not be readily available to operators who have acquired systems, estimated original costs may be used. We have also modified the original cost approach, as we discuss below, to permit the use of book value if it approximates original cost. 58. We recognize 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 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, we can take 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 here we have adopted a rate toward the high end of the zone of reasonable returns, as a cautious approach to assure continued incentives for future investment. 59. The original cost approach is also consistent with the objectives of the Cable Act of 1992. The Act directs this Commission to consider various factors in establishing criteria for evaluating the reasonableness of rates, including reducing administrative burdens, and taking into account direct costs, joint and common costs, advertising and other revenues, franchise fees and taxes, franchise requirements, and a reasonable profit. It does not direct us to include other acquistion costs. The adoption of the original cost valuation method allows us to meet express statutory concerns; i.e., original cost valuation excludes costs that would not have arisen in a competitive environment, and a primary factor in our evaluation of cost-of-service showings is the rates for cable systems subject to effective competition. 60. While it might be possible to develop a different valuation approach, including one of the various approaches suggested by cable operators, we perceive no reason to believe that any one of those methods would better carry out the purposes of the Cable Act. Approaches based on market value at the time of acquisition are likely to include expectations of supra- competitive profits that would be difficult to disentangle from other aspects of market valuation, such as the expectations at the time of the growth and profitability of unregulated services. We also believe that the commenters favoring market valuation methods understate the practical difficulty of applying sale prices of some systems or trends in stock prices to setting a market price for other systems. Certainly these methods are more complex than use of original cost, even if they could be developed into a reliable valuation method that excludes supra- competitive earnings and non-regulated activities. To the extent that acquisitions occurred at different times in the past, those expectations are also likely to have varied, and use of the full acquisition price is thus likely to produce uneven and unreliable valuations. Moreover, the full acquisition price might well represent an imprudently high purchase price rather than a fair valuation for customers, even if it was arrived at on an arm's length basis at the time. 61. An attempt to apply a market value test as of the date of the adoption of the Cable Act in 1992 or at some later date presents similar problems of circularity, assessment of investor expectations, and allocations to regulated services. In practice, these issues have proven very difficult to solve in developing workable public utility ratemaking mechanisms. What has proved workable, even if far from simple, has been use of original cost for valuation, and assessment of market requirements for return in the setting of an allowable rate of return based upon that valuation method. The Cable Act of 1992 does not state or imply that the Commission must take into account the market value of cable systems in evaluating reasonable rates, and we conclude that use of market value in setting the value of plant in the ratebase would be less workable, and would not result in more reasonable rates, than use of original cost in implementing the 1992 Cable Act of 1992. 62. Similarly, we reject the replacement cost, reproduction cost and fair value approaches as unwieldy, difficult to apply consistently, and likely to produce ratebase values that would not generate reasonable rates. Estimating the cost of replacing a system or reproducing it would likely prove a contentious exercise in competing opinions concerning, for example, current construction costs, best practices, and choices of technology. Attempts to implement a fair value approach have also historically proved unworkable. 63. We also are unpersuaded that the other methods proposed are preferable to original cost in carrying out the purposes of the Cable Act of 1992. COA's suggestion in its reply comments that an operating ratio analysis could be adopted to test rates seeks to draw an analogy to cases such as transit utilities where the ratebase is very small. It is improbable, however, that the cable industry, with its heavy capital investment in facilities, is analogous to situations where operating ratio approaches have been adopted. This and other approaches, such as Comcast's "Z factor" proposal, Arthur Andersen's trended original cost proposal, and BellSouth's proposal for amortization of goodwill, appear primarily to be approaches seeking to include in the ratebase some portion of excess acquisition costs. We discuss these approaches and the extent to which acquisition costs may appropriately be included in the ratebase in a later section of this decision. 64. Commenters arguing that original cost is often simply unascertainable were numerous and insistent, and we believe that there may be some validity in this concern in some cases for purchased systems. We note that telephone regulation provides for use of an estimated original cost when actual original cost is not available. Because this approach creates the need for individual scrutiny not only of the estimated original cost but also of underlying 'particulars,' it is not our preferred alternative to original cost for cable services regulation. However, in the event that an operator does not possess adequate records of original cost, we will permit an operator to estimate original cost. The operator will be required to show the basis for the estimate with supporting documentation. In addition, we will permit 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. 65. We believe that this approach to valuation strikes a fair balance between the interests of ratepayers and investors, and that it will produce reasonable rates for subscribers while allowing operators to recover costs that they have prudently incurred for plant that is used and useful in the provision of regulated cable service. Under this approach, cable operators will be able to attract capital, and will have an opportunity to earn reasonable earnings. The original cost approach will also protect consumers from paying for costs inappropriately incurred by operators, or for monopoly rents. Finally, it will help in reducing administrative burdens on both cable operators and regulatory authorities in the administration of our rate regulations by permitting reliance on estimated original cost or book value in some cases. 66. The original cost valuation approach for tangible plant in service is also consistent with the Act because it will allow operators to develop rates that approximate the rates that would have developed in a competitive market, and will thus protect subscribers from paying inappropriate costs and unreasonable charges that reflect operators' expectations of noncompetitive earnings or earnings from non-regulated activities. This approach also assures operators' ability to respond to competitive forces by means of facility and service requirements, because it allows them to recover costs prudently invested in plant that is used and useful in the provision of regulated cable service. We also believe that by instituting an original cost approach to initial determination of ratebase, we are setting the groundwork for a level playing field for the telephone companies and cable companies, because our telephone company valuations are also based on original costs. 67. As several parties have noted, Congress identified the goal of ensuring that cable operators continue, where economically justified, to expand their telecommunications infrastructure. The Commission agrees that cable operators can, and should, contribute to the continued development of an advanced telecommunications infrastructure. Contrary to some commenters' suggestions, we believe the approach we adopt today allows operators to participate in the development and establishment of a modern telecommunications infrastructure, by assigning a reasonable value to tangible plant in service and permitting operators to recover that value in rates for regulated cable services. 3. Additions to Ratebase a. Accumulated Start-Up Losses i. Notice 68. In the Notice we remarked that some operators may have expensed, rather than capitalized, some expenditures which have resulted in the creation of assets with future economic value. We noted that the application of certain depreciation practices may have resulted in a general undervaluation of property, plant, and equipment on the books of cable operators as the industry comes under regulation, and that financial losses in the industry may be due in some part to write-offs of various organizational and development costs, and to use of accelerated depreciation practices. We sought comment on the appropriate treatment of accumulated losses, noting that it might be reasonable to view such losses as capital invested with an expectation of recovery in future periods as the industry reaches maturity. We asked whether these losses should be amortized over some future period, and whether a return should be allowed on such unrecovered amounts until they are fully recovered. ii. Comments 69. In response, several parties contend that cable operators incur more substantial early losses than traditional utilities. Small Systems argues that start-up losses, deferred system development costs, and accumulated losses which operators invested to make their cable systems viable commercial operations should be recoverable. Others add that these losses should be both capitalized (to include a return on investment), and amortized (to allow recovery of expense). Many parties propose recovery methodologies and periods. iii. Discussion 70. We conclude 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. We are also concerned, 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. 71. Financial Accounting Statements Board Standard No. 51 ("FASB 51") suggests that a two-year period is a reasonable and representative startup time for cable systems. We believe, based on the record, 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. We therefore allow 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. 72. These accumulated losses may be included in the ratebase, and the operator may earn on them the reasonable rate of return that we define below. However, we do not believe that these accumulated losses should be included in the ratebase indefinitely. Instead, we will require that they be amortized over a reasonable period. We determine presumptively that this amortization period should not be longer than fifteen years. This amortization period should provide flexibility for operators, without burdening subscribers with unreasonable rates. 73. We conclude that other losses should be presumptively excluded from the ratebase: these include continuing operating losses after the system reaches maturity, and accumulated losses associated with amortization of disallowed goodwill or interest expense associated with disallowed goodwill. We believe that 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. b. Acquisition Costs, Intangibles, and Goodwill i. Notice 74. In the Notice we observed that cable operators purchasing cable systems in an unregulated environment may have paid a price that exceeded the value of plant under our valuation methodology; we termed this an "excess" acquisition cost. We stated that the legislative history of the Cable Act of 1992 reveals a congressional concern that pre-regulation cable system purchase prices may reflect the undue market power of cable operators not subject to effective competition -- that they are higher, in other words, than they would have been under more competitive market conditions. We tentatively concluded that excess acquisition costs, including portions assigned to goodwill, customer lists, franchise rights, and other intangible assets, should be excluded from the ratebase, and we sought comment on whether such disallowance was Congress' intent. We also sought comment on whether we should allow the amortization of such costs over time as an annual expense. We stated that an equitable balancing of consumer and cable operator interests might require that some excess acquisition costs be allowed in the ratebase, in order to allow for the transition of the industry from a nonregulated to a regulated environment. ii. Comments 75. Several parties support the exclusion of excess acquisition costs from the ratebase, and state that inclusion of these costs would reflect monopolistic expectations, and would harm subscribers. For example, Seaford argues that none of the purchase price of a cable system in excess of the value of plant in service should be allowed recovery as goodwill or intangibles, because that is merely the excess value which an unregulated monopolist can wring from its captive ratepayer. Austin argues against allowance of intangible assets because courts have already decided, based on the industry's own representations, that monopoly cable companies do not have goodwill. Other parties argue that excluding excess acquisition costs from the ratebase is consistent with general principles of utility regulation. Bell Atlantic argues that allowing these costs in the ratebase would provide an unjustified competitive advantage for cable over telephone. Austin asserts that excess acquisition costs fail to meet the prudent investment test. 76. Other parties suggest the possibility of a less stringent approach; for example, Aerie suggests that there may be a limited need for special treatment of excess plant or acquisition costs for those unaffiliated small companies that show that, absent the possibility of recovery of these costs, they may face reorganization or insolvency. Michigan and Utah state their belief that exceptions to allowance of excess acquisition costs include reasonable allocations for goodwill, customer lists, and franchise rights. 77. Cable operators argue, however, that calling their acquisition costs "excess" is unfair, and that these costs do not represent monopoly rents. Operators argue that we should allow full acquisition costs, or at least provide operators an opportunity to overcome a presumptive disallowance. They assert that Congress did not intend exclusion of these costs. Several parties argue that unlike traditional utilities, cable includes a significant investment in intangibles. COA argues that a company's intangible resources are often what separates the company from the competition, so these resources must have some future value. COA also asserts that subscribership growth should be included in the ratebase, and that goodwill should be included in the ratebase as a going-concern value. 78. California urges the Commission to take further study to determine the value of the monopoly component of intangible assets, if any, and in the interim to permit a cable system to establish the value of these assets, net any monopoly component, using accepted valuation theory. California and Summit argue that these costs should be included in the ratebase and should be eligible for amortization as part of system expenses. TMC argues that at a minimum, and as a transition method, the Commission must allow intangibles to be amortized over the remaining life of the franchise. 79. Other parties argue that the exclusion of excess acquisition costs from the ratebase is unconstitutional. Some urge that a regulatory system that does not allow recovery of acquisition premiums will have a significant adverse impact on the industry, its financial structure, its ability to attract capital, and the reasonableness of returns granted to investors in these acquiring companies. Many cable operators point out that competitive firms and regulated industries are routinely purchased at significant multiples of book value, and that this does not necessarily reflect monopoly rents. 80. Further, these parties argue, purchases that occurred prior to regulation do not raise traditional concerns warranting disallowance of excess acquisition costs; the arms-length purchase price of these systems should be accepted as a fair measure of the value of the system's assets. Some cable operators also assert that systems should be valued at the time the assets were first dedicated to public use, which they contend is when regulation was imposed under the Cable Act of 1992. They assert that if the Commission decides to exclude excess acquisition costs, it should do so only on a going-forward basis. 81. Several cable operators argue for amortization of excess acquisition costs and intangibles as annual expenses, although they propose different amortization periods. Other parties, including some local governments, argue that if excess acquisition costs other than goodwill are included in the ratebase, they should be amortized over a period of at least fifteen years, which will produce the lowest subscriber rates possible. Some parties are opposed to any amortization of excess acquisition costs. iii. Discussion 1) Introduction 82. In instances where there is a lack of effective competition, as in the period prior to the adoption of the Cable Act, we find that acquisition prices are likely to include amounts paid in expectation of supracompetitive profits, growth premiums for unregulated services, and, quite possibly, simple overpayments. Traditional principles of ratemaking and the policies embodied in the Cable Act 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. 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. 83. We also believe, however, that operators are correct in pointing out that some intangible costs do represent costs 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. We refer to our 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." These costs produce assets that provide benefits to subscribers and are thus reasonably recoverable from subscribers. As we discuss below, 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. 84. To balance investors' and ratepayers' interests fairly, we will presumptively allow those types of intangible costs that generally represent reasonable costs of providing service and that would be incurred under competition. We believe that some intangible costs do generally represent costs used and useful in the provision of regulated services, and thus should properly be recovered in rates. Other intangible costs, including goodwill, will be presumptively excluded. Herein, we discuss which costs should be presumptively included, and which should be presumptively excluded, and the manner in which these costs should be treated in ratemaking. 2) Intangible Costs Presumed To Be Includible In Rates 85. In this section we discuss the specific categories of costs that we conclude should be presumptively includible, and how those costs should be treated in ratemaking. 86. Organizational Costs. 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 ratepayers, in that they must necessarily be incurred for the entity to be able to provide service. For that reason, we conclude that we should presumptively allow these costs into the ratebase to the extent they are prudently invested and are useful in the provision of regulated cable service. Operators will be allowed 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. 87. Franchise Costs. The 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. We conclude that we should allow the original costs associated with a government franchise into ratebase if they: (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. We conclude that we should presumptively allow these costs to the extent they are prudently invested and are useful in the provision of regulated cable service. Operators will be allowed to continue to recover their capitalized franchise rights 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. 88. Customer Lists. Customer lists, too, are presumptively allowed into ratebase, to the extent that they reflect costs capitalized during prematurity, as defined by FASB 51, and are prudently invested and are 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. 3) Intangible Costs Presumed To Be Excluded From Rates 89. 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 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 we apply should recognize the prices paid for cable systems in the past, especially during the period when systems were unregulated. 90. The issue is one of some importance and controversy, for both 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, which we have termed excess acquisition costs, were presumably recorded as goodwill. In arguing for recognition of acquisition costs for computing costs of service, the 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. 91. We continue to believe 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. It appears certain that those 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 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 the investors' assessment of the risks of competitive entry and re-regulation. But 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 analysis we conducted as part of our development of governing rates set under the benchmark approach strongly supports this conclusion. The study submitted in support of the use of acquisition prices by Viacom, one of the largest cable operators, also recognizes the possibility that capitalized monopoly profits were included in those prices, though it suggests a smaller effect. 92. It is also quite 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-per-view 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 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. 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. 93. 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. This is because these costs typically benefit the seller, not the ratepayer; they do not contribute to the plant supporting regulated service. We also note that disallowance of goodwill for monopoly cable systems is consistent with findings of the United States Tax Court. We believe that disallowing acquisition costs, to the extent they include captialized 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 us to consider 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. Allowance of the acquisition price of cable systems as part of the costs of service would present a substantial probability, in our view, of passing on to customers costs that reflect neither the costs of providing service nor the costs that would be incurred under competition. 94. We also find unpersuasive arguments that acquisition costs should be accepted because they represent the arm's-length purchase prices of assets. While the market price paid for assets may be presumed to be an appropriate measure of the original cost in many regulatory contexts, for example because it is likely to represent the value of the asset to ratepayers at the time the utility begins using the asset to provide service, that is not the case here. As we discussed above, the acquisition prices paid prior to the Cable Act of 1992 are likely to be inflated in various ways, notably by the expectation of supra-competitive profits. Because of this, it is not reasonable or fair to ratepayers to include those prices presumptively or automatically in the ratebase. 95. Moreover, we also do not believe that the acquisition price should be accepted as representing the value of the assets at the time the system was dedicated to the public service, or that, even if this were the case, the acquisition price should be accepted for ratemaking. Cable systems were providing service to the public prior to the reimposition of regulation under the Cable Act of 1992, and generally were subject to local franchises. The reimposition of regulation recognized the existence of their market power, and sought to restrain it. Allowing into the ratebase prices that reflect and capitalize that market power would effectively perpetuate that market power rather than, as the Cable Act of 1992 plainly intended, protect customers from it. 96. An alternative approach, which we set for comment in the Notice and which is urged by some commenters, is not to use the acquisition price as a measure of value for setting the ratebase, but to permit excess acquisition costs to be recovered through amortization over a period of years. This approach would reduce the amount that customers would be liable to pay in order to compensate operators for their acquisition costs by not permitting operators to earn a return on such costs, but would still permit operators to recover all such costs. The comments also propose other mechanisms that would effectively permit acquisition costs or the debt service costs associated with acquisition costs to be recovered from ratepayers. 97. Commenters favoring some form of recovery argue that acquisition costs should be allowed in fairness to buyers who could not have expected that rate regulation would be imposed, or that denial of full acquisition costs will impede the ability of the cable industry to obtain financing to improve its facilities and programming offerings. We conclude, nonetheless, that inclusion of acquisition costs that do not provide value to subscribers would undercut the purposes of the Cable Act of 1992 and unnecessarily favors operators over subscribers, by requiring subscribers to pay rates above the levels of the costs actually and reasonably applied to provide regulated service, and above the costs that would likely be incurred under competition. We thus reject the various approaches suggested to include acquisition costs in the ratebase. As we discuss above, allowing operators to claim categories of intangible costs that do in fact represent reasonable costs of providing service that benefit subscribers, while not permitting supra-competitive and other unreasonable costs from being imposed on subscribers, is fair to operators and investors and to consumers. 98. Operating Efficiencies. There may be sales, as some commenters claim, that benefit subscribers by generating operating efficiencies that are unobtainable by the seller. We believe it is appropriate to consider whether these efficiency gains warrant inclusion of some part of goodwill in the rate calculation. However, in any such case, the operator must 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 would not lay the foundation for allowing goodwill to be included in the rates subscribers pay. 99. Rebuttal of Presumption. In summary, we define 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. We conclude 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. We believe this approach fairly balances the interests of consumers and investors. Operators wishing to overcome this presumption should demonstrate that allowance of these costs would result in reasonable rates, that the costs were 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. In reviewing such showings, the franchising authority or this Commission will 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 in the ratebase of these costs. 100. Constitutional Issues. As we have discussed, in this Order we are substantially broadening the list of intangibles that may be included in rates by cable operators beyond those proposed in the Notice. Even intangible costs such as goodwill are only presumptively disallowed; upon a proper showing that rebuts the presumption and demonstrates that the cost does meet the tests of benefit to subscribers and rates that are not above competitive levels, the costs will be allowed. We believe that this approach assures that our treatment of acquisition costs does not impair the constitutional rights of cable operators; instead, it fairly balances the rights and interests of investors and customers. Moreover, as we explain later in this Order, we are providing for hardship showings by operators who claim that neither the benchmark/price cap nor the normal cost-of-service approach permits them the opportunity to set rates that permit them to attract capital. These procedures fully protect operators' constitutional rights. 4. Plant Under Construction i. Notice 101. In the Notice the Commission solicited comment on whether we should impose any limits on inclusion of plant under construction in the ratebase. We requested comment on what practices the cable industry currently follows in accounting for plant under construction. Further, the Commission sought comment on whether it should apply the traditional rule under ratebase/ rate of return regulation, that plant under construction will be withheld from the ratebase until it meets the used and useful test, but that interest during construction can be capitalized. ii. Comments 102. Several parties argue that plant under construction should not be allowed in the ratebase, absent a showing of severe financial distress, until it is used and useful. Michigan and Utah argue that any interest paid during construction could be capitalized during construction, thereby providing the operator some benefit during the construction period. Georgia Cable asserts that this is not a real issue, while New York requests that we allow franchising authorities to examine whether construction costs, or a portion thereof, might properly be included in the ratebase prior to completion. 103. Several cable operators argue that plant under construction should be included in the ratebase, arguing that its exclusion would make financing impossible and might endanger the financial integrity of some cable operators. Continental asserts that exclusion of plant under construction from the ratebase will produce a disincentive to improve technology and service. Continental suggests that the appropriate method for including plant under construction in the ratebase requires an adjustment to the historical test year to add into ratebase: (1) plant under construction during the years in which activation is scheduled; (2) known and measurable increases in plant under construction; (3) interest during construction; and (4) capitalized marketing costs associated with the rebuild. Continental argues that to the extent that plant under construction is not allowed in the ratebase, cost of service showings will proliferate, capital management will become more problematic due to regulatory delays, and the ratebase will need to be further adjusted by interest during construction. iii. Discussion 104. In the Notice we proposed two options for valuating plant under construction for ratebase purposes, the capitalization method and the revenue requirement offset method. 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. 105. Under the revenue requirement offset method, plant under construction is included in the ratebase, and AFUDC is treated as part of the cost of construction. Because plant under construction is included in the ratebase, the amount of AFUDC capitalized is included in income for ratemaking purposes. This serves to offset the revenue requirement determination for the development of rates for services. Both of these methods meet GAAP requirements. 106. We are adopting the capitalization method to govern ratemaking treatment of plant under construction. 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. We believe that "it is in the public interest that investors receive a reasonable compensation on the funds they have provided to finance construction projects which will, when placed into service, benefit future ratepayers." AFUDC will be allowed only to the extent the related costs are not already included in start-up losses. 107. Cable operators express concern that construction loans may require the operator to have more up-front capital in order to begin repaying its debt. We believe that these concerns are overstated. As portions of plant move into service, they become used and useful, and so the cost of those portions can be entered into the ratebase. This approach has provided adequate recovery in the telephone area, and we believe that it will do so here. 5. Cash Working Capital i. Notice 108. In the Notice we proposed to allow operators to include in their ratebases a working capital allowance. We solicited comment on several different approaches for determining the allowable amount, and stated that any of these methods could produce a negative or positive allowance, depending on operating characteristics. ii. Comments 109. Cable operators commenting on this issue generally favor inclusion of a working capital allowance, but differ on the preferable methodology. Local governments, however, favor the use of lead/lag studies, in the expectation that they would provide more accurate results. Other commenters support use of the balance sheet approach (current assets - current liabilities) as an appropriate method. iii. Discussion 110. Traditionally, we have included in the ratebase of telephone companies a cash working capital allowance based on an estimate of the average amount of investor-supplied capital used to finance operations from the time that services are provided to the time that revenues are collected. In that context, we have approved several methods for determining the cash working capital allowance: lead-lag studies; a simplified formula method; and a standard allowance method. We have considered many factors regarding the telephone industry, and have recognized that, in that context, any one of several estimation methods will produce a reasonable cash working capital allowance. 111. The record indicates 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. Given these circumstances, we are adopting a presumption that a zero allowance is needed to support the regulated cable services. We note that it is possible, where receipts lead outlays, to establish a negative cash working capital allowance. We believe that our zero presumption is appropriate, however, in that it takes account of the characteristics of regulated cable service provision, is fair to both operators and subscribers, and furthers the goals established by the Cable Act of 1992. 6. Other Costs - Excess Capacity, Cost Overruns, and Premature Abandonments i. Notice 112. In the Notice the Commission sought comment on whether we should disallow from the ratebase costs that represent excess capacity, cost overruns, and premature abandonments. We solicited comment on whether we should establish regulatory limitations or whether we can monitor industry practices and impose requirements later if necessary. We specifically sought comment on several ways that the Commission could treat excess capacity, cost overruns, and premature abandonments for ratebase purposes. ii. Comments 113. Several parties agree with the Commission's tentative conclusion that the costs of excess capacity, cost overruns, and premature abandonments should be excluded from the ratebase. Michigan and Utah argue that these costs should be depreciated or amortized, which would allow operators to recover these costs over time, but not earn an annual return. Austin argues that the burden should be on the operator to show that unused channel capacity or similar investments will enhance regulated services and that such investments were prudent. 114. Several cable operators argue against exclusion of costs for excess capacity, cost overruns, and premature abandonments. These parties argue that certain costs for expanding channel capacity remain the same for expansion of differing numbers of channels, and that it would therefore be imprudent not to expand to the largest number of channels at the same cost even where the additional channels' usage is not immediately envisioned. NCTA argues that the Commission should not disallow these costs if they were prudently incurred plant investments. Summit suggests that GAAP and IRS guidelines should govern the treatment of excess capacity and cost overruns but fails to distinguish the cable industry from other regulated industries to justify the use of these guidelines. NYS Commission states that it may be difficult to exclude the costs of excess capacity from ratebase because sometimes franchise authorities require operators to rebuild or upgrade systems to a certain size. 115. BellSouth argues the middle ground that the exclusion of these costs from the ratebase should be dealt with on a case- by-case basis, with application of the used and useful and prudent investment standards to determine whether disallowance is appropriate in an individual case. The Commission, BellSouth suggests, could then monitor industry practices in this regard and impose rules later, if necessary. iii. Discussion 116. Excess capacity. We conclude that operators should be allowed to include in the ratebase any excess capacity that will be used within a twelve month period. We believe it is prudent for a cable operator to expand capacity beyond immediate needs, when such a present-day investment saves subscribers future costs for additional labor and equipment. We also note that telephone regulation provides for a certain limited amount of excess capacity. Nonetheless, we find that cable service regulation presents a different situation than telephone regulation; here, there is no annual or biannual filing, no opportunity to adjust the ratebase downward if excess capacity does not become used and useful within a certain period. 117. Further, our price cap adjustment and network upgrade plans make adequate provision for the addition of channels and capacity. Thus we will direct that any facilities that are not currently used and useful, but will be used and useful within one year, may be included in the ratebase, but that 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. We believe this approach strikes a reasonable balance between the interests of cable operators and those of subscribers by allowing an operator to include in the ratebase costs that benefit subscribers now or will benefit them very soon, while assuring that no double or excessive recovery of costs, and no double payment for capacity, can occur. 118. Cost overruns. We believe that cable operators should be able to recover the costs of overruns that have occurred through no fault of the operator. At the same time, we must ensure that subscribers do not bear any burden for unnecessary, extravagant, or imprudent expenses that may constitute cost overruns. We therefore find that cost overruns should be presumptively disallowed from the ratebase, but that operators may overcome this presumption on a case-by-case basis by showing that the costs were prudently invested. 119. Premature abandonments. We conclude 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. 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. This decision will protect subscribers by precluding recovery of a rate of return on abandoned plant, while preserving an opportunity for the cable operator to invest in more advanced technology. This approach allows the cable operator to recover the investment in outdated technology while not encouraging replacement of still useful equipment. Thus it helps achieve our goal of permitting operators to participate in the development of an advanced telecommunications infrastructure. B. Expenses 1. Operating Expenses i. Notice 120. In the Notice we proposed allowing cable operators to recover operating expenses as annual expenses incurred in providing cable service. We tentatively concluded that plant- specific costs (e.g., maintenance), plant non-specific costs (e.g., programming expense, power, engineering and testing), customer operations (e.g., marketing, billing and collection), and corporate operations (e.g., legal, planning, accounting and finance) should be included as operating expenses that cable operators are entitled to recover in rates for regulated cable service. We tentatively prohibited recovery through regulated cable rates, of expenses unrelated to provision of regulated cable service. In addition, we requested comment on whether other operating expenses should be recoverable, and on what costs should be treated as expenses in the year incurred, and what costs should be capitalized and depreciated over a number of years. ii. Comments 121. Commenters, including cable operators, programmers, state and local governments, and telephone companies, agree that the enumerated categories of expenses should be treated as operating expenses and should be recoverable in rates for regulated cable service. 122. Some commenters note that our rules already exclude costs unrelated to the provision of regulated cable service. Some cable operators suggest other costs that should be treated as operating expenses. For example, Cablevision Systems contends that the Commission has apparently excluded costs associated with system power, security, and quality assurances from operating expenses recoverable through rates for regulated services. Medium Operators states that advertising costs associated with regulated programming services should be included as a recoverable operating expense. 123. The exclusion of special expenses from recovery generated debate among commenters. Eagle agrees that special expenses should not be recoverable. While not opposed to the exclusion generally, Small Systems states that such expenses are relatively small, and that most operators do not list them separately on their books. BC states that any charitable contribution made in fulfillment of a franchise agreement or made to a local school or other governmental facility in the franchise area should be recoverable in basic service rates. Continental similarly argues that charitable expenses, club fees, and other money expended in the franchise community should be allowed as necessary operating expenses. Cablevision Systems agrees with the concept of excluding recovery of unrelated expenses, but believes that unrelated expenses and costs should be identified on a case-by-case basis. State and local governments generally support the exclusion of special expenses. BellSouth believes that the Commission should permit a reasonable allocation of such costs to be recovered through rates for both cable operators and telephone companies. Bell Atlantic supports exclusion of special expenses. 124. Little comment was directed to which costs should be expensed and which should be capitalized. Small Systems suggests that all budgeted capital expenditures to be made within the following 12 month be included in the ratebase. ETC argues that we should establish clear criteria for expenses that should be capitalized pursuant to IRS and GAAP guidelines. iii. Discussion 125. We will permit recovery of all operating expenses normally incurred by cable operators in the provision of regulated cable service. This will permit cable operators to recover fully the reasonable costs of providing regulated service, while protecting ratepayers from paying rates that reflect costs not reasonably associated with regulated services. We affirm our decision to exclude from recovery those operating expenses and other costs unrelated to the provision of regulated cable service pursuant to our proposed cost accounting and cost allocation rules. We note that the examples of operating expenses provided in the Notice were not meant as an exclusive list of the only types of operating expenses available for recovery. Other costs incurred in the provision of regulated cable service are recoverable if legitimate and reasonable. The Commission and local franchising authorities will, however, review operating expenses in each cost showing to assure that they meet our cost standards. In this way we can ensure that a cable operator that elects to make a cost-of-service showing is able to recover all fair and reasonable costs incurred in serving its customers. 126. We also adopt our tentative conclusion that certain special expenses are presumptively excluded from recovery as not reasonably related to the provision of regulated cable services. Cable ratepayers should not be responsible for reimbursing cable operators for unreasonable costs. We further conclude that, for the time being at least, GAAP should guide the determination of costs to be expensed and those that must be capitalized by each cable operator. 2. Depreciation i. Notice 127. In the Notice we tentatively concluded that the Commission should prescribe depreciation rates for purposes of developing cost-based rates for regulated cable service. We noted several different prescription methods and asked for comment on which was most suitable. We also asked commenters to address the necessary number of depreciable plant categories, evidence that should be taken into account in setting rates, and whether we should prescribe recovery on a straight line remaining life basis or use some other methodology. We tentatively concluded that depreciation rates should be based on book value of the asset as opposed to its economic or fair market value. 128. In addition, we tentatively concluded that any depreciation rates we prescribe should be designed accurately to reflect, and recover, the costs of the asset over its useful life. We requested comment on what the impact on cable rates would be if we prescribed, for the purpose of a cost-of-service showing, depreciation schedules designed to allow recovery of capitalized costs over the maximum reasonable expected life of the plant. We sought comment on a number of current industry depreciation practices, and on the useful life and salvage value of all categories of facilities used by cable operators to provide regulated cable service. Finally, as an alternative to prescription of depreciation rates, we asked whether we should for the time being only monitor operator depreciation practices. ii. Comments 129. Most cable operators oppose our tentative conclusion, or argue for deferral of consideration of this issue. Cablevision Industries states that treatment of depreciation for ratemaking purposes poses a challenge due to the many changes affecting the cable industry. Other cable operators argue that the Commission should defer consideration of depreciation rules to a later time or a second phase of this proceeding. Cablevision Systems urges the Commission to adopt a monitoring approach instead of prescription; COA believes it would be better for the Commission to accept current depreciation practices, monitor results, and correct for observed abuses. COA offers as a possible method to determine depreciation rates the "price cap carrier option" considered recently in a separate proceeding. Under this option, common carriers subject to price caps would file proposed depreciation rates with the Commission. The Commission would propose to adopt the carriers' proposed rates and seek comment on their reasonableness. Prescription of rates would be based on the proposed rates and any comments made thereon. 130. The majority of local and state governments filing comments support prescription of depreciation rates, but nonetheless are concerned about implementing prescription at the franchise level, which they believe would be too administratively burdensome. New York advocates use of a band of industry-wide reasonable rates with a band of individual rates for each plant category. Connecticut believes that monitoring of depreciation practices will suffice if cable operators are required to explain and justify their practices in the cost-of-service filings. 131. Telephone companies offer different prescription approaches. Bell Atlantic favors uniform practices for cable and telecommunications companies. GTE suggests formulating a depreciation standard for price caps that would be applied in cost-of-service proceedings. BellSouth recommends that the Commission prescribe basic depreciation practices for all cable operators except those subject to effective competition. 132. Comments on our tentative conclusion that depreciation rates should be designed to reflect and recover the cost of an asset over its useful life were mixed. Some cable interests agree with this conclusion but suggest that operators be allowed to challenge it on a case-by-case basis. Cablevision Industries argues that we should require the use of straight line depreciation over the useful life of the assets on a system-wide basis and with assets broken into general categories. Small Systems suggests that depreciation for cable operators be uniformly restated based on an average 12-year useful life. State governments favor the useful life standard. Arthur Andersen suggests that the Commission could prescribe a range of approved lives. Aerie states that cable operators should not be permitted accelerated depreciation on existing plant or valuation above original cost of service. BellSouth suggests that cable operators be permitted to estimate remaining life, with those estimates subject to comparison by the Commission against similar estimates offered by the cable operator for other purposes, such as SEC financial statements. iii. Discussion 133. After a careful review of the comments herein, we conclude that we need not adopt our tentative conclusion that we should prescribe depreciation rates. We believe prescription of depreciation rates to be unnecessary, at least pending completion of the cost study and analysis that we are directing the Cable Bureau to undertake. Further, we believe a depreciation prescription requirement would impose unjustified burdens without providing a balancing benefit to subscribers. Instead, regulators will closely monitor industry depreciation practices and carefully review depreciation showings in individual cost proceedings to assure that these depreciation practices are reasonable. In addition, we will examine depreciation practices of operators in individual cases to assure that resulting rates are reasonable. 134. We recognize, as stated in the Notice, that depreciation expense may significantly influence development of rates for cable service. Allowing rapid depreciation could increase a system's cash flow and provide additional funds to invest in infrastructure, though the system is not obligated to use such funds for infrastructure improvements. Rapid depreciation can also increase subscriber rates. Depreciation practices will play an important role in our balancing of goals for cost-based rates of cable service. Therefore, we may in the future revisit the issue of whether we should prescribe depreciation practices for development of rates for regulated cable service. 3. Taxes i. Notice 135. In the Notice, we proposed to allow, in determining a cable operator's annual expenses, taxes incurred in the provision of regulated cable services. We proposed that these taxes would include all state and federal taxes on the provision of cable service, and income taxes attributable to the provision of regulated cable service. We tentatively concluded that income taxes payable on income from cable operations by individual owners, partners or Subchapter S Corporation shareholders would not be recoverable in rates for regulated cable service. ii. Comments 136. Cable operators generally agree with our proposal to treat taxes incurred in providing regulated cable service as an allowable annual expense; however, they object to limiting this tax treatment to Chapter C corporations. They contend that the cable industry is comprised of all types of business entities, unlike a traditional public utility industry, which most often is comprised of Chapter C corporations. In addition, cable operators contend that legal precedent supports the treatment of income taxes as an allowable annual expense for non-C corporation entities. Cable operators argue that distinguishing between ownership forms for tax treatment will create artificial incentives for operators to alter their corporate status, which may be difficult for many operators, particularly smaller systems. Cable operators believe that our proposal will punish certain operators because of their business form, which in most cases was chosen in an unregulated environment and for reasons unrelated to cable service rates or tax consequences. Cable operators thus urge the Commission to reconsider our proposal and to design an income tax allowance that provides equal tax treatment of systems, for ratemaking purposes, regardless of ownership form. 137. Local authorities generally agree that inclusion of taxes incurred in providing regulated cable service is appropriate. However, Michigan Committee and Utah oppose permitting operators to recoup federal income taxes, and Austin contends that only taxes actually paid, and not an amount based on the statutory tax rate, should be included as an annual expense. Austin argues that, to the extent a cable operator realizes tax benefits, a matching principle should require the operator to pass through such benefits in subscriber rates. iii. Discussion 138. Regulators have generally permitted rate-regulated companies to recover income taxes in order to compensate the utility for taxes imposed directly on the utility, but not for taxes imposed on individual investors in the utility. Regulated public utilities generally operate in the traditional corporate form. This has meant that corporate taxes may be recovered from subscribers whereas taxes on dividends paid to owners of the corporation may not be recovered from subscribers. As indicated, however, cable operators operate under diverse ownership forms including corporations, Subchapter S corporations, partnerships (including partnerships of other ownership forms), and sole proprietorships. Based on the record in this proceeding, we are persuaded that we should design an income tax treatment that permits recovery of income taxes regardless of the form of ownership of the regulated cable service enterprise. 139. We affirm our 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 we adopt will be determined as follows: the permitted rate of return on the ratebase is first calculated in accordance with the requirements we adopt in this Report and Order. This amount is then 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 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. 140. Traditional cost-of-service regulation allows for recovery of allowable tax expense on an annual basis. Here, however, it is possible that a rate 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 we do 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. For example, the following illustration of the 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 110000 110000 110000 (@ 11%) 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 25758 51515 (25758) (@ estimate 34% grossed up) 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 25758 77273 51515 141. We do not require the three-year calculation shown above. We do require, however, that cost-of-service showings that include a tax allowance show some calculation of likely changes in retained earnings. Our overall approach will establish a tax treatment that is equitable for all ownership forms. This is fair to subscribers, as cable operators that are other than Chapter C corporations are compensated by subscribers only for those taxes attributable to earnings retained in the business and that can be used to provide service to subscribers, while taxes on profits and earnings paid to and potentially used by the owners for purposes unrelated to provision of regulated cable activities will be paid by those owners. C. Test Year Methodology i. Notice 142. In the Notice, we solicited comment on the appropriate methodology for selecting a test year. The test year is used by the regulator as a basis for estimating future revenue requirements. This estimate is one of the most difficult problems in a rate case because while a regulator sets rates for the future, only historic data (expenses, revenues, demand conditions) is available as a guide. To the extent that relationship between these variables changes, the actual rate of return earned by the company may be quite different from the rate authorized by the regulator. For many years, regulators have adjusted test year data for "known changes." Known changes are generally defined as changes that actually took place during or before the test year (e.g., a new wage agreement that occurred toward the end of the year). More recently, due primarily to inflation, some regulators have modified the traditional test year approach by using a projected test year (either partial or full) or by permitting pro forma expense and revenue adjustments. Use of a projected test year is most often justified as a more accurate methodology for calculating future revenue requirement ii. Comments 143. Arthur Andersen asserts that while the test year may conceptually be any twelve month period, as a practical matter, the historic test year is probably most convenient for most cable service providers. Arthur Andersen further asserts that the Commission should use the most recently completed accounting period available at the time of the rate filing, since this would reflect appropriate period-ending adjustments and has usually been subject to an independent audit. Finally, Arthur Andersen maintains that the historic test year should be adjusted for "known and measurable" changes and that the Commission should specify the time frame for such adjustments. 144. Cablevision Systems asserts that the Commission should permit the use of any test year at the discretion of the cable operator. Eagle contends that the Commission should use an historic test year and recommends either the latest twelve month period or the latest complete fiscal year at the discretion of the cable operator. ETS advocates an historic test year for three reasons: the actual data are known and not speculative; the use of projected test year data potentially results in more challenges to the assumptions used in the projections; and a projected test year is unfair to investors if the projected costs and expenses are underestimated, and unfair to ratepayers if costs and expenses are overestimated. 145. NCTA argues against establishing any specific test year methodology at this time, asserting that the Commission has insufficient experience with cable rate regulation to prescribe a methodology. Instead, NCTA proposes to require that whatever test year methodology is used is a reliable indicator of expected revenue requirements during the effective period of the rates being set. iii. Discussion 146. Based on careful consideration of the record before us, we are persuaded that use of an adjusted historic test year is the most appropriate methodology. The test year may be adjusted for "known and measurable" changes that have occurred by the time the rates take effect. We further find 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 new systems, for which no historic data are available, projected data may be used, but careful scrutiny shall be paid to the assumptions used. IV. Rate of Return 147. A major component of our 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. In this section, we prescribe an interim, overall rate of return of 11.25% for use in cable cost- of-service proceedings. A. Uniform Rate of Return i. Notice 148. In the Notice, we proposed to include a reasonable return on allowed investment in the cost of service for regulated cable operations. We also proposed to establish that rate of return in this proceeding by prescribing a single, overall rate of return for use in all cable cost-of-service showings. We indicated that this approach would be preferable to establishing separate rates of return for each franchise area or cable company, an approach that we tentatively concluded would be impracticable. We sought comment on our proposals and analysis, and on the alternative of establishing different rates of return for appropriate groups or types of cable operators. ii. Comments 149. Some cable operators agree with the Commission that it is not practical to establish a separate rate of return for each franchise area. Cablevision Industries and Viacom maintain that the Commission should prescribe a uniform national rate of return applicable to all cable systems. Continental agrees in principle with the Commission's assessment that establishing an industry-wide rate of return would be highly preferable for the efficient administration of the cost-of-service rules by all stakeholders. 150. Many telephone companies, state commenters, and municipalities also support an industry-wide rate of return. Telephone companies argue that a single rate of return for all cable operators is the only practical approach, and that setting separate rates of return for each cable operator or franchise area would be costly. Most state and local governmental commenters support a single rate of return for regulated cable service, rather than setting a separate rate of return for each cable company or franchise area. 151. Some cable operators argue that a cable firm's cost of capital varies to a large degree with location and size. These commenters maintain that, as a result, small cable firms are inherently more financially risky than large operators, and thus should be allowed a higher rate of return. Comcast claims that application of a single rate of return to an industry as diverse as cable would result in confiscatory rates. TMC recommends that each cable operator be permitted to submit its own rate of return based on its capital structure; Time Warner believes each cable system should be allowed to show the rate of return appropriate for the operations for which prices are being reviewed. 152. Some commenters assert that, while a unitary rate of return may be appropriate for telephone company regulation, the cable industry is very different from the telephone industry, and merits different rate of return treatment. Commenters describe the cable industry as inherently risky: California Cable contends that the Commission must ensure that investors are fully compensated for the risks they have assumed, and should thus require different rates of return for differently situated firms. Others argue that the Commission should consider setting a range of permitted rates of return to help compensate operators for the risks present in their systems. New York maintains that the Commission should set two separate rates of return, one for publicly-traded and the other for privately-held firms, rather than separate rates of return for each franchise area. Small Cities contends that firm or ownership unit size, rather than individual system size, should be the operative measure for rate of return calculations, since it is on the former basis that financing is obtained. iii. Discussion 153. In proposing to establish a single, overall rate of return for cable cost-of-service proceedings, we stated that individualized rates of return might permit the most precise balancing of subscriber and operator interests. We indicated, however, that the burdens on franchising authorities, cable operators, and the Commission of establishing individualized rates of return would outweigh any possible increase in precision from individualized treatment. 154. The record confirms that the burdens 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. We are 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. 155. Although some commenters argue that we should prescribe a range of permitted returns, or separate rates of return for publicly-traded and privately-held firms, to help compensate cable operators for the particular risks they encounter, these commenters do not provide any concrete information that we could use to distinguish among different cable operators or cable systems. In particular, the parties have not proposed a specific mechanism for identifying, nor does the record reveal, a discernible relationship between the cost of capital for regulated cable service and the cable system's size or location, or the cable operator's method of financing. Therefore, we reject these commenters' arguments. Further, we believe that a carefully determined single, overall rate of return for regulated cable service will enable cable companies to earn a reasonable return on their allowed investment, while protecting consumers from unreasonable rates. We reject the assertion that we must ensure that investors are fully compensated for risks unrelated to the provision of regulated cable service. We prescribe a rate of return to ensure that companies have the opportunity to earn a reasonable recovery on their prudent investment in property that is used and useful for that service. 156. Some cable operators may believe that the overall rate of return we establish 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, we will not foreclose parties to such proceedings from attempting to justify different rates of return. Accordingly, we establish an overall rate of return for application to cable operators in individual cost-of-service proceedings. B. General Methodology i. Notice 157. In the Notice, we invited comment on the method we should employ to establish a single overall rate of return. We proposed to identify one or more surrogates having risks comparable to those cable operators encounter. We tentatively concluded that the Standard and Poors 400 Industrials (S&P 400) offers a broad range of investors' expectations regarding the trade-off between risk and return, and that investors in the S&P 400 experience risks that are roughly equivalent to those experienced in the provision of regulated cable service. We also tentatively concluded that either the S&P 400 as a whole, or a subgroup within it, would constitute a reasonable surrogate for regulated cable service, and that the cost of capital of the S&P 400 should be our primary guide in determining the rate of return for regulated cable service. 158. We also proposed in the Notice to determine the cost of capital by estimating the surrogate's cost of equity and cost of debt, and then deriving a composite, weighted average cost of capital reflecting the surrogate's capital structure. While we stated that this average would weigh heavily in our determination of an overall rate of return for cable cost-of-service proceedings, we recognized that the cable industry may differ from mature regulated industries that earn steady returns on investment. We also recognized that the cable industry is a relatively new industry, characterized by growth and earnings reinvestment as well as a heavy reliance on private and semi- public sources of capital, and that cable investors' expectations may differ from those of other investors. We invited commenters to submit detailed economic analysis on the extent to which these differences should affect our development of a rate of return for cable. We also invited expert economic analysis regarding the models we should employ to ensure that we establish a reasonable rate of return. ii. Comments 159. While many parties proposed cable surrogates, none provided a detailed analysis that attempted to quantify the risks of regulated cable service. Some commenters accept the use of the S&P 400 as a suitable surrogate as a starting point for estimating the cost of capital. These commenters, however, suggest varying approaches to adapting the S&P 400 to what they perceive to be the unique risk characteristics inherent in the cable industry. Several commenters suggest a rate of return at least two percent above the S&P 400 average to adjust for the added risk of cable investments. Bell Atlantic urges a capital structure composed of 86% debt and 14% equity, and suggests that, given this capital structure, the third quartile of the S&P 400 would represent an overall risk level comparable to cable industry investments. 160. NCTA opposes using the S&P 400 as a surrogate, contending that the average risk characteristics of companies within that group are too removed from cable company risks to offer a meaningful comparison. TCI contends that S&P 400 data are an inappropriate substitute for specific data unique to the cable industry. Georgia Cable argues that cable companies, unlike the companies in the S&P 400, are small entities that depend heavily on private and semi-public sources of capital. 161. Other commenters suggest the LEC industry as an appropriate surrogate. Municipals argues that telephone companies are comparable to cable companies because both are local distributors with "virtual monopolies" in their traditional business areas. Michigan Committee claims that the competitive pressures placed on the cable industry by direct broadcast satellite services and multichannel microwave distribution services are comparable to those telephone companies face from cellular services and competitive access providers. Seaford and Municipals contend that the maximum allowed rate of return for cable companies should be set no higher than the rate of return prescribed for telephone companies because the cable and telephone industries face comparable risks. Indeed, these commenters suggest that an overall rate below the prevailing rate for LECs might be appropriate for both industries, given the recent general trend toward lower interest rates. 162. Other commenters oppose the use of the telephone industry as a surrogate. NCTA, for example, argues that telephone, unlike cable television, is an essential service and therefore carries an investment risk below that of cable. Other commenters would support reliance on the telephone industry as a partial surrogate only, incorporating other telecommunications companies, broadcast companies, leisure and recreation concerns, and selected companies from the S&P Industrials Index as a composite comparable group from which expected earnings and returns for cable companies can be estimated. 163. Commenters generally do not oppose the proposed weighted average cost of capital methodology. That method assumes a post-tax return on equity. Comcast's and COA's expert, AUS Consultants (AUS), suggests that, as an alternative, we could estimate a pre-tax overall cost of capital, thus avoiding the need to combine equity and debt cost estimates. iii. Discussion 164. We conclude that we should use the weighted average cost of capital method, with its cost of equity, cost of debt, and capital structure components. Although Comcast's and COA's consultant, AUS, proposes a pre-tax overall cost of capital, that proposal is based on AUS's comparable earnings methodology. Since we reject that approach, infra, we will apply the more traditional, weighted average cost of capital approach. 165. In order to apply that method, we must estimate the cost of the capital contributing to the provision of regulated cable service. Most cable companies have diverse operations. Even those described as "pure play" cable operators provide a mixture of regulated and unregulated services. No company for which the parties presented data engages only in provision of regulated cable service, and surrogate firms must thus be chosen to represent the risks of regulated cable in any cost of capital analysis. 166. The surrogate firms must operate at levels of risks comparable to those of regulated cable service, because our fundamental goal is to determine 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, we must also recognize the limitations imposed by the available information. Because we have different kinds of information available with regard to cost of equity, cost of debt, and capital structure, we address each of these components of the overall cost of capital separately. Sections IV.C. through IV.E., infra, provide our analyses. C. Cost of Equity i. Introduction 167. The ideal cost of equity estimate should accurately reflect investor expectations as to the returns, both in terms of capital gains and in terms of dividends, investors will earn. Since investor expectations are not directly measurable, a variety of indirect methods are used. Generally the methods used by commenters in this proceeding fall into three categories: risk premium, discounted cash flow (DCF), and comparable earnings. Commenters submitted four studies. Two studies use the capital asset pricing model (CAPM) version of the risk premium method to analyze cable surrogates and cable companies. One study relies upon the DCF method to analyze the S&P 400. The final study applies the comparable earnings methodology to surrogate groups and cable companies. In Attachment D, we describe these three methods of estimating the cost of equity and our analysis of the studies submitted by commenters advocating them. 168. In the Notice we proposed to apply the DCF method to the companies composing the S&P 400. We indicated that companies in the S&P 400 as a whole, or a subgroup within it, encounter risks comparable to those encountered by companies that provide regulated cable service, and that an average of DCF cost of equity estimates for the S&P 400 could therefore serve as an estimate for the regulated cable industry's cost of equity. We thus tentatively concluded that S&P 400 data should be our primary guide for our cost of capital determination. ii. Comments 169. As previously stated, the record contains four studies addressing cost of equity issues. CATA presents a CAPM study performed by Peter K. Pitsch (Pitsch) that estimates a cost of equity for cable of 18%. Based on this study, CATA recommends an overall rate of return in the 15% to 17% range in recognition of the cable industry's asserted lack of access to public debt and stock markets. Cablevision Industries, relying on a CAPM study conducted by the Brattle Group (Brattle), recommends a 16% overall rate of return for the cable industry. Bell Atlantic relies on the results of the DCF analysis by James H. Vander Weide (Vander Weide), and recommends a cost of equity between 11.85 and 15.11% depending upon the capital structure adopted. Comcast and COA propose a pre-tax cost of equity of 18.9% based on the results of a comparable earnings study performed by AUS. 170. BellSouth maintains that there are no publicly traded "pure play" cable operators that provide only regulated cable service. It notes that by definition regulated cable services remain monopoly services and thus, it argues, the risks associated with regulated cable are something less than that associated with the S&P 400 as a whole. BellSouth recommends the average return of companies making up the lower range of the S&P 400 be used as a surrogate to develop the equity element of the cost of capital for regulated cable service. 171. GTE submits that the risks of cable and telephone are similar and recommends using the S&P 400, concentrating on those companies with returns on equity in the upper quartile. CFA maintains that cable has a degree of market power enjoyed by few S&P 400 companies and that cable faces no real competition. It asserts that this lower risk makes the bottom quartile of the S&P 400 an appropriate surrogate for cable. 172. Small Cities states that it was recently told "that a 20% cash-on-cash return would be required to attract equity in today's market for small companies." Avenue states that a typical return on equity for cable companies is 12%-15%. NCTA's consultant, Economist, Inc., concludes that cable is 30% to 50% riskier than the overall market. Time Warner's consultant, NERA, provides for illustrative purposes cost of equity estimates for three cable companies. Using an 8.6% risk premium, NERA's average estimate (weighted by company size) is 18.4%. NERA notes that betas of the three companies have risen from previous results, and ascribes this increase to anticipation of regulation-depressed earnings. iii. Discussion 173. We find arguments against the DCF methodology and against the use of the S&P 400 as a surrogate unpersuasive. For the reasons stated in Attachment D, we are also unpersuaded that other approaches suggested in the cost of equity studies by commenters are superior. Accordingly, we apply the DCF methodology to the S&P 400 to develop the cost of equity for companies providing regulated cable service. 174. The S&P 400 includes companies spanning a very wide range of total risks, and a wide variety of combinations of financial and business risks. A primary reason for our choice of the S&P 400 as a surrogate is that the information relied upon by investors to assess the risks of S&P 400 companies is widely available. In contrast, cable equity is generally closely held, and information on its risks and expected returns is not a matter of public record. We also believe, as explained below, that the DCF methodology is the best, most appropriate methodology for determining the cost of capital in this case. 175. In opposing the S&P 400 as a source of surrogates for estimating the cost of equity for cable, the parties make two basic assertions. The first is that neither the S&P 400 nor any subgroup of the S&P 400 combines financial and business risks in the same proportions as cable. We believe that investors care about (and therefore an investment's required return reflects) the composite (financial and business) risk of a potential investment. Therefore, we find the parties' objection unpersuasive. 176. The second assertion is that the cost of equity for regulated cable service exceeds that found for the S&P 400, or for any subgroup thereof. The parties rely on two sources for this assertion: the cable stock betas and cable capital structures. As we note in Attachment D, the high betas of some cable equity issues reflect the closely-held nature of the stock. We believe that the historic pattern of fluctuations in cable stock prices is not purely the outcome of the changing risk-and- return assessments of market investors, but instead reflects in large measure insider decisions regarding cable stocks. Even if cable betas were purely a reflection of the changes in investor evaluations of the risks and return from cable services, we would still have to adjust for the monopoly-profit component of investor expectations. We believe that the monopoly profit component was by far the most variable element in investor expectations. We, therefore, give no weight to this source of evidence about the risks of the cable industry. 177. The parties also identify the capital structure of the cable industry as a source of financial risk, and we agree that this is so. Investors assess all sources of risk, and will consider that one element of risk, relatively high financial risk, may be offset by another element, relatively low business risk. We believe the cable industry attained its current high levels of debt financing largely on the basis of its low business risk. None of the parties has demonstrated that the overall risks of regulated cable service exceed that of the S&P 400 companies, and we find assertions to that effect not credible. 178. The objections parties raise to use of the DCF method center on its application to specific cable companies. Cablevision Industries and others reiterate our caution in the Notice that analysts' estimates for pure growth companies must be carefully scrutinized. We generally agree that DCF, like CAPM, is difficult to apply to specific cable companies. The DCF method requires dividend, stock price, and estimated growth data regarding each company to which it is applied. The cable companies for which such data are available are closely held and subject to insider decisions. Further, we note that even if we were to apply the DCF method to data regarding the few "pure play" cable companies, we would have to adjust the estimates to obtain a reasonable surrogate for the cost of equity for regulated cable service. 179. These problems, however, do not affect the usefulness of the DCF method as a tool for estimating the cost of equity for companies within the S&P 400 and using those estimates to determine the cost of capital for regulated cable service. With regard to the studies submitted in this proceeding, we find the Vander Weide study more appropriate to the task at hand than any of the other submissions. The Commission's "classic DCF" methodology, as employed by Vander Weide in estimating the cost of equity for the S&P 400, incorporates the risk-return assessments of virtually all stockmarket investors. The long- term growth estimates relied upon by the DCF method represent the consensus estimates of a large number of widely-followed stock analysts. 180. Although a number of cable operators suggest using cable companies as surrogates for determining the cost of equity for the provision of regulated cable service, the record does not support their use. As we previously stated, determining cost of equity requires indirect analysis, usually through models such as the DCF model and the CAPM model. We have been presented with essentially three methods for estimating the cost of equity for regulated cable service. In Attachment D, we explain why two of these methods, the CAPM and comparable earnings methods, cannot be applied to cable at this time, even though the methods' proponents use cable companies as surrogates for the provision of regulated cable service. 181. The remaining method, the DCF method, requires dividend, stock price, and estimated growth data. The cable companies for which this information is available are closely- held and subject to insider decisions. Thus, the data may reflect a bias for which we are unable to adjust. For these reasons, we reject, at this time, the use of cable companies as surrogates for the provision of regulated cable service. Given that we do not find cable companies to be useful surrogates and we reject other potential surrogates as set forth in Attachment D, we believe that the S&P 400 firms for which sufficient data are available to make DCF calculations provide a large group of publicly-traded firms that is roughly representative of the universe of nonregulated firms and, thus, provide the most appropriate source of surrogates for regulated cable service available in the record. 182. 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, we believe that we should look at the S&P 400 broadly and define a broad zone of reasonableness for the cost of equity. Based on his DCF analysis, Vander Weide estimates the cost of equity for regulated cable service to be 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). We believe that these estimates provide reasonable outside bounds for the cost of equity for regulated cable service, approximately 12% and 15%. Because of the thinness of the record, we are unable to establish with certainty any specific number within this range as the cost of equity, nor do we believe there is a need to do so. Instead, we use 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. 183. We thus adopt the application of the DCF methodology to the S&P 400 in our development of a reasonable interim rate of return for regulated cable service activities. We perform our analysis in Section IV.F., infra, to set an overall rate of return based on our estimate that the cost of equity lies within this 12% to 15% range. D. Debt i. Notice 184. In the Notice we solicited comment on how we should measure the cost of debt for regulated cable service. We tentatively concluded that we should rely on the cost of debt of the surrogate we used to determine the cost of equity, but asked for comment on the weight to accord cable debt. ii. Comments 185. AUS (Comcast and COA) finds an average 1992 embedded cost of debt of 8.5% for five cable companies. AUS notes that more recent debt information would decrease its overall cost of capital recommendation by 0.25% to 0.50%. AUS also calculated the 1992 embedded cost of debt for the companies in its asserted comparable groups: 9.5% (industrial), 10.0% (broadcast), 8.1%(telephone), and 8.9% (recreation). 186. Bell Atlantic's Vander Weide examines financial data for six cable companies, which provide cable service to approximately 30% of all cable subscribers. He divides interest expense by the book value of debt to arrive at an average embedded cost of debt of 7.8%. 187. Small Cities states that its experience has been that senior bank debt costs small companies at least 1.24% and as much as 4% or more above the prime rate. Avenue states that, as a privately held company, it does not have access to international debt rates such as the London Interbank Offering Rate (LIBOR), and that the average debt cost for similarly situated companies is 10%-12%. iii. Discussion 188. The record on the cost of debt includes compilations of debt costs for specific cable operators. The information on is both industry-specific and concrete, and does not appear to share the biases we found in the cable company-specific information the parties used to estimate the cost of equity. We believe 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. 189. 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. We note that currently the prime rate is 6% and LIBOR is 3.56% (90 day) and 3.75% (180 day). 190. The range for the average cost of fixed rate debt established by this information for the most recently available period (1992-93) is 7.8% to 8.65%. The prevalence of floating rate debt financing in the cable industry persuades us to be cautious in selecting a percentage within this range. We believe that 8.5% represents a reasonable estimate of the cost of debt for cable. In addition to reflecting historical debt costs, this rate allows for an increase in the cost of floating rate debt above current rates. E. Capital Structure i. Notice 191. In the Notice we asked parties to compare the capital structures within the cable industry to those within traditional regulated industries. We noted the difficulty in evaluating current cable industry practices given that much financing is provided by private or closely held companies for which SEC scrutinized statements of position are not available. We noted that at least some cable operators are very highly leveraged (that is, debt contributes all but a small portion of their total capital.) We sought comment on the impact of requirements adopted in this proceeding on the current overall financial structure of the cable industry. In particular, we asked for comment on the impact on the cable industry if we relied on a traditional regulated industry capital structure, such as one composed of 50% debt and 50% equity. ii. Comments 192. Comcast's consultant, AUS, found the equity/total capital ratios of 12 cable companies to range from nearly 50% to nearly -100%. AUS recommends a hypothetical capital structure having 50% debt and 50% equity if the prescribed overall return is based on an after-tax cost of equity. AUS would eliminate the capital structure issue with a pre-tax overall return. 193. Bell Atlantic's Vander Weide would use what he considers to be the actual capital structures of six large cable operators. He examined the balance sheets of these companies and found debt exceeding their total book assets or, in other words, that these companies had negative shareholder equity. The average debt/debt + equity ratio was 113.77%. Excluding losses, the ratio was 86.01%. Vander Weide adopts the 86% debt figure, arguing that it is impossible to calculate an average cost of capital when debt exceeds 100% of total investor-supplied capital, and that 86% approximates industry's long-run target capital structure. Vander Weide contends that hypothetical capital structures, such as a structure composed of 40% debt and 60% equity, or the 50% equity and 50% debt structure proposed in the Notice, would produce an overall cost of capital exceeding that required to attract capital to cable. He asserts that the S&P 400's average overall cost of capital of 11.88% would translate into an equity return of 36.93% for cable operators with 86% debt and 14% equity. 194. Viacom rejects Vander Weide's use of average cable company debt, and argues that Vander Weide should more properly have used the average yield on cable bonds. Viacom asserts Vander Weide's calculated cable equity return would be only 23.4% if he had used an average cable bond yield of 10% instead of the average cable company debt cost of 7.8%. Viacom contends the cable equity return would fall to 17% had Vander Weide assumed the 73% debt/27% equity of cable companies studied by Brattle. 195. Comcast's consultant, Schink, sees a 40% debt/60% equity capital structure as more appropriate for the assertedly high risks of cable. He proposes that companies above 50% equity use their actual capital structures. Schink maintains that Vander Weide's 15.11% cost of equity for the third quartile of the S&P 400 would be 28.88% if adjusted from S&P 400 average capital structure of 44% debt/56% equity to 86% debt/14% equity. Schink contends that this capital structure would increase the embedded cost of debt from the 7.8% to 11% (the yield on a low-rated 10-year bond), and would increase cable's overall cost of capital to 13.5%. 196. Time Warner's consultant, NERA, contends that ratios based on book equity and debt vary widely within cable and that many cable companies have nearly zero or negative book equity. NERA argues that market value of cable equity and debt is more consistent with finance theory and provides market value debt/equity ratios for 24 cable companies. Calculating the average for NERA's group of companies with significant cable operations yields a capital structure composed of 60% debt and 40% market equity. 197. Brattle (Cablevision Industries) would base capital structure on the market value, rather than book value, of equity and debt. Brattle (Viacom) argues that only a small portion of market value of cable equity reflects monopoly profit expectations. Pitsch assumes a 50% debt/50% equity capital structure. iii. Discussion 198. We have generally relied on embedded capital structures of the regulated entities' owners on the assumption that they represent the steady-state, long-term basis for financing regulated activity. However, the current capital structures in the cable industry are based on the use of debt, rather than a combination of debt and equity, to finance accumulated losses. We agree with the cable operators that suggest that these structures are not sustainable in the long- term. Although Vander Weide adjusts the capital structures by eliminating accumulated losses, we find his method arbitrary and unlikely to provide a reasonable basis for setting prospective rates. Therefore, we reject the capital structure of 86% debt and 14% equity he proposes. 199. We also reject recommendations that we adopt capital structures based on the market value of equity. We believe that market value may reflect substantial expectations of non- competitive profits and of growth in nonregulated activities. In addition, the long-term average capital structure of the industry is not clear at this time. Therefore, we believe that we should consider a capital structure range, rather than a single capital structure, for use in our determination of the overall cost of capital for regulated cable operations. Based on the record, we believe 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 adopted above. F. Overall Cost of Capital i. Notice 200. In the Notice we tentatively concluded that an overall cost of capital in the range of 10% to 14% would reflect a reasonable balancing of subscriber and cable operator interests, and that we should select a return from within this range to achieve our balancing of goals for cost-based rates for cable service. We sought comment on choosing the maximum allowable rate of return for regulated cable service from within this range. ii. Comments 201. AUS (Comcast and COA) states its overall recommendation in terms of a pre-tax cost of capital. Schink calculates a 12.9% after-tax cost of capital based on the AUS recommendation. Bell Atlantic's Vander Weide recommends an overall rate of return of 8.83%. This rate combines the 15.11% average DCF cost of equity for the third quartile of the S&P 400 and a 7.80% cost of debt with the 86% debt/14% equity capital structure he calculated by excluding accumulated losses from the capital structures of six large cable companies. Vander Weide would use the 11.80% first quartile S&P 400 average cost of equity if a 50% debt/50% equity capital structure is adopted. 202. Small Cities proposes an overall rate of return of 15% to 20% for rural areas. Avenue proposes an overall rate of return of 15% to 20% based on an equity return of 12% to 15%, debt costs of 10% to 12%, and a desired debt-to-equity ratio of 10%. Medium Operators recommends an 18% to 20% rate of return. Municipals would prescribe a rate of return no higher than interstate rate of return currently in effect for LECs. Municipals contends that the current 11.25% prescription for LECs is too high because the cost of capital has dropped precipitously since this return was adopted in September 1990. Austin sees regulated cable service as not particularly risky and more akin to regulated telephone service. Austin argues that the telephone return of 11.25% is too high for cable because cable is financed with far less equity than assumed by the telephone prescription. 203. Cablevision Industries recommends 16% as the overall average cost of capital for cable, based upon a 2% premium added to the top of the 10% to 14% return range proposed in the Notice. Cablevision Industries also proposes that operators with rates targeting the prescribed rate of return be allowed 1% more if it can be achieved through increased efficiency. iii. Discussion 204. The Cable Act of 1992 requires that our 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." Companies regulated under this standard must be allowed the opportunity to earn a return sufficiently high to maintain the company's financial integrity and ability to 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 we must use our judgment to select a return within that zone. 205. In the previous sections we have considered the evidence presented by the parties, and have identified a reasonable range for the cost of equity for regulated cable service. We have also identified a 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 Equity Estimate 40% 50% 60% 70% 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% 206. We do not believe that any one cell in this table should be given definitive weight. We therefore concentrate on the averages shown on the last row. Based on these averages, we find that the overall cost of capital for regulated cable service lies within a "zone of reasonableness" of 10.0% to 11.5%. 207. We believe that it is appropriate to be cautious when selecting a number within this zone, since the record is less than perfect. In addition, we cannot know with certainty the risks of regulated cable operations, since those risks are dependent in part on the cost-of-service rules and principles adopted in this Order and on our revised benchmark methodology. Our caution in prescribing is reinforced by our desire to encourage infrastructure development. We believe 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, we are prescribing an overall cost of capital of 11.25%, a figure that lies between the two estimates at the upper end of the range. 208. As further evidence of our caution, we note that our prescription is an interim one. In the Further Notice, we seek information on the relative risks of cable operations given our recent actions, and we seek further analysis of S&P 400 companies' costs of capital. V. Accounting Requirements i. Background 209. Under existing rules, regulated cable operators are required to maintain their accounts in accordance with GAAP. They also are required to maintain their accounts in a manner that will enable identification of appropriate costs and application of cost assignment and cost allocation procedures to cost categories necessary for rate adjustments due to changes in external costs and for cost-of-service showings. 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. Costs associated with franchise fees, franchise requirements, local taxes, and local programming must be identified at the franchise level. ii. Notice 210. In the Notice, we sought comment on supplemental financial and accounting requirements that were contained in Appendix A. We proposed that all cable operators would be required to maintain their accounts in a manner that would permit them to report in accordance with these requirements if they elect cost-of-service regulation. We also sought comment on whether we should establish a uniform accounting system for cable operators electing cost-of-service regulation similar to the Uniform System of Accounts (USOA) for telephone companies in Part 32 of the Commission's rules. Finally we asked for comment on the organizational level at which we should require that costs be identified. iii. Comments 211. Several cable operators argue that we should not adopt additional accounting requirements until all of the rules for determining just and reasonable rates have been adopted. Comcast claims that most operators comply with GAAP and that GAAP standards are sufficient for monitoring the cable industry. NCTA states that the Commission can consider adopting an accounting system for the cable industry if the Commission ultimately finds that GAAP is inadequate. 212. A number of commenters point out that cable companies have not maintained their accounting systems in a uniform manner nor at a high level of detail, and that to require them to do so now would be burdensome and costly. Cable operators observe that an accounting system will not be necessary for the vast majority of companies whose rates will be regulated under the benchmark/price cap approach. In addition, Aerie asserts that this Commission need not adopt an accounting system for the cable industry because state commissions have authority to require supplemental filings from cable operators. Medium Operators also urge deferral of the accounting issues in this proceeding, and request that the Commission not limit itself by adopting detailed and rigid criteria in these early stages of regulation. 213. Several telephone companies argue that cable operators should be made subject to the equivalent of the USOA that is imposed upon telephone companies. BellSouth submits that, if cost-of-service filings are to be addressed efficiently, the Commission must adopt uniform accounting requirements to ensure that reported financial results are stable and consistent, and facilitate auditing. BellSouth also suggests that, if the Commission determines that an accounting system would be too burdensome for small cable operators, the Commission can allow them to maintain accounts at a summary level. Bell Atlantic states that an accounting system for cable operators is necessary for federal-state coordination. 214. Other commenters support a simplified accounting system for cable, and suggest that the accounts listed in Appendix A to the Notice provide a satisfactory level to achieve the goals of uniformity and simplicity. New Jersey urges the Commission to adopt an accounting system for all cable companies. Arthur Andersen urges adoption of a simplified accounting system for cable operators that elect cost-of-service regulation. Arthur Andersen states that this accounting system should be based on GAAP, and where GAAP is not specific, the accounting system should provide guidelines. Acknowledging that cable operators almost universally oppose an accounting system as burdensome and prefer GAAP as the standard, Arthur Andersen suggests that the Commission could prescribe an account structure and accounting practices for reporting purposes only. Arthur Andersen states that this would allow cable operators to maintain books and records in a manner which both meets their own needs and provides the desired consistency of accounting and reporting for cost-of-service regulation. 215. Cable operators discourage the Commission from either specifying averaging at the multiple system operator (MSO) level, or requiring the maintenance of costing detail at the franchise level. They generally request flexibility to average at the level most appropriate considering operator accounting and operating practices. Among smaller operators, Avenue TV and TMC express concern that the Commission will require detailed accounting at too low a level. TMC suggests that cost-of- service showings should be at the company level rather than at the system or franchise level. GTE suggests that costs be allocated at the highest level possible, to allow for simplification to the extent possible. State regulator commenters suggest that the system level is the appropriate level for cost averaging. 216. Arthur Andersen, however, states that it would be in the best interest of cable operators to determine cost of service at a level no higher than the franchise level, to avoid the inevitable response of competitors to rates which reflect unrelated costs. Aerie cautions against allowing large companies to use simplified cost-of-service showings based on standardized costs, because such practices may provide substantial windfalls and duplicative recovery of costs. iv. Discussion 217. Cable Accounting System. We will adopt a uniform accounting system for cable operators that elect cost-of-service regulation in order to ensure that they accurately record their revenues, operating expenses, depreciation expenses, and capital investments. In the Further Notice, we seek comment on the precise form the accounting system should take. We also explain the process we intend to follow to develop and adopt an accounting system for cable operators. The system of accounts we are proposing is contained within Attachment C. 218. Cable operators that are regulated under the benchmark/price cap approach will not, however, be required to maintain their accounts in accordance with a uniform system. We find that it is unnecessary to require uniform accounting under the benchmark/price cap approach because, while a uniform accounting system is designed to help measure a regulated company's cost of providing service, the benchmark/price cap approach is concerned with the prices a regulated company charges for providing service. 219. A uniform accounting system is an important component of cost-of-service regulation, because accounting records will serve as the principle source of information for determining the reasonableness of rates charged by cable operators that elect cost-of-service regulation. We conclude that neither GAAP nor the interim summary level accounts that we are requiring with the adoption of this Order will adequately provide, in the long run, for uniform accounting practices among cable operators. A uniform accounting system is important, for example, to help ensure that cable operators that elect cost-of-service regulation properly distinguish between expenditures that should be charged to capital and those that should be charged to operating expenses. 220. In addition, we believe a uniform accounting system will help minimize variations in accounting practices, thus simplifying cost-of-service proceedings. Since the accounting practices of cable operators may vary widely, cost-of-service regulation could be less than ideally effective unless all operators that elect such regulation are required to follow a uniform accounting system. Uniform accounting has long been recognized as an important component of cost-of-service regulation. In fact, all state and federal agencies that engage in cost-of-service regulation, including this Commission, recognize the importance of uniform accounting. 221. Although numerous cable operators have argued against the imposition of an accounting system because it would be burdensome, we conclude that the burden on those companies that elect cost-of-service regulation is outweighed by the need for the most accurate information possible on the companies' cost of service. Moreover, a uniform accounting system is important to the cost-of-service approach because it will reduce the administrative burdens on the Commission and on local franchising authorities. Without a uniform system, the regulatory body charged with evaluating cost-of-service showings may find it necessary to engage in greater scrutiny of each cost-of-service filing and to require cable operators to supplement and clarify their filings to ensure that cost-of-service principles are followed. Further, we are streamlining and simplifying the accounting system to the extent possible. 222. Interim Summary Level Accounts. We are adopting an interim summary accounting system for use by cable operators that elect cost-of-service regulation, until we have a permanent uniform system of accounts 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. These cost categories are similar to the categories that we proposed in the Notice, and we believe that this information will provide regulators with necessary basic information on the cable operators' costs of service. We note that there are no substantive objections to these requirements in the record. 223. We are concerned, however, that even this summary accounting approach may be burdensome for some small systems. We are directed by the Cable Act of 1992 to reduce the administrative burden on regulated cable operators, and particularly on small systems. In order to provide further relief to small system, we are aggregating still further the summary level accounts that small operators will be required to report as a part of their cost-of-service filings. Hence, small cable system operators shall identify their costs in FCC Form 1225, which contains 32 summary level accounts. 224. With regard to the level at which these accounting requirements apply, we will continue to require 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. We will continue to explore in this proceeding 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. 225. Further, cable operators shall provide any additional financial data and explanations reasonably requested by franchising authorities and this Commission to substantiate cost- of-service showings or other related proceedings. Where a reasonable response is not forthcoming, franchising authorities are authorized to make such disallowances as are appropriate, pending the presentation of convincing evidence by cable operators. The Commission will follow this procedure as well. VI. Cost Allocation Requirements i. Background 226. The purpose of cost allocation is to assign costs (both investment and expenses) accurately to the regulated services offered by an operator, so that the rates charged for such services are just and reasonable. The goal of cost allocation regulation is to provide a fully distributed costing methodology that emphasizes direct assignment and cost causation principles in assigning costs to the various services offered. Just and reasonable rates depend upon the support provided by the cost allocation methodology. 227. In the Rate Order we adopted allocation rules for regulated cable operators. These rules are applicable to cable operators for which the basic service tier is regulated by local franchising authorities or the Commission, or, with respect to a cable programming services tier, for which a complaint has been filed with the Commission. The requirements are applicable for purposes of cost-of-service showings and for rate adjustments for external costs. Under these rules, cable operators that aggregate their expenses and revenues at the system, regional, or company level, are required to allocate these expenses and revenues to the franchise level based on the ratio of the total number of subscribers served at the franchise level to the total number of subscribers served at the higher level. In general, costs that are identified at the franchise level or allocated to the franchise level must be allocated among the basic service tier and each tier of cable programming services based on the ratio of channels in each tier to the total number of channels offered in the franchise area. 228. The rules require that costs of programming and retransmission consent fees be directly allocated to the tier on which the programming is offered. Further, costs associated with franchise fees must be allocated among equipment and installations, program service tiers and subscribers in a manner that is consistent with the methodology of assessment of franchise fees by local authorities. Costs associated with public, educational, and governmental access must be directly assigned to the basic tier where possible. 229. In the Rate Order we determined that common costs must be allocated to service cost categories based on direct analysis of the origin of the costs. Where direct analysis is not possible, common costs must be allocated to service cost categories based on an indirect, cost-causative linkage to other costs directly assigned or allocated to the service cost category. When neither direct nor indirect measures can be found, common costs must be allocated to each service cost category based on the ratio of all costs directly assigned and attributed to a service cost category over total costs directly assignable and attributable. ii. Notice 230. In the Notice, we proposed to require that cable operators allocate their costs among the following service cost categories: basic service tier activities, cable programming services activities, other cable programming services activities, other cable activities, and non-cable activities. We proposed that, to the extent possible, all costs should be directly assigned to their service cost category. 231. The Notice also sought comment on whether we should adopt different or supplemental cost allocation requirements to govern allocation of costs between regulated cable service and unregulated activities. We stated that we see a continuum between the poles of franchise-specific allocations and MSO-wide cost averaging, and that we would consider requiring cable operators either to identify all costs that are unique to the cost of the franchise, or to determine the average company-wide costs. We sought comment on which approach would come closest to achieving the right balance of accuracy and administrative burden. We also sought comment on how these proposals would affect the ability of cable operators to recover their costs, make improvements in service, and expand channel capacity and program offerings. In addition, the Notice sought comment on how these proposals would impact on the ability of the Commission and local franchising authorities to ensure reasonable rates for regulated services. 232. Within the context of our proposal to require the identification of costs to a franchise on a case-by-case basis, we sought comment on the level at which general industry practice would allow the identification of major categories of joint and common costs to the franchise level, and what costs are joint and common, and should be so allocated. We requested comment, for example, on the impact of a per-subscriber allocator on the allocation of costs to systems with low and high penetration rates, and on how the number of channels in a tier might be factored into the allocator. iii. Comments 233. Some cable operators state that little or no additional specific allocation requirements are necessary. Others express concerns with the specification of allocators, and especially with the concept of tier-neutral allocations. Continental states that the application of a single basis across all cost elements would present problems, and urges the Commission not to mandate inflexible methods of allocating costs. TCI urges that cable operators be allowed to support allocations on a case-by-case basis. 234. Other cable operator commenters challenge the validity of channels as the basis of allocations between regulated and nonregulated operations. Arthur Andersen opposes allocation of costs between tiers on the basis of relative number of channels, and states that the Commission should adopt for cable operators the cost allocation principles used for telecommunications carriers. It argues that this is necessary because the two may eventually compete. Other parties support the use of per- channel allocators. 235. California Cable states that accounting-based allocation rules may not be workable. California Cable is concerned that decisions to expand systems and add unregulated services could be held hostage to inflexible allocation rules which might allocate a disproportionate cost to any new expansion. Small Systems recommends development of a model that would provide for different allocators to be applied to the appropriate expense and investment categories. 236. Other parties argue that further allocation rules are necessary. BellSouth recommends that the scope of the cost allocation requirements in Section 76.924(a) of the rules be expanded to include all cable operators. Bell Atlantic, claiming that there must be parity of treatment for telephone companies and cable operators, states that cost allocation rules must be established to allow the Commission to examine the manner in which cable operators allocate common costs among different lines of business and account for transactions between affiliates. iv. Discussion 237. We find 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. Section 76.924(e)(2) of the Commission's rules currently requires that costs be allocated among the basic service tier and each tier of cable programming service. This 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. 238. Accordingly, as we proposed in the Notice, we are requiring that, after revenues and costs are identified at the appropriate organizational level(s), cable operators shall allocate costs among the equipment basket 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. 239. We also require that, to the extent possible, all costs be directly assigned among the equipment basket and the service cost categories. In making this determination, we are modifying 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. We find 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 more accurately reflects cost causality. 240. For those costs that cannot be directly assigned, cable operators shall allocate such costs among the service cost categories and the equipment basket through methodologies that are consistent with the procedures in Section 76.924(f)(5) of our rules. The Commission and local franchising authorities will review the allocators proposed by cable operators on a case-by- case basis and determine whether the allocators achieve reasonable results. We agree with those commenters who suggest that we should be cautious at this time in adopting specific allocators or rigid cost allocation schemes. 241. For the purpose of establishing costs at the franchise level, we will maintain 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. We amend our rules, 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 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. Second, this procedure shall be repeated at every organizational level at which recoverable costs have been identified until all costs have been allocated to the franchise level. VII. Accounting and Cost Allocation Requirements for External Costs i. Background 242. Our current accounting and cost allocation rules apply to cable operators seeking adjustments for changes in their external costs as well as to cable operators that elect cost- of-service regulation. These rules also contain specific accounting and cost allocation requirements for certain external costs. First, the following external costs must be identified at the franchise level: franchise requirements, franchise fees, local taxes, and local programming. Second, costs of programming and retransmission consent fees must be allocated to the tier on which the programming or broadcast signal is offered. Third, franchise fees must be allocated among the programming service tiers, the equipment basket, and subscribers, in a manner that is most consistent with the methodology of the assessment of the franchise fees by local authorities. Fourth, the costs of public, educational, and governmental access must be directly assigned to the basic service tier where possible. In the Notice, we sought comment on whether any proposals for changes to the accounting and cost allocation requirements applicable in cost-of-service proceedings should be also applied to external costs. ii. Comments 243. BellSouth argues that the allocation requirements outlined in the Notice should be extended to external costs. Georgia Cable opposes applying the proposed accounting and cost allocation requirements to the development of external costs on the grounds that these costs are specific to the franchise or system. New Jersey, however, urges that the basic cost-of- service principles be applied uniformly to all costs, including external costs in cost-of- service filings. iii. Discussion 244. We believe that franchising authorities and this Commission must be able to ascertain readily the bases for proposed external cost adjustments in order to be able to effectively implement rate regulation of cable service. We will, therefore, apply to external cost calculations the changes to the accounting and cost allocation rules that we adopt in this Report and Order. Thus, we will continue to require that the following external costs be identified at the franchise level: franchise requirements, franchise fees, local taxes and local programming. For all other external costs, we will continue to require that cable operators identify such 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 and on our cost of service forms. Moreover, after external costs have been identified at the appropriate organizational level(s), cable operators shall allocate such costs among the service cost categories and the equipment basket in the manner specified for cost-of-service showings. 245. With respect to the specific requirements for allocating certain external costs, we will continue to require that the costs of programming and retransmission consent be allocated to the service cost category on which the signal or programming is offered. We also will continue to require 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. 246. We will modify, however, 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." We find that 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 in which such costs should be allocated. We find that the equipment basket and the service cost categories are the only appropriate categories for allocation purposes. It should also be noted we already require that the cost of franchise fees be identified at the franchise level. 247. We also shall modify existing rules to require that, to the extent possible, all external costs be directly assigned among the service cost categories. For those external costs that cannot be directly assigned, we require that cable operators propose specific allocators that reasonably allocate costs among the service cost categories and the equipment basket. 248. For the purpose of establishing external costs at the franchise level, we will retain 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. We are amending our rules, however, to specify the particular procedures that must be followed for allocating costs to the franchise level and these procedures shall apply to cable operators seeking adjustments to external costs as well as operators electing cost of service regulation. VIII. Affiliate Transactions i. Notice 249. In the Notice, we stated that we would adopt rules to prevent cable operators from imposing the costs of nonregulated activities on regulated cable subscribers through improper cross- subsidization. We proposed that these rules include rules for valuing transactions between regulated and nonregulated portions of cable systems, and we invited comment on specific valuation methods. In particular, we invited comment on whether we should require cable operators to record affiliate transactions at prevailing company prices offered in the marketplace to third parties, whenever the supplying affiliate has established such prices. We also invited comment on whether we should require cable operators to record each affiliate transaction 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. 250. We proposed that the valuation methods we adopt for affiliate transactions govern the amounts cable operators may include in rates based on cost-of-service showings. In addition, we tentatively concluded that those methods should apply to the programming transactions of cable operators that do not elect cost-of-service ratemaking. We noted that, in establishing our benchmark methodology, we had limited the pass- through of affiliate programming charges to no more than inflation. We sought comment on whether we should employ the affiliate transactions requirements we adopt in this proceeding instead of, or as alternatives to, that inflation-based limitation. 251. We further proposed in the Notice to define affiliate as including any entity having a five percent or greater ownership interest in the cable company. We proposed to include within the scope of our affiliate transaction rules those transactions that occur between regulated and nonregulated portions of the same cable company as well as transactions between separate companies. 252. Subsequently, in the First Reconsideration Order in MM Docket No. 92-266, we modified our external cost requirements to permit cable operators to pass through as external costs the costs of affiliated programming that exceed inflation as long as the prices charged the affiliate 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 such programming. We stated, however, that we would further examine and refine our treatment of affiliated programming costs for external cost purposes in this proceeding. ii. Comments 253. Cable operators generally maintain that they should be allowed to record purchases at the prices at which the providing affiliate sells to third parties. TCI observes that the Commission has allowed telephone companies to record affiliate transactions at such prevailing company prices. TCI states that similar treatment should be accorded cable companies because all affiliated programmers offer and sell their products to third parties. Cablevision Industries and Viacom oppose the imposition of affiliate transaction rules and argue that there is no history of abuse in this area. Small Cities suggests that the Commission allow management fees between cable operators and affiliates where the amounts charged can be shown to be customary and reasonable for transactions between third parties at the time of the agreement. 254. Cablevision Industries and Viacom also maintain that the Commission already resolved the valuation issue in the First Reconsideration in MM Docket No. 92-266. This rule should apply, they assert, for purposes of setting rates under both the cost of service and the benchmark approach. These commenters argue that application of the prevailing market approach would retain all of the benefits inherent in vertical integration, but would still ensure that costs are market-based and not artificially inflated. 255. NCTA states that affiliate transaction rules for cable are not necessary at this time. NCTA claims that, unlike telephone companies, cable operators generally are not affiliated with vendors of equipment and other items except programming. NCTA also states that there is no history of cable operator cross-subsidization and no evidence that such is to be expected. If a pattern of problems does develop, the Commission can adopt narrow rules to address the abuses, according to NCTA. 256. Bell Atlantic states that cable operators should be required to record affiliate transactions according to the same rules that apply to telephone companies. The need to prevent operators from shifting profits upstream by paying inflated prices to programming affiliates is heightened, Bell Atlantic claims, by the Commission's ruling that affiliate programming costs are external costs that can be passed through to subscribers. Bell Atlantic further observes that cable operators acknowledge that they are upgrading their systems to provide telephone and other advanced services, not just cable services. Bell Atlantic claims that as long as cable operators are not covered by the rules that apply to telephone common carriers, cable operators will be free to use revenues extracted from their regulated cable customers to pay for the improvements to provide telephone services. Requests to delay implementation of affiliate transaction rules, Bell Atlantic maintains, are transparent efforts to preserve cable's existing competitive advantage. 257. BellSouth argues that cable operators should be allowed to record affiliate transactions at the prices affiliates charge third parties. Otherwise, BellSouth states, the transactions should be recorded at the selling affiliates' fully distributed costs. GTE also proposes that cable operators be subject to the same affiliate transactions rules as telephone companies, but recommends that the rules currently applicable to telephone companies be amended to allow all affiliate transactions to be recorded at fair market value. 258. New Jersey claims that cable operators should record affiliate transactions in accordance with GAAP and that the burden of proof for affiliate prices should rest with the operators who have the relevant data. Seaford supports a market-based approach that derives the price from the providing affiliates' recent sales to third parties, rather than from estimated fair market value. 259. Municipals, NATOA, and Muzak support application of the telephone company rules to cable. Additionally, NATOA responds to those who claim that affiliate transactions rules for cable are not necessary because there is no history of abuse. NATOA observes that, given the nature of cost-of-service showings and the preponderance of vertically integrated cable companies, cable operators will have an enormous incentive and opportunity to show inflated costs wherever possible. NATOA claims that implementation of rules similar to those required of telephone companies would protect subscribers from paying rates based on "phantom higher costs" with a minimum burden on cable operators. 260. A number of commenters criticize our proposal to use a five percent ownership interest as the threshold for defining an affiliate. Some propose a twenty percent threshold, consistent with GAAP. BellSouth asserts that an affiliate relationship exists when an entity is controlled by, or is under common control with, another entity. Likewise, GTE observes that the five percent standard is too burdensome and recommends a twenty percent threshold. Michigan Committee, however, supports the five percent rule, and maintains that the same standard is used for cellular and other common carrier services. iii. Discussion 261. In enacting the Cable Act of 1992, Congress intended to ensure that consumers pay reasonable rates for regulated cable service. We find that it would be inconsistent with this Congressional intent if we were to allow the rates for regulated cable service to reflect the prices affiliates charge each other for transactions that occur at other than arm's length. As we observed in proposing to strengthen our affiliate transactions rules for telephone companies, companies that are able to pass increases in their costs on to ratepayers may be motivated to pay excessive amounts for assets and services obtained from nonregulated affiliates. In addition, companies may also have incentives to undercharge their nonregulated affiliates when the undercharges can be offset by increased charges to ratepayers. 262. Therefore, we will adopt 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. Under the rules we are adopting with this 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. These methods distinguish between asset transfers and the provision of services. 263. When a cable operator sells assets to an affiliate or buys assets from an afiliate, 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. 264. 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. 265. In determining the prevailing company price, we require 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. We do not adopt our proposal that an offer to sell will be sufficient to establish a prevailing company price because the price at which a company offers to sell a product or service to a third party will not necessarily reflect the price a third party would be willing to pay for an asset or service. We anticipate that affiliate transactions will usually be set at the prevailing company price, because the record indicates that affiliate transactions in the cable industry primarily involve purchases from affiliated programmers who sell the same products to third parties. 266. In determining the cost of both assets and services, cable operators shall apply the costing methods and the rate of return this Order adopts 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 we adopt with this Report and Order. 267. For the purpose of evaluating affiliate transactions that involve programming, we shall 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. 268. Except to the extent that they are relevant for estimating fair market value, we will not allow the establishment of affiliate prices by reference to the prices independent suppliers charge third parties for the same or similar products. The difficulty of establishing comparability of assets, products, and services creates an inherent problem for a methodology that bases affiliate prices on prices that independent suppliers charge to third parties. This is particularly the case when the product is programming. What may appear comparable from a production viewpoint, for example, may in no way be comparable from the perspective of the program viewer. Thus, a low-cost production that provides the producer with a high price on the basis of high viewer demand may not be comparable to a similarly low-cost production with little viewer demand. 269. We will apply our rules adopted in the program access proceeding to define affiliated programmers. 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. 270. We find that a five percent ownership interest provides a reasonable threshold because it ensures that affiliate transaction rules do not apply where the ownership arrangement between a cable operator and another company is de minimis. At the same time, it ensures that affiliate transaction rules apply where there is clear potential for cross-subsidization. Accordingly, we do not agree with those parties who suggest that a 20 percent threshold is appropriate. We find that 20 percent ownership exceeds the minimum level at which a cable operator and an affiliate may have an incentive to engage in cross- subsidization. We find that the issue is not whether the cable operator controls the affiliate, the affiliate controls the cable operator, or the cable operator and the affiliate are under common control; the issue is whether an affiliate relationship is significant enough to create a possible incentive for cross- subsidization. 271. Finally, we expect cable operators to provide detailed disclosure of affiliate transactions so that the Commission and franchising authorities can ensure that affiliate transactions are treated in a manner consistent with the limits of this Report and Order. Where cable operators have not demonstrated that their affiliate transactions meet the requirements of our affiliate transaction rules, disallowances shall be made by the Commission and franchising authorities. IX. Streamlined Filing and Review A. Small Systems i. Notice 272. In the Notice, we solicited comment on whether we should modify for small systems any proposed cost-of-service requirements, and if so, what modifications we should make. We specifically sought comment on whether we should adopt streamlined alternatives for small systems. We also asked whether small systems means systems serving 1,000 subscribers or fewer, whether or not these systems are controlled by large MSOs, or whether some other definition was more appropriate. ii. Comments 273. Many of the commenters, stating that the proposed cost-of-service requirements do not reduce administrative burdens for small systems, suggest other methods for reducing such burdens. For example, some commenters propose more generous benchmarks. California would allow systems with 5,500 subscribers or less up to 20 percent flexibility with the benchmark formula before a cost-of-service showing is required. NY Commission argues that small systems and franchise authorities should be permitted to decide among per-channel benchmark rates for systems with fewer than 1,000 subscribers. NCTA would allow small systems to increase their rates to the benchmark cap and to pass through rebuild costs. 274. Several commenters propose the creation of a special advisory group or program within the Commission that would develop an average cost schedule for small systems and assist them with cost-of-service showings. The SBA argues that we should require that large MSOs show administrative hardship in the operation of their small systems before they can join such a program. Small Systems describes how its model forms could be used for small systems' cost-of-service showings. 275. Other proposed methods for reducing the burden on small systems include: the establishment of a programming pool to equalize the purchase price between large and small, and urban and rural, systems; providing subsidies and revenue supports to small systems akin to those provided by Congress, the Commission, and state regulators to rural telephone companies for their high costs; adoption of a simplified accounting approach similar to Class B telephone company accounts; the negotiation of basic service rates; the adoption of a simple income statement approach; and the establishment of a liberal waiver policy for provisions imposing undue costs or burdens on small systems. 276. Several parties comment on the feasibility of the proposed general streamlined measures for small systems' cost-of- service showings. SBA supports the benchmark plus significant capital improvement approach. Some commenters emphasize that the key to streamlining cost-of-service showings for small systems is to identify the unique characteristics and costs associated with such systems, i.e., higher costs for capital, wiring, and programming. SBA opposes the 1986 adjusted rate approach for small systems, arguing that the 1986 rates resulted from franchise bidding wars and did not reflect economic reality. Small Cable supports the 1986 adjusted rates approach but with no productivity offset for small systems. Pegasus supports its safe harbor formula for small systems, contending that this formula allows small system operators to raise cost- based rates to a formula-derived level without full cost-of- service showings. iii. Discussion 277. The Cable Act of 1992 directs us to reduce the administrative burdens of, and costs of compliance with, our cable regulations for small cable systems. We are adopting an abbreviated cost of service form for use by small systems. We believe this will reduce the administrative burdens of cost showings for small system operators, while retaining the necessary regulatory oversight and assurance of reasonable rates. We will require that the 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. 278. Consistent with our eligibility standards for small system administrative relief, independent small systems and small systems operated by small MSO's may use this form. Small MSO's are those multiple system operators that (1) serve 250,000 or fewer subscribers, (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 we adopt for other small system administrative relief. Use of this form will not be available for small operators affiliated with larger systems. 279. While we believe that all cable companies that choose to make cost-of-service filings should be subject to the uniform accounting requirements we propose here, at least in abbreviated form, we acknowledge commenters' argument that such accounting requirements may increase the administrative burden on small operators to the point of hardship, and that small operators are unlikely to require the same level of regulatory oversight as larger entities. Thus, in our Further Notice, we solicit comment on whether we should exempt small systems and/or small operators from these requirements entirely. We also adopt reduced accounting requirements for small systems. B. Network Upgrades i. Notice 280. In the Notice, we sought comment on establishing an abbreviated cost-of-service alternative for significant prospective capital expenditures used to improve the quality of service or to provide additional services. Under this approach, operators seeking to raise rates to recover the costs of a planned upgrade would submit only the costs of the upgrade instead of all current costs. If otherwise in accordance with cost-of-service requirements, the costs of the upgrade would then be added to the rates permitted under the benchmark and price cap approach to the extent these costs could not be recovered under that approach. We stated that any cost recovery must comply with our cost allocation requirements, to ensure that only the costs allocable to regulated services are imposed on subscribers to those services. ii. Comments 281. Cable operators commenting on this approach generally express a preference for passing through the cost of system upgrades as external costs. They indicate, however, that in the alternative, an abbreviated approach would be acceptable. Comcast, for example, states that if the Commission decides not to permit system improvement costs to be passed through, it should adopt a "middle tier" or "abbreviated" showing for operators to justify the costs associated with system upgrades that would not discourage operators from investing in newer technologies to improve service to customers. Georgia Cable strongly supports an abbreviated approach, based on its observation that the benchmark and price cap framework does not include system upgrades and service improvements. It agrees with the Commission's proposal to add the cost of an upgrade to the benchmark rate subject to the cost allocation rules adopted by the Commission. 282. NATOA supports the objective of an abbreviated cost- of-service showing for significant prospective capital expenditures, but not in the form proposed, which it believes has a number of pitfalls. The most serious difficulty, according to NATOA, is that the proposed approach does not take into account the possibility that operators are unable to recover upgrade costs because the operators are inefficient or because the costs are frivolous or otherwise unjustified. Local governments state that they might support this approach, but only for rates that will not be effective until the system upgrade is completed and operational. 283. BellSouth opposes a capital improvement add-on for four reasons. First, it believes that benchmark rates already reflect the rapid capital recovery employed by the cable industry in an unregulated environment, thereby providing cash flow to cable operators to reinvest in system upgrades; second, it asserts that most system upgrades should be recovered through depreciation expenses; third, it argues that competitive parity requires that depreciation expense for cable operators be treated as it is in the local telephone exchange carrier price cap plan, as an "endogenous" cost included in the benchmark; and fourth, it concludes that the cost-of-service approach would not provide significant administrative savings because it would require regulators to examine not simply the cost of the upgrades, but also the benefit to the cable operator in the form of reduced expenses and additional revenues. 284. In reply, Corning endorses the abbreviated filing approach. It contends that the benchmark/price cap mechanism would typically fail to permit the full recovery of capital investment in upgrades and rebuilds, and that the streamlined cost-of-service mechanism would appear to offer the only means by which the Commission can spare regulators and cable operators the burden of full cost-of-service proceedings every time an operator wishes to rebuild or upgrade its system. iii. Discussion 285. We conclude 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. 286. 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. 287. While we understand NATOA's and BellSouth's concerns that the abbreviated approach might be abused or that the add-on rate might not be needed, we believe these concerns can be addressed while still expediting rate increases needed to pay for worthwhile upgrades. First, this option will be available only for significant upgrades requiring added capital investment, such as expansion of band width capacity and conversion to fiber optics, and for system rebuilds. Normal improvements and expansions of service will remain subject to the usual rate review process. Second, 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. This requirement will help assure that operators do not abuse the abbreviated filing option by requiring regulated service customers to pay higher rates to fund upgrades that actually only benefit other services. 288. Third, as suggested by the Municipalities, we agree 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, such as the frivolous or inefficiently incurred costs cited by NATOA, will be deducted from total cost. We anticipate that issues of allowable costs can be resolved if raised by comparison with costs of similar systems and, in particular, systems subject to competition. 289. Fourth, to assure that the upgrade rate increase is justified by higher costs, the operator will 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. And fifth, as we said in the Notice, 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. 290. Based upon this showing of the net increase in allowable costs associated with the capital improvement, the operator would be permitted to set a rate based on two elements. The first element is the benchmark rate, as governed by the Rate Order and the price cap. The second element will be the capital improvement add-on. The sum of these two elements will yield the maximum allowable rate that might be charged to subscribers. The capital improvement add-on will not be adjusted for inflation but will be a fee charged over the useful life of the improvement determined in accordance with our cost-of-service requirements. 291. As part of our collection of forms for operators' cost-of-service showings, we will also develop forms for the abbreviated showings associated with network upgrades. We delegate to the Cable Services Bureau the development of appropriate forms for these abbreviated showings. X. Hardship Rate Relief for Operators 292. Some cable operators urge that to ensure the continued growth of the cable industry, while conforming with the Cable Act of 1992 and the Fifth Amendment, the cost-of-service rules must be tailored to the economic and financial requirements of that industry. We believe that the combination of the benchmark/ price cap mechanism with the cost-of-service backstop will in fact provide a workable and effective approach that recognizes both the requirements of the industry and the rights of customers, especially in combination with the abbreviated filing option, experimental incentive plan, and average cost approaches we have established or are seeking to develop. Thus, we believe our rules respond to these concerns. Nonetheless, we also recognize 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. 293. To address this possibility, 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. Given the carefully balanced approach in our cost-of-service rules, it is extremely difficult for us to conceive of such a situation arising. Nevertheless, we believe cable operators should have the opportunity to attempt to make such a showing if they deem it warranted. 294. 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, we 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. XI. Upgrade Incentive Plan 295. In the Cable Act of 1992, Congress set as one of its policy goals ensuring that cable operators continue to expand the capacity and programs offered over their systems, where economically viable. In the Notice, we sought to develop methods to encourage cable operators to provide additional services and improve the quality of service, while reducing regulatory burdens. The specific method we suggested was to permit an abbreviated cost-of-service showing for rate increases associated with significant prospective capital expenditures. We have also established requirements for the showing for Network Upgrades, supra part IX.B. Upon further analysis and consideration of the comments, however, we believe that the goal of promoting economically justified system upgrades, as well the goals of the Cable Act and of this proceeding, may also be furthered by development of an incentive regulation approach to upgrading cable services, similar to the incentive plans we have implemented for telephone carriers. 296. The basic outline of this approach would be to permit an operator 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 rate 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. 297. 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. Because this plan would also be more consistent with the incentive plans that this Commission applies to telephone companies, it may also help position us for the future, when it is quite possible that telephone and cable companies may be providing similar and competing services. 298. This approach should 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. This is so because the level of profits the operator can hope to achieve depends on the extent to which it can keep its costs below what customers are willing to pay. The greater the value for customers, and the lower the costs for the operator, the higher the profits the operator will be able to achieve. 299. We also anticipate that 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. Under the Upgrade Incentive Plan, we would ordinarily expect to review only whether the operator is continuing to offer existing services at rates no higher and quality no lower than the operator contracted to provide. We 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. 300. We believe that 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. 301. In addition, we expect that the 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. 302. To generate an incentive plan that is effective in encouraging operators to invest in worthwhile upgrades, but also fair to customers, we would expect that 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. In the case of telephone companies, we set an initial review 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. We thus propose to review the plan in the fifth year of operation. 303. We believe the need to introduce a plan to encourage cable upgrades and otherwise carry out the policies of the Cable Act of 1992, coupled with the experience we have already acquired in implementing incentive regulation for telephone companies and the record developed in this proceeding warrant adopting 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. 304. To gain experience with this approach, we 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 we have 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. Further Notice of Proposed Rulemaking XII. Cost-Based Cable Rate Regulation A. Cost-of-Service Requirements 305. In the Report and Order, we establish a comprehensive interim regulatory framework for setting cost-based rates for regulated cable service. We tentatively conclude that the rules adopted here reflect goals and policies that will continue to apply, and that those rules may therefore appropriately be adopted on a final basis. We request comment on whether we should adopt these requirements as our final cost rules in this proceeding. In the Report and Order, for example, we establish an interim overall rate of return of 11.25% for use in cable cost-of-service proceedings. We invite comment on whether we should establish a different permanent rate of return for regulated cable service, including the equipment basket. In this regard, we request interested persons to submit data and expert analyses regarding the risks of regulated cable service, and on how those risks are affected by our cost-of service and our benchmark/price cap rules for cable. We also invite commenters to submit data and expert analyses regarding equity and debt costs for regulated cable service, and the capital structure we should use in determining any permanent rate of return for that service. We also invite comment on whether we should adopt fixed cost of debt and capital structure methodologies for possible use in changing the rate of return for cable in the future and, if so, what those methodologies should be. B. Cable Accounting System 306. As explained in the Report and Order, we have decided to establish a uniform accounting system for cable operators electing cost-of-service regulation. Attachment C sets forth a draft system that we intend to serve as a starting point for development of a uniform accounting system for cable operations. We seek comment on this proposal. The Cable Services Bureau will obtain suggestions on how to improve this proposal through informal meetings with representatives from the cable industry and other interested parties. Following these meetings and the completion of the initial comment cycle, we may seek comment on a revised proposal for a uniform system of accounts for provision of regulated cable service. 307. The system of accounts that we are proposing is adapted from the USOA for Class B telephone companies contained in Part 32 of the Commission's rules, and from NARUC model cable accounting rules. This proposed system of accounts is highly aggregated and is, therefore, far less burdensome than the USOA for Class A telephone companies. We have relied on Part 32 in developing an accounting system for cable because it was designed as a functional accounting system that would be adaptable to changes in communications technology. We tentatively conclude that we can accommodate the cable technology of signal transport by adding certain cable-specific accounts and by modifying account definitions to include cable-specific equipment and activities within existing functions. 308. In the Report and Order, we adopt an abbreviated cost of service form for use by small systems. We also seek comment on whether smaller cable systems that elect cost-of-service regulation should be required to maintain their books in accordance with the accounting system we adopt for cable or with some alternative system of accounts. In addition, we seek comment on accounting requirements for cable operators seeking rate adjustments due to changes in their external costs under the benchmark/price cap approach. Although we conclude in the Order that operators regulated under that approach should not be subject to the USOA we adopt for cable, we believe accounting requirements may be necessary to ensure that external cost adjustments are correct. Finally, we propose an exemption from these requirements for companies that are currently required to maintain their accounts in accordance with Part 32 of our rules. We tentatively conclude that it would be unduly burdensome to require such companies to follow separate accounting procedures for their telephone and cable operations. C. Affiliate Transactions 309. In the Report and Order, we adopt affiliate transaction requirements that will govern the costs incurred that can be recovered in rates for regulated cable service. These requirements are substantially similar to our proposals in the Notice in this proceeding. Subsequent to the release of that Notice, however, we conducted a detailed analysis of each of these transaction methods for telephone companies. In the Telco Notice, we proposed to sharply curtail prevailing company pricing for transactions between telephone companies and their nonregulated affiliates. We also proposed to require telephone companies to value affiliate transactions for which we do not permit prevailing company pricing at the higher of cost and estimated fair market value when the telephone company is the seller, and at the lower of cost and estimated fair market value when the telephone company is the buyer. 310. We tentatively conclude that the general changes we have proposed for telephone companies should be applied to cable operators as well. Therefore, we propose to limit the application of the prevailing company price as a measure of a reasonable price for an affiliate transaction. We tentatively conclude that we should not permit prevailing company pricing as a valuation method for transactions between cable operators and their affiliates when a primary purpose of the non-cable affiliate in transactions is to serve the cable operator and its affiliates. We tentatively conclude that prevailing company pricing for affiliate transactions should only be utilized where the predominant purpose of the non-cable affiliate in the transaction is to serve nonaffiliates. We believe that we can identify when the non-cable affiliates's predominant purpose is to serve nonaffiliates by measuring the percentage of each non- cable affiliate's total output that is sold to nonaffiliates. 311. Accordingly, we propose that any non-cable affiliate that sells less than 75 percent of its output to non-affiliates has too large a volume of affiliate transactions to be deemed to have a predominant purpose of serving non-affiliates. Therefore, we propose to continue to allow prevailing company pricing only for affiliate transactions in which the non-cable affiliate sells at least 75 percent of its output to non-affiliates. We invite the commenters to discuss this proposal as well as alternative percentages we might use. We also invite comment on whether we should abandon prevailing company pricing as a valuation method for all affiliate transactions if we find no workable test for determining when prevailing company prices provide reliable measures of how affiliate transactions should be valued. 312. For those transactions that do not meet the prevailing company price test, we propose to require cable operators to value all affiliate transactions at the higher of cost and estimated fair market value when the cable operator is the seller, and at the lower of cost and estimated fair market value when the cable operator is the purchaser. Since this proposal applies to the sale of both assets and services, it would, in effect, retain the existing standard that applies to affiliate transactions that involve the sale of assets and it would expand the application of this rule to affiliate transactions that involve the sale of services. Hence, our proposal would change the requirement under the rules we have adopted with this Report and Order, which provides that affiliate transactions that do not meet the prevailing company price test and involve the sale of services shall be recorded at cost. We invite comment on this proposal. 313. We propose to retain the definition of affiliate that we adopt in the Report and Order. We also propose that our final affiliate transactions rules for cable, like the interim rules, apply to cable operators who either elect cost-of-service regulation or seek to adjust benchmark/price cap rates for affiliated programming costs. We propose, in addition, to require cable operators to apply the costing methods and rate of return we adopt for cable in determining the costs of affiliate transactions. We propose to include our final affiliate transactions rules in the USOA we adopt for cable. We invite comment on these proposals. Consistent with our approach with regard to the USOA, we also invite comment on whether we should adopt alternative affiliate transactions rules for small cable companies. D. Productivity Offset 314. In the Rate Order, we incorporated an annual inflation adjustment into our price cap mechanism governing rates for cable television service. Specifically, we adopted the Gross National Product Price Index (GNP-PI) as the annual adjustment index for the cap for basic service tier rates. As a result, regulated cable operators are permitted to adjust the capped based per channel rate for the basic service tier annually by the GNP-PI. In addition, there are certain categories of costs that cable operators are permitted to "pass through" to subscribers without a cost-of-service showing, even if the resulting rates exceed the applicable price cap. 315. In the Rate Order, we declined to adopt a productivity offset to the GNP-PI for the non-programming costs incurred by cable companies given the paucity of information in the record that would provide a basis for determining productivity in the cable industry. We made it clear, however, that we would seek such information in the Notice. 316. In the Notice, we solicited comment on whether there is a valid economic basis for assuming that cable television service has been, and will be, experiencing efficiency gains. We observed that there had been insufficient information in the record to adopt a productivity offset in the price cap mechanism for cable operators. In considering a regulatory framework to govern cost-of-service ratemaking for cable service, we invited the submission of industry studies or other expert economic analysis to examine four possible options: (1) no productivity offset; (2) a consumer productivity dividend of 0.5 percentage points; (3) a "telecommunications" industry adjustment of between 3.0 (for AT&T) and 3.3 (for the local exchange carriers) percentage points; and (4) a different productivity offset for cable operators. 317. The comments received in response to the Notice provided three general perspectives on the use of a productivity offset in cost-of-service ratemaking. The first perspective, which incorporates the views of cable operators and programmers, generally supports the first option -- that is, no productivity offset under the cost-of-service rules. The second perspective, articulated by New Jersey, supports the use of a productivity offset of 2% as reflecting the known benefits of technology improvement in the cable industry. The third perspective, which includes CFA, municipal franchising authorities, local exchange carriers, and ETS, generally supports the adoption of a 3.3% productivity offset, the standard imposed on the local exchange carriers, to be the standard for the cable television companies that choose cost-of-service ratemaking. 318. In this Further Notice, we affirm our tentative decision to incorporate an annual inflation adjustment into our price cap mechanism governing rates for cable television service. We believe that the use of the GNP-PI index in the benchmark will help achieve the statutory goal of reducing administrative burdens on cable systems, consumers and regulators by permitting rate increases when cable operators experience increases in the cost of doing business shared by all sectors of the economy, without requiring cable operators to make, and regulators to consider, cost-of-service showings. 319. We also tentatively conclude that cable operators should reasonably be expected to achieve productivity gains in the future analogous to those historically realized by other communications firms. Cable television networks are similar in many ways to telephone networks, and both have benefited from advances in telecommunications technology in the past; both are likely to see benefits in the future, especially as cable and telephone networks converge. Both are likely to have opportunities to improve their productivity in other aspects of their operations, including customer service and maintenance. In the near term, however, the productivity growth that cable operators may reasonably be expected to achieve may differ from that of telephone companies, because of the current differences in their networks, operations, services, and histories. For example, local telephone companies have benefited from advances in computerized local switches, which are not in general use by cable systems. Moreover, the productivity offsets selected for telephone companies reflect adjustments to conform them with Commission policy goals. While we recognize the merits of moving toward regulatory parity for cable and telephone regulation, we do not believe the current record provides adequate support for the automatic adoption of the same productivity factor for cable systems as for local telephone companies subject to price caps. 320. The only evidence of record for productivity growth by cable systems appears to be that submitted by New Jersey, supporting a 2 percent productivity offset. We take note, however, of comments from cable operators that there is not sufficient evidence to adopt a productivity offset, without providing them the opportunity to develop such data. We will accordingly allow them another opportunity to provide this data. Based on the current record, we tentatively propose to adopt a 2 percent productivity offset as part of the benchmark for regulated cable rates. Any interested party seeking to justify a different productivity offset will of course be expected to provide reliable, detailed, and credible evidence that some other figure represents the productivity gains, after inflation, that cable systems can reasonably be expected to achieve. In particular, cable systems should not expect that their failure to provide any evidence of cable system productivity gains, information they are best able to provide, should justify the conclusion that cable systems cannot reasonably be expected to achieve productivity improvements. 321. We envision this benchmark, including the inflation adjustment and productivity offset, as a basic part of the two alternatives open to cable operators for setting rates. Under the first, the benchmark would apply to all regulated rates. Under the second, an operator can elect to use cost-of-service regulation, under the standards discussed in this Order. Once the operator's rates are set based upon actual costs of service, however, we would ordinarily expect that the operator could achieve the same future productivity gains as other operators. We therefore propose that future rate changes should at least meet the productivity offset, absent a credible demonstration in the cost-of-service showing that this will not be the case. 322. We do not, however, wish indirectly to restrict the ability of cable programmers to obtain fair value for their products. As a result, we tentatively conclude that programming costs should not be included within the productivity offset for cable system technological and operational improvement. 323. We invite comment on these proposals, including the 2 percent productivity offset and exemption of programming costs from the effects of the offset. We emphasize that comments should be supported by relevant evidence, such as detailed industry studies and expert economic analysis. E. Upgrade Incentive Plan 324. As we discussed above, the Upgrade Incentive Plan that we will implement on an experimental, case-by-case basis is intended to provide greater assurance of reasonable, stable rates to customers for existing services, while also generating profit incentives to operators to upgrade their systems in cost- effective ways that will benefit subscribers. The basic approach of the plan is to establish a type of social contract between customers and operators, under which the rates for current regulated services are frozen or limited to changes permitted by the benchmark/price cap mechanism, while the quality of service is at least maintained at current levels by some reasonable measure. For their part, operators are given substantial rate flexibility for the new services and capabilities they introduce. The operator thus gains the opportunity to earn higher profits as an incentive and reward for successful innovations. The contract would remain in effect for a fixed, minimum term of years. 325. Developing a permanent incentive plan for cable systems is also likely to raise other issues, including issues that might suggest different regulations than in the case of the incentive programs we have adopted for telephony. One issue involves enrollment. We might, for example, require cable systems to seek enrollment in the incentive plan in advance of any system upgrade if it wishes to claim the rate and profit flexibility accorded to additional regulated services and capabilities. Enrollment would make clear to this Commission and to customers that the operator was committing itself to keeping existing service rates and quality within the bounds set by the plan. We request comment on these issues. 326. Another issue involves coordination with the regulation of basic service tier rates exercised by local franchising authorities. Setting price and quality limits on regulated services above the basic tier may encourage operators to attempt to shift costs to the basic tier. It may be difficult to identify such cost-shifting in a cost-of-service study review. One remedy for this problem, which may also reduce regulatory burdens for operators, franchising authorities, and this Commission, may be to require the operator to commit to maintaining its basic service tier rates and quality within baseline/price cap guidelines set by a certified franchise authority. We request comment on this or approaches to coordinating FCC and local regulation of cable rates within the Plan. 327. An important part of any incentive plan that limits prices is to assure that the value of the service provided to customers under those prices does not suffer. The customer should be assured that the regulated company is not evading the intent of the plan by increasing profits not through improved efficiency or added services, but by adulterating the products or services the customer receives. For cable service, assuring that appropriate standards are maintained includes assuring that programming services valued by customers are not shifted out of current tiers and into the additional tiers for which the operator would seek to claim rate flexibility. We seek comment on appropriate standards to assure that operators subject to the incentive plan provide services equal to or better than that offered under current rates applicable to those services. 328. One possible approach to maintaining the value of current services while permitting flexibility to adjust tiers might be to require operators to seek the approval of its customers to changes in the composition or rates for current regulated services, in effect empowering customers to decide whether the change is worthwhile. If most of the operator's customers affirmatively agreed by ballot to revise regulated services subject to the incentive plan, this Commission could be confident that the change was reasonable. In any case, of course, operators would be free to offer new services, and we expect this Plan will encourage them to do so. The only issue would be whether the operator had fulfilled its commitment to maintain or improve the quality of the service provided at regulated rates. We request comment on this and other approaches that would permit reasonable revisions to the current services and rates subject to the incentive plan, especially approaches that take into account the views of the customers using those services. 329. We request comment on whether we should adopt rules for our Upgrade Incentive Plan. We request that commenters address how the plan, if adopted permanently, might best be structured to maximize the benefits to consumers and operators and to encourage efficient operation and innovative services, and what procedures should govern implementation of the Upgrade Incentive Plan by operators. We solicit comment on what standard we should adopt to measure quality of service for existing services; we seek comment also on the extent to which we should permit operators to move existing channels to new regulated tiers eligible for pricing flexibility under an upgrade incentive plan. F. Average Cost Schedules 330. The Cable Act of 1992 instructs us to consider administrative burdens in establishing rate regulation, and to design rate regulation in a manner that reduces "the administrative burdens and cost of compliance of cable systems that have 1,000 or fewer subscribers." We have met this mandate by providing in the Benchmark Order for streamlined rate reductions for small systems; by providing in the Report and Order here for abbreviated Cost of Service filings by small systems; and by other measures adopted in this Rate Order. 331. We sought comment in the Notice regarding the desirability of allowing cable operators to justify rates based on average costs of providing regulated cable service, in an approach similar to the 'average schedule' regulatory scheme for provision of interstate access by some telephone companies. We believe that average cost schedules could provide administrative relief for cable operators and regulators by permitting setting of rates for regulated equipment and cable service by reference to average costs rather than an evaluation of each individual operator's costs. Accordingly, we tentatively conclude that we should establish average cost schedules for provision of regulated cable service and equipment. 332. We will obtain necessary cost information through our industry cost studies. In addition, operators and other interested parties may submit other cost information that they believe will be useful. The Cable Service Bureau will additionally work informally with interested organizations to facilitate the compilation, analysis and development of average cost schedules. 333. We solicit comment on whether average cost schedules should be available for all operators, or only small systems. If use of average cost schedules should be limited to small entities, we solicit comment on how we should define small systems for this purpose. Commenters suggesting the restriction of average schedules to small entities, or suggesting a particular threshold or definition for 'small,' should support their recommendations with data, including differences in costs, efficiencies, corporate structures or other factors, that would necessitate the proposed differences in treatment. XIII. Initiation of Cost Studies 334. In the Notice we stated that we would conduct cost studies of the cable industry to provide information that could be useful to develop requirements to set rates based on costs. We have additionally tentatively concluded in this proceeding to develop average cost schedules for provision of regulated cable service and equipment. In the Benchmark Order, we have determined that we will collect information on costs with respect to small operators and systems with relatively low prices. Actually, we are initiating at this time general cost studies of the cable industry that will be used for these purposes as well as to provide information that will help us determine whether any changes should be made in our interim framework for cost-of- service regulation. We delegate to the Chief, Cable Services Bureau authority to conduct these studies. Since the cost studies will be part of this rulemaking proceeding, the ex parte rules for non-restricted proceedings apply. Requests for confidentiality may be made pursuant to Section 0.459 of the Commission's rules. XIV. Regulatory Flexibility Analysis A. Final Regulatory Flexibility Analysis for the Report and Order 335. 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: 336. 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 Competition 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. 337. 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. 338. 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 as 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. 339. 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. 340. 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. 341. Most of the proposals raised by the Office of Advocacy were adopted by the Commission in some form, or are the subject of further comment. For example, the definition of a small cable operator for purposes of cost of service showings was broadened to 15,000 subscribers. We expect that this definition will fairly balance the costs of regulation with the need to ensure reasonable rates. 342. 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. We are also seeking the information needed to consider development of average cost schedules. The Upgrade Incentive Plan we are 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. 343. 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. 344. 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. B. Initial Regulatory Flexibility Analysis for the Further Notice 345. Pursuant to Section 603 of the Regulatory Flexibility Act, the Commission has prepared the following initial regulatory flexibility analysis (IRFA) of the expected impact of these proposed policies and rules on small entities. Written public comments are requested on the IRFA. These comments must be filed in accordance with the same filing deadlines as comments on the rest of the Further Notice, but they must have a separate and distinct heading designating them as responses to the regulatory flexibility analysis. The Secretary shall cause a copy of the Further Notice, including the initial regulatory flexibility analysis, to be sent to the Chief Counsel for Advocacy of the Small Business Administration in accordance with Section 603(a) of the Regulatory Flexibility Act, Pub. L. No. 96-354, 94 Stat. 1164, 5 U.S.C. Section 601 et seq. (1981). 346. Reason for action. The Cable Television Consumer Protection and Competition Act of 1992 requires the Commission to prescribe rules and regulations for determining reasonable rates for basic tier cable service and to establish criteria for identifying unreasonable rates for cable programming services. The Commission has adopted rate regulations that require a comparison to the rate of cable systems subject to effective competition, as defined in the Cable Act of 1992, and interim regulations for setting rates for regulated services based on cost. This Further Notice proposes to establish additional and permanent regulations governing the setting of rates for regulated cable service based on costs. 347. Objectives. To propose rules to implement Section 623 of the Cable Television Consumer Protection and Competition Act of 1992. We also desire to adopt rules that will be easily interpreted and readily applicable and, whenever possible, minimize the regulatory burden on affected parties. 348. Legal Basis. Action as proposed for this rulemaking is contained in Sections 4(i), 4(j), 612(c), and 623 of the Communications Act of 1934, as amended. 349. Description, potential impact and number of small entities affected. Until we receive more data, we are unable to estimate the number of small cable systems that would be affected by any of the proposals discussed in the Further Notice. We have, however, attempted to reduce the administrative burdens and cost of compliance for cable systems that have 1,000 or fewer subscribers as required by Section 623(i) of the Cable Act of 1992. 350. Reporting, record keeping and other compliance requirements. The proposals under consideration in this Further Notice include new and revised reporting and record keeping requirements for cable systems. These reporting requirements include the filings by cable operators of financial and/or leased access data annually at the Commission or participating in an annual survey. Additionally, this Further Notice proposes the permanent use of forms to submit data that is to be presented to the regulating entity in a cost-of-service showing by a cable operator. Furthermore, the Further Notice proposes general cost accounting and cost allocation requirements that could be imposed on the cable industry. 351. Federal rules which overlap, duplicate or conflict with this rule. None. 352. Any significant alternatives minimizing impact on small entities and consistent with stated objectives. Wherever possible, the Further Notice proposes general rules, or alternative rules for small systems, to reduce the administrative burdens and cost of compliance for cable systems that have 1,000 or fewer subscribers as required by Section 3(i) of the Cable Act of 1992. XV. Paperwork Reduction Act 353. 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. XVI. Procedural Provisions 354. For purposes of this non-restricted informal rulemaking proceeding, members of the public are advised that ex parte contacts are permitted from the time of issuance of a notice of proposed rulemaking until the time a draft Order proposing a substantive disposition of the proceeding is placed on the Commission's Open Meeting Agenda. In general, an ex parte presentation is any written or oral communication (other than formal written comments or pleadings and oral arguments) between a person outside this addresses the merits of the proceeding. Any person who submits a written ex parte presentation addressing matters not fully covered in any written summary must be served on this Commission's Secretary for inclusion in the public file, with a copy to the Commission official receiving the oral presentation. Each ex parte presentation discussed above must state on its face that the Secretary has been served, and must also state by docket number the proceeding to which it relates. See generally Section 1.1231 of the Commission's Rules. 47 C.F.R. ÀÀ1.1231. 355. Pursuant to applicable procedures set forth in Sections 1.415 and 1.419 of the Commission's Rules, 47 C.F.R. Sections 1.415 and 1.419, interested parties may file comments on or before July 1, 1994 and reply comments on or before August 1, 1994. To file formally in this proceeding, you must file an original plus four copies of all comments, reply comments, and supporting comments. If you want each Commissioner to receive a personal copy of your comments and reply comments, you must file an original plus nine copies. You should send comments and reply comments to Office of the Secretary, Federal Communications Commission, 1919 M Street, N.W. Washington, D.C. 20554. Comments and reply comments will be available for public inspection during regular business hours in the FCC Reference Center, Room 239, Federal Communications Commission, 1919 M Street N.W., Washington D.C. 20554. XVII. Ordering Clauses 356. 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. ÀÀÀÀ 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 C.F.R. Part 76, IS AMENDED as set forth in Attachment B. 357. IT IS FURTHER ORDERED that, the rules, policies, and requirements adopted herein SHALL BE EFFECTIVE May 15, 1994. 358. IT IS FURTHER ORDERED that, pursuant to Sections 4(i), 4(j), 612(c) and 623 of the Communications Act of 1934, 47 U.S.C. ÀÀÀÀ 154 (i), 154 (j), 532 (c), 542(c), and 543, NOTICE IS HEREBY GIVEN of proposed amendments to Part 76, in accordance with the proposals, discussions, and statement of issues in this Further Notice of Proposed Rulemaking, and that COMMENT IS SOUGHT regarding such proposals, discussion, and statement of issues. 359. 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. Pub. L. No. 96-354, 94 Stat. 1164, 5 U.S.C. ÀÀÀÀ 601 et seq. (1981). 360. 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. 361. IT IS FURTHER ORDERED pursuant to Sections 4(i), 4(j), 623(b), and 623(c) of the Communications Act, 47 U.S.C ÀÀÀÀ 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. FEDERAL COMMUNICATIONS COMMISSION William F. Caton Acting Secretary Attachment A Comments Aerie Aerie Group Incorporated Arlington Arlington County, Virginia Arthur Andersen Arthur Andersen & Co. Austin Austin, Texas; King County, Washington; and Montgomery County, Maryland Avenue TV Avenue TV Cable Service, Inc. Bell Atlantic Bell Atlantic, The NYNEX Telephone Companies, and The Pacific Companies BellSouth BellSouth Telecommunications, Inc. BC Benchmark Communications COA Cable Operators and Associations Cablevision Cablevision Industries Corporation, Industries Consolidated Cable Partners, L.P., Crown Media, Inc., Multivision Cable TV Corp., Parcable, Inc., and Providence Journal Company Cablevision Systems Cablevision Systems Corporation California Cable The California Cable Television Association CATA Community Antenna Television Association, Inc. CFA Consumer Federation of America Comcast Comcast Cable Communications, Inc. Connecticut Connecticut Department of Public Utility Control Continental Continental Cablevision, Inc. C-Span National Cable Satellite Corporation (C-Span and C-Span 2) Discovery Discovery Communications, Inc. Duncan Duncan Cable TV E! E! Entertainment Television, Inc. Eagle Eagle Communications, Inc. ETC Economic and Technical Consultants, Inc. Georgia Cable Cable TV of Georgia Limited Partnership, Falcon Cable TV, Insight Communications, Mid-America CATV Association, Mount Vernon Cablevision, Inc., Nashoba Communications, Pennsylvania Cable Television Association, Prestige Cable TV, Westar Communications, and Whitcom Investment Company GTE GTE Service Corporation MCATC Massachusetts Community Antenna Television Commission Media General Media General Cable of Fairfax County, Inc. Medium Operators Medium-Sized Operators Group Michigan Committee Michigan Ad Hoc Committee for Fair Cable Rates MPAA Motion Picture Association of America, Inc. Multichannel Multichannel Communication Sciences, Inc. MunicipalsCounsel to the Municipal Franchising Authorities Muzak Muzak Limited Partnership NATOA National Association of Telecommunications Officers and Advisors, The National League of Cities, The United States Conference of Mayors, and The National Association of Counties NCTA National Cable Television Association New JerseyStaff of the New Jersey Board of Regulatory Commissioners New York New York State Commission on Cable Television NTCA National Telephone Cooperative Association Comments (continued) NY Assembly New York State Assembly, Committee on Oversight, Analysis and Investigations Omega Omega Communications Inc. Pegasus Pegasus Cable Television Philips Philips Broadband Networks Inc. SBA United States Small Business Administration SCBA Small Cable Business Association Seaford City of Seaford, Delaware Small Cities Small Cities Cable Television Small Systems Prime Cable, Harron Communications Corp., Georgia Cable Partners, Atlanta Cable Partners, L.P., Wometco Cable Corp., and the Coalition of Small System Operators Summit Summit Communications, Inc. TCI Tele-Communications, Inc. Time Warner Time Warner Entertainment Company, L.P. TMC Tele-Media Corporation Utah Utah League of Cities and Towns Viacom Viacom International Inc. Reply Comments Aerie Arthur Andersen Austin Bell Atlantic Blade Blade Communications, Inc. COA Cablevision Industries Cablevision Systems Comcast Continental Corning Corning Incorporated and Scientific-Atlanta, Inc. Georgia Cable GrassrootsGrassroots Cable Systems GTE Liberty Liberty Media Corporation Media General Medium Operators Municipals NATOA NCTA NTCA Pegasus SCBA Seaford Small Systems TCI Time Warner Viacom Ex Partes Grand Rapids City of Grand Rapids and other Michigan municipalities ParCable IParCable, Inc., Star Cable Associates, Bend Cable Communications, Inc., Etan Industries, Inc., and River Valley Cable TV Parcable II ParCable, Inc. COA Continental Comcast Comcast Corporation McConnell Senator Mitch McConnell, Jr. Sun Country Sun Country Cable Attachment B Rules 1. Section 76.922 is amended by adding paragraphs (g) through (k) to read as follows: ÀÀ 76.922 Rates for the basic service tier and cable programming services tier * * * * * (g) Cost of Service Charge. (1) For purposes 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 tier 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 Section 76.932 of the Commission's Rules. A test year for a change in a cable programming service charge after the initial date 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. (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 ÀÀ 76.924 of this subpart. (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. 2. Section 76.924 is amended by revising paragraphs (b), (c), (d), (e), and (f) as follows: ÀÀ 76.924 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 Section 76.922(b)(5)(A) of this subpart, 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. RATEBASE Net Working Capital Headend Trunk and Distribution Facilities Drops Customer Premises Equipment Construction/Maintenance Facilities and Equipment Programming Production Facilities and Equipment Business Offices Facilities and Equipment Other Tangible Assets Accumulated Depreciation Plant Under Construction Organizational and Franchise Costs Subscriber Lists Capitalized Start-up Losses Goodwill Other Intangibles Accumulated Amortization Deferred Taxes OPERATING EXPENSES Cable Plant Employee Payroll Cable Plant Power Expense Pole Rental, Duct, Other Rental for Cable Plant Cable Plant Depreciation Expense Cable Plant Expenses - Other Plant Support Employee Payroll Expense Plant Support Depreciation Expense Plant Support Expense - Other Programming Activities Employee Payroll Programming Acquisition Expense Programming Activities Depreciation Expense Programming Expense - Other Customer Services Expense Advertising Activities Expense Management Fees General and Administrative Expenses Selling General and Administrative Depreciation Expenses Selling General and Administrative Expenses - Other Amortization Expense - Franchise and Organizational Costs Amortization Expense - Customer Lists Amortization Expense - Capitalized Start-up Loss Amortization Expense - Goodwill Amortization Expense - Other Intangibles Operating Taxes Other Expenses (Excluding Franchise Fees) Franchise Fees Interest on Funded Debt Interest on Capital Leases Other Interest Expenses REVENUE AND INCOME ADJUSTMENTS Advertising Revenues Other Cable Revenue Offsets Gains and Losses on Sale of Assets Extraordinary Items Other Adjustments (2) Small operators, as defined by Section 922(b)(5)(A) of this subpart, 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: RATEBASE Net Working Capital Headend, Trunk and Distribution System and Support Facilities and Equipment Drops Customer Premises Equipment Production and Office Facilities, Furniture and Equipment Other Tangible Assets Accumulated Depreciation Plant Under Construction Goodwill Other Intangibles Accumulated Amortization Deferred Taxes OPERATING EXPENSES Cable Plant Maintenance, Support and Operations Expense Programming Production and Acquisition Expense Customer Services Expense Advertising Activities Expense Management Fees Selling, General and Administrative Expenses Depreciation Expense Amortization Expense - Goodwill Amortization Expense - Other Intangibles Other Operating Expense (Excluding Franchise Fees) Franchise Fees Interest Expense REVENUE AND INCOME ADJUSTMENTS Advertising Revenues Other Cable Revenue Offsets Gains and Losses on Sale of Assets Extraordinary Items Other Adjustments (3) Cable operators shall not be required to report their investments, expenses and revenues to the summary accounts listed in subsections (1) and (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 subsection (d) of this section shall be allocated among the Equipment Basket, as specified in ÀÀ 76.923 of this subpart, 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 ÀÀ 76.901(a) of this subpart. The basic service cost category may only include allowable costs as defined by ÀÀÀÀ 76.922(g) through 76.922(k) of this subpart. (ii) Cable programming services cost category. The cable programming services category shall include the cost of providing cable programming services as defined by ÀÀ 76.901(b) of this subpart. 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 category 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 ÀÀ 76.922(g) through 76.922(k) of this subpart. (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 (1) on a pay-per-channel basis (2) on a pay-per-program basis or (3) 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 ÀÀ 76.923 of this subpart, and the following service cost categories: (i) The basic service category as defined by subsection (1) (i) of this section; (ii) The cable programming services category as defined by subsection (1)(ii) of this section; (iii) The nonregulated cable programming services cost category as defined by subsection (1)(iii) of this section; (iv) The other cable activities service cost category as defined by subsection (1)(iv) of this section; and (v) The non-cable activities service cost category as defined by subsection (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 ÀÀ 76.924(c) of this subpart. (1) 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. (2) 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. (3) Costs of public, educational, and governmental access channels carried on the basic tier shall be directly assigned to the basic tier where possible. (4) 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. (5) 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 cost 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. 3. Section 76.924 is amended to redesignate paragraph (g) as (j) and to add paragraph (g) to read as follows: * * * * * (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 subsection (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. * * * * * 5. Section 76.924 shall be amended by adding the following as paragraph (i): * * * * * (i) Transactions with 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 charges 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 nonaffililates. If a prevailing company price for the services received by the regulated activity is not available, the charges for 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 Sections 76.924(i)(1) through 76.924(i)(4), cost shall be determined in accordance with the standards and procedures specified in Sections 76.922, 76.924(b), and 76.924(d) of this subpart. Attachment C Proposed Accounting Rules 1. Part 76 is proposed to be amended by adding Subpart P as follows: UNIFORM SYSTEM OF ACCOUNTS FOR CABLE SYSTEM OPERATORS Section 76.1100 Background 76.1101 Reporting Companies 76.1102 Records 76.1103 Accounts - General 76.1104 Regulated Accounts 76.1105 Interpretation of Accounts 76.1106 Waivers 76.1107 Address for Reports and Correspondence 76.1108 Number Convention 76.1109 Sequence of Accounts 76.1110 Nonregulated Activities 76.1111 Compensated Absences 76.1112 Materiality 76.1113 Nonregulated Investments CURRENT ASSETS 76.1114 Cash and Equivalents 76.1115 Accounts Receivable - Cable Services 76.1116 Accounts Receivable Allowance - Cable Services 76.1117 Other Accounts Receivable 76.1118 Accounts Receivable Allowance - Other 76.1119 Notes Receivable 76.1120 Notes Receivable Allowance 76.1121 Interest and Dividends Receivable 76.1122 Inventories 76.1123 Prepayments 76.1124 Other Current Assets NONCURRENT ASSETS 76.1125 Investments in Affiliated Companies 76.1126 Investments in Nonaffiliated Companies 76.1127 Nonregulated Investments 76.1128 Unamortized Debt Issuance Expense 76.1129 Sinking Funds 76.1130 Other Noncurrent Assets 76.1131 Deferred Maintenance and Retirements 76.1132 Deferred Charges REGULATED PLANT 76.1133 Instructions for Cable Services Plant Accounts 76.1134 Cable Service Plant in Service 76.1135 Property Held for Future Use 76.1136 Cable Service Plant Adjustment 76.1137 Nonoperating Plant 76.1138 Goodwill 76.1139 Land 76.1140 Buildings 76.1141 Head End Equipment 76.1142 Distribution System 76.1143 Drops 76.1144 Production Equipment 76.1145 Customer Premises Equipment 76.1146 Maintenance and Warehouse Equipment 76.1147 Furniture 76.1148 Office Equipment 76.1149 Capital Leases 76.1150 Leasehold Improvements 76.1151 Intangibles 76.1152 Accumulated Depreciation 76.1153 Accumulated Depreciation Held for Future Use 76.1154 Accumulated Depreciation - Nonoperating 76.1155 Accumulated Amortization - Capitalized Leases 76.1156 Accumulated Amortization - Leasehold Improvements 76.1157 Accumulated Amortization - Intangible 76.1158 Accumulated Amortization - Other CURRENT LIABILITIES 76.1159 Accounts Payable 76.1160 Notes Payable 76.1161 Advance Billing and Payments 76.1162 Customers' Deposits 76.1163 Current Maturities - Long Term Debt 76.1164 Current Maturities - Capital Leases 76.1165 Income Taxes - Accrued 76.1166 Other Taxes - Accrued 76.1167 Net Current Deferred Operating Income Taxes 76.1168 Net Current Deferred Nonoperating Income Taxes 76.1169 Other Accrued Liabilities 76.1170 Other Current Liabilities 76.1171 Funded Debt 76.1172 Premium on Long - Term Debt 76.1173 Discount on Long - Term Debt 76.1174 Reacquired Debt 76.1175 Obligations Under Capital Leases 76.1176 Advances from Affiliated Companies 76.1177 Other Long - Term Debt 76.1178 Other Long - Term Liabilities 76.1179 Unamortized Operating Investment Tax Credits - Net 76.1180 Unamortized Nonoperating Investment Tax Credits - Net 76.1181 Net Noncurrent Deferred Operating Income Taxes 76.1182 Net Noncurrent Deferred Nonoperating Income Taxes 76.1183 Other Deferred Credits 76.1184 Capital Stock 76.1185 Additional Paid - In Capital 76.1186 Treasury Stock 76.1187 Other Capital 76.1188 Retained Earnings REVENUE ACCOUNTS 76.1189 Instructions for Revenue Accounts 76.1190 Basic Service Tier Revenues 76.1191 Cable Programming Services Revenues 76.1192 Equipment and Installation Revenues 76.1193 Nonregulated Cable Programming Services 76.1194 Other Cable Revenues 76.1195 Uncollectible Revenue - Cable Services 76.1196 Uncollectible Revenue - Other EXPENSE ACCOUNTS 76.1197 Instructions for Expense Accounts 76.1198 Property Held for Future Use Expense 76.1199 Land and Building Expense 76.1200 Headend Equipment Expense 76.1201 Distribution System Expense 76.1202 Drops Expense 76.1203 Production Equipment Expense 76.1204 Customer Premises Equipment Expense 76.1205 Maintenance and Warehouse Expense 76.1206 Furniture and Artworks Expense 76.1207 Office Equipment Expense 76.1208 Basic Cable Programming Expense 76.1209 Basic Cable Programming Expense 76.1210 Retransmission Consent Expense 76.1211 Public, Educational, Governmental Access Expense 76.1212 Local Origination Expense 76.1213 Other Basic Cable Programming Expense 76.1214 Cable Programming Service Expense 76.1215 Cable Programming Service Satellite Programming Expense 76.1216 Cable Programming Service Retransmission Consent Expense 76.1217 Cable Programming Service Local Origination 76.1218 Other Cable Programming Expense 76.1219 Accumulated Depreciation and Amortization Expense 76.1220 Accumulated Depreciation Expense - Cable Services Plant in Service 76.1221 Accumulated Depreciation Expense - Property Held for Future Cable Services Use 76.1222 Amortization Expense - Tangible 76.1223 Amortization Expense - Intangible 76.1224 Amortization Expense - Other 76.1225 Other Property, Plant and Equipment Expenses 76.1226 Cable System Operations Expenses 76.1227 Marketing 76.1228 Customer Services 76.1229 Executive and Planning 76.1230 General and Administrative 76.1231 Provision for Uncollectible Notes Receivables 76.1232 ` Instructions for Other Income Accounts 76.1233 Contents of Accounts 76.1234 Other Operating Income and Expenses 76.1235 Operating Taxes 76.1236 Nonoperating Income and Expense 76.1237 Nonoperating Taxes 76.1238 Interest and Related Items 76.1239 Extraordinary Items 76.1240 Nonregulated Net Income 76.1241 Glossary of Terms Subpart P -- Uniform System of Accounts for Cable System Operators ÀÀ 76.1100 Background The Uniform System of Accounts (USOA) for cable systems is designed for those cable operators that elect cost of service regulation. The purpose of the USOA is to help ensure that in cost of service proceedings, regulators will have accurate records of cable operators' revenues, operating expenses, depreciation expenses and capital investments. In order for an accounting system to fulfill this purpose, it must exhibit consistency and stability in financial reporting. This USOA has, therefore, been designed to reflect stable, recurring, financial data, based to the extent regulatory considerations permit, upon the consistency of the well established body of accounting theories and principles commonly referred to as generally accepted accounting principles. ÀÀ 76.1101 Reporting companies (a) Cable operators, that elect cost of service regulation must have or develop accounting records in accordance with this Subpart for the relevant test year in the cost of service proceeding. (b) If a cable operator does not develop or maintain its accounting records in accordance with this subpart for the relevant test year, the cable operator's cost of service application will be dismissed. ÀÀ 76.1102 Records (a) The reporting company's financial records shall be kept in accordance with generally accepted accounting principles to the extent permitted by this system of accounts. (b) The reporting company's financial records shall be kept with sufficient particularity to show fully the facts pertaining to all entries in these accounts. The detail records shall be filed in such manner as to be readily accessible for examination by representatives of this Commission. (c) The Commission shall require a company to maintain financial and other subsidiary records in such a manner that specific information, of a type not warranting disclosure as an account or subaccount, will be readily available. When this occurs, or where the full information is not otherwise recorded in the general books, the subsidiary records shall be maintained in sufficient detail to facilitate the reporting of the required specific information. The subsidiary records, in which the full details are shown, shall be sufficiently referenced to permit ready identification and examination by representatives of this Commission. ÀÀ 76.1103 Accounts-General (a) As a general rule, all accounts kept by reporting cable companies shall conform in numbers and titles to those prescribed herein. However, reporting companies may use different numbers for internal purposes when separate accounts (or subaccounts) maintained are consistent with the title and content of accounts and subaccounts prescribed in this system. A company may subdivide any of the accounts prescribed. The titles of all such subaccounts shall refer by number or title to the controlling account. (b) A company may make any such subdivisions, reclassifications or consolidations of existing balances as are necessary to meet requirements of this system of accounts. ÀÀ 76.1104 Regulated Accounts (a) In the context of this subpart, regulated accounts shall be interpreted to include the investments, revenues and expenses associated with basic cable service, cable programming services, equipment and installation and other cable activities. For those cable operators that elect cost of service regulation, these regulated products and services are fully subject to the accounting requirements in this subpart. (b) In the application of detailed accounting requirements contained in this subpart, when a regulated activity involves the common or joint use of assets and resources in the provision of regulated and nonregulated products and services, companies shall account for these activities within the accounts prescribed in this system. Assets and expenses shall be subdivided in subsidiary records among amounts solely assignable to basic cable services, amounts solely assignable to cable programming services, amounts solely assignable to equipment and installation, amounts solely assignable to nonregulated cable programming services, amounts solely assignable to other cable activities, amounts solely assignable to noncable activities and amounts related to assets used and expenses incurred jointly or in common, which will be allocated among these service cost categories. Companies shall submit reports identifying regulated and nonregulated amounts in the manner and at the times prescribed by this Commission. Nonregulated revenue items not qualifying for incidental treatment shall be recorded in the Nonregulated Operating Revenue account. (c) Other income items which are incidental to the provision of regulated products and services shall be accounted for as regulated activities. ÀÀ 76.1105 Interpretation of accounts. In order to maintain uniform accounting within the prescribed system, questions involving matters of significance which are not clearly provided for, shall be submitted to the Chief, Cable Services Bureau, for explanation, interpretation, or resolution. Questions and answers thereto with respect to this system of accounts will be maintained by the Cable Services Bureau. ÀÀ 76.1106 Waivers. A waiver from any provision of this system of accounts shall be made by the Federal Communications Commission upon its own initiative or upon the submission of written request therefor from any reporting company, provided that such waiver is in the public interest and each request for waiver expressly demonstrates that: existing peculiarities or unusual circumstances warrant a departure from a prescribed procedure or technique; a specifically defined alternative procedure will result in substantially equivalent or more accurate portrayal of operating results or financial condition, consistent with the principles embodied in the provisions of this system of accounts; and the application of such alternative procedure will maintain or improve uniformity in substantive results as among reporting companies. ÀÀ 76.1107 Address for reports and correspondence. Reports, statements, and correspondence submitted to the Federal Communications in accordance with or relating to instructions and requirements contained herein shall be addressed to the Cable Services Bureau, Federal Communications Commission, Washington, D.C. 20554. ÀÀ 76.1108 Number convention. (a) The number "76" (appearing to the left of the first decimal point) indicates the part number. (b) The numbers immediately following to the right of the decimal point indicate, respectively, the section or account. All account numbers contain 4 digits to the right of the decimal point. (c) Cross references to accounts are made by citing the account numbers to the right of the decimal point; e.g., Account 1114, rather than the corresponding complete reference number 76.1114. ÀÀ 76.1109 Sequence of accounts. The order in which the accounts are presented in this system of accounts is not to be considered as necessarily indicative of the order in which they will be scheduled at all times in reports to this Commission. ÀÀ 76.1110 Nonregulated activities (a) This section describes the accounting treatment of activities classified for accounting purposes as "nonregulated." Activities classified as "nonregulated cable programming services" and "noncable activities" will be classified for accounting purposes as "nonregulated." Activities that qualify for incidental treatment under the policies of this Commission will be classified for accounting purposes as regulated activities. The treatment of nonregulated activities shall differ depending on the extent of the common or joint use of assets and resources in the provision of both regulated and nonregulated products and services. (b) When a nonregulated activity does not involve the joint or common use of assets and resources in the provision of both regulated and nonregulated products and services, reporting companies shall account for these activities on a separate set of books. In the separate set of books, reporting companies may establish whatever detail they deem appropriate beyond what is necessary to provide this Commission with the information required in this subpart. (c) When a nonregulated activity does involve the common or joint use of assets and resources in the provision of regulated and nonregulated products and services, the reporting company shall account for these activities within accounts prescribed in this system. Assets and expenses shall be subdivided in subsidiary records among amounts solely assignable to nonregulated cable programming activities, amounts solely assignable to other cable activities, amounts solely assignable to noncable activities, amounts solely assignable to basic cable services, amounts solely assignable to cable programming services, amounts solely assignable to equipment and installation, and amounts related to assets used and expenses incurred jointly or in common, which will be allocated among these service cost categories. Companies shall submit reports identifying regulated and nonregulated amounts in the manner and at the times prescribed by this Commission. Nonregulated revenue items not qualifying for incidental treatment shall be recorded in the nonregulated operating revenue account. ÀÀ 76.1111 Compensated absences. Reporting companies shall record a liability and charge the appropriate expense accounts for compensated absences (vacations, sick leave, etc.) in the year in which these benefits are earned by employees. ÀÀ 76.1112 Materiality Reporting companies shall follow this system of accounts in recording all financial and statistical data irrespective of an individual item's materiality under GAAP, unless a waiver has been granted under the provisions of ÀÀ 76.1106 of this subpart to do otherwise. ÀÀ 76.1113 Nonregulated investments. Nonregulated investments shall include the investments in nonregulated activities that are conducted through the same legal entity as the cable operator, but does not involve the joint or common use of assets or resources in the provision of both regulated and nonregulated products and services. ÀÀ 76.1114 Cash and Equivalents. (a) This account shall include the following: (1) The amount of current funds available for use on demand in the hands of financial officers and agents, deposited in banks or other financial institutions and also funds in transit for which agents have received credit. (2) The amount of cash on special deposit, other than in sinking and other special funds provided for elsewhere, to pay dividends, interest, and other debts, when such payments are due one year or less from the date of deposit; the amount of cash deposited to insure the performance of contracts to be performed within one year from date of the deposit; and other cash deposits of a special nature not provided for elsewhere. Cash on special deposit shall include the amount of cash deposited with trustees to be held until mortgaged property sold, destroyed, or otherwise disposed of is replaced, and also cash realized from the sale of the company's securities and deposited with trustees to be held until invested in physical property of the company or for disbursement when the purposes for which the securities were sold are accomplished. Cash on special deposit to be held for more than one year from the date of deposit shall be included in the Other Noncurrent Assets Account. (3) The amount of cash advanced to officers, agents, employees, and others as petty cash or working funds from which expenditures are to be made and accounted for. (4) The cost of securities acquired for the purpose of temporarily investing cash, such as time drafts receivable and time loans, bankers's acceptances, United States Treasury certificates, marketable securities, and other similar investments of a temporary character. Accumulated changes in the net unrealized losses of current marketable equity securities shall be included in the determination of net income in the period in which they occur in the Other Nonoperating Income Account. ÀÀ 76.1115 Accounts receivable - cable services. (a) This account shall include all amounts due from customers for services rendered or billed and from agents and collectors authorized to make collections from customers. This account shall also include all amounts due from customers or agents for products sold. This account shall be kept in such manner as will enable the company to make the following analysis: (1) Amounts due from customers who are receiving cable service. (2) Amounts due from customers who are not receiving service and whose accounts are in process of collections. (b Collections in excess of amounts charged to this account may be credited to and carried in this account until applied against charges for services rendered or until refunded. ÀÀ 76.1116 Accounts receivable allowance - cable services. (a) This account shall be credited with amounts charged to the Uncollectible Revenue Account, to provide for uncollectible amounts included in the Accounts Receivable - Cable Services account. There shall be credited to this account amounts collected which previously had been written off through charges to this account and credits to the Accounts Receivable - Cable Services Account. There shall be charged to this account any amounts covered thereby which have been found to be impracticable of collection. (b) If no such allowance is maintained, uncollectible amounts shall be charged directly to the Uncollectible Revenue account. ÀÀ 76.1117 Other accounts receivable. This account shall include all amounts currently due, and not provided for in other accounts, such as divisions of revenue, material and supplies, matured rents, and interest receivable under monthly settlements on short term loans, advances, and open accounts. ÀÀ 76.1118 Accounts receivable allowance - other. (a) This account shall be credited with amounts charged to Uncollectible Revenue - Other account to provide for uncollectible amounts included in Other Accounts Receivable account. There shall also be credited to this account amounts collected which previously had been written off through charges to this account and credits to the Other Accounts Receivable account. There shall be charged to this account any amounts covered thereby which have been found to be impracticable of collection. (b) If no such allowance is maintained, uncollectible amounts shall be charged directly to the Uncollectible Revenue - Other account. ÀÀ 76.1119 Notes receivable. This account shall include the cost of demand or time notes, bills and drafts receivable, or other similar evidences (except interest coupons) of money receivable on demand or within a time not exceeding one year from date of issue. ÀÀ 76.1120 Notes receivable allowance. (a) This account shall be credited with amounts charged to the Provision for Uncollectible Notes Receivable account to provide for uncollectible amounts included in the Notes Receivable account. There shall also be credited to this account amounts collected which previously had been written off through charges to this account and credits to the Notes Receivable account. There shall be charged to this account any amounts covered thereby which have been found to be impracticable of collection. (b) If no such allowance is maintained, uncollectible amounts shall be charged directly to the Provision for Uncollectible Notes Receivable account. ÀÀ 76.1121 Interest and dividends receivable. (a) This account shall include the amount of interest accrued to the date of the balance sheet on bonds, notes and other commercial paper owned, on loans made, and the amounts of dividends receivable on stocks owned. (b) This account shall not include dividends or other returns on securities issued or assumed by the company and held by or for it, whether pledged as collateral, or held in its treasury, in special deposits, or in sinking and other funds. (c) Interest receivable under monthly settlements on short term loans, advances, and open accounts, shall be included in the Accounts Receivable - Cable Services account or the Accounts Receivable - Other account, as appropriate. (d) Dividends received and receivable from affiliated companies accounted for on the equity method shall be included in the Investments in Affiliated Companies account, as a reduction of the carrying value of the investment. ÀÀ 76.1122 Inventories (a) This account shall include the cost of materials and supplies held in stock and inventories of goods held for resale or lease. The investment in inventories shall include materials and supplies and property held for sale or lease. This account shall not include items which are related to a nonregulated activity unless that activity involves joint or common use of assets and resources in the provision of regulated and nonregulated products and services. (b) This account shall include cost of material and supplies held in stock, including plant supplies, motor vehicles supplies, tools, fuel, other supplies and material and articles of the company in process of manufacture for supply stock. (c) This account shall include transportation charges and sales and use taxes, so far as practicable, as a part of the cost of the particular material to which they relate. Transportation and sales and use taxes which are not included as part of the cost of a particular material shall be equitably apportioned among the detail accounts to which material is charged. (d) So far as practicable, cash and other discount on material shall be deducted in determining cost of the particular material to which they relate or credited to the account to which the material is charged. When such deduction is not practicable, discounts shall be equitably apportioned among the detail accounts to which material is charged. (e) Material recovered in connection with construction, maintenance or retirement of property shall be charged to this account as follows: (1) Reusable items that, when installed or in service, were retirement units, shall be included in this account at the original cost, estimated if not known. (2) Reusable minor items that, when installed or in service, were not retirement units, shall be included in this account at current prices new. (3) The cost of repairing reusable material shall be charged to the appropriate account in the Plant Specific Operations Expense accounts. (4) Scrap and nonusable material included in this account shall be carried at the estimated amount which will be received therefor. The difference between the amounts realized for scrap and nonusable material sold and the amounts at which it is carried in this account, so far as practicable, shall be adjusted in the accounts credited when the material was taken up in this account. ÀÀ 76.1123 Prepayments. (a) This account shall include the following: (1) The amounts of rents paid in advance of the period in which they are chargeable to income, except amounts chargeable to cable plant under construction and minor amounts which may be charged directly to the final accounts. (2) The balance of all taxes, other than amounts chargeable to cable services plant under construction and minor amounts which may be charged to the final accounts, paid in advance and which are chargeable to income within one year. (3) The amount of insurance premiums paid in advance of the period in which they are chargeable to income, except premiums chargeable to cable services plant under construction and minor amounts which may be charged directly to the final accounts. (b) As the term expires for which any prepayment applies, this account shall be credited monthly and the appropriate account charged. ÀÀ 76.1124 Other current assets. This account shall include the amount of all current assets which are not includable in Accounts 1115 through 1123. ÀÀ 76.1125 Investments in affiliated companies. (a) This account shall include the acquisition cost of the company's investment in equity or other securities issued or assumed by affiliated companies, other than securities held in special funds which shall be charged to the Sinking Funds account. The carrying value of the investment (securities) accounted for on the equity method shall be adjusted to recognize the company's share of the earnings or losses and dividends received or receivable of the affiliated company from the date of acquisition. (b) Declines in value of investments accounted for under the cost method shall be charged to the Other Capital account, if temporary and as a current period loss if permanent. Detail records shall be maintained to reflect unrealized losses for each investment. (c) This account shall also include advances represented by book accounts only with respect to which it is agreed or intended that they shall be either settled by issuance of capital stock or debt; or shall not be subject to current cost settlement. (d) A subsidiary record shall be kept identifying separately common stocks, preferred stocks, long-term debt, investment advances and special deposits of cash for more than one year from the date of deposit. Further, the company's record shall identify the securities pledged as collateral for any of the company's long-term debt or short-term loans or to secured performance of contracts. (e) Amounts due from nonaffiliated companies which are subject to current settlement shall be included in the Accounts Receivable - Cable Services account or the Notes Receivable account, as appropriate. (f) Subsidiary record categories shall be maintained in order that the entity may separately report the amounts contained herein that relate to the equity method and the cost method. ÀÀ 76.1126 Investments in nonaffiliated companies. (a) This account shall include the acquisition cost of the company's investment in securities issued or assumed by nonaffiliated companies and individuals, other than securities held in special funds which shall be charged to the Sinking Funds account, and also its investment advances to such parties and special deposits of cash for more than one year from date of deposit. (b) Declines in value of investment shall be charged to the Other Capital account, if temporary and as a current period loss if permanent. Detail records shall be maintained to reflect unrealized losses for each investment. (c) This account shall also include advances represented by book accounts only with respect to which it is agreed or intended that they shall be either settled by issuance of capital stock or debt; or shall not be subject to current cost settlement. (d) A subsidiary record shall be kept identifying separately common stocks, preferred stocks, long-term debt, investment advances and special deposits of cash for more than one year from the date of deposit. Further, the company's record shall identify the securities pledged as collateral for any of the company's long-term debt or short-term debt or short-term loans or to secure performance of contracts. (e) Amounts due from nonaffiliated companies which are subject to current settlement shall be included in the Accounts Receivable - Cable Services account, the Accounts Receivable - Other account, or the Notes Receivable account, as appropriate. ÀÀ 76.1127 Nonregulated investments. This account shall include the reporting company's investment in nonregulated activities accounted for in a separate set of books as provided in ÀÀ 76.1110(b). ÀÀ 76.1128 Unamortized debt issuance expense. (a) This account shall include the total unamortized balance of debt issuance expense for all classes of outstanding long-term debt. Amounts included in this account shall be charged to Interest and Related Items account. (b) Debt Issuance expense includes all expenses in connection with the issuance and sale of evidence of debt, such as fees for drafting mortgages and trust deeds; fees and taxes for issuing or recording evidences of debt; costs of engraving and printing bonds, certificates of indebtedness, and other commercial paper; fees paid trustees; specific costs of obtaining governmental authority; fees for legal services; fees and commissions paid underwriters, brokers, and salesmen; fees and expenses of listing on exchanges, and other like costs. (c) A subsidiary record shall be kept of each issue outstanding. ÀÀ 76.1129 Sinking funds. (a) This account shall include the amount of cash and other assets which are held by trustees or by the company's treasurer in a distinct fund, for the purpose of redeeming outstanding obligations. (b) Interest or other income arising from funds carried in this account shall generally be charged to this account. (c) A subsidiary record shall be kept for each sinking fund which shall designate the obligation in support of which the fund was created. ÀÀ 76.1130 Other noncurrent assets. This account shall include the amount of all noncurrent assets which are not includable in Accounts 1125 through 1129. ÀÀ 76.1131 Deferred maintenance and retirements. This account shall include such items as the unprovided-for loss in service value of cable plant for extraordinary nonrecurring retirement not considered in depreciation and the cost of extensive replacements of plant normally chargeable to the current period Plant Specific Operations Expense accounts. ÀÀ 76.1132 Deferred charges. (a) This account shall include all deferred charges not provided for in the Deferred Maintenance and Retirements account. Such charges include unaudited amounts and other debit balances in suspense that cannot be cleared and disposed of until additional information is received; the amount, pending determination of loss, of funds on deposit with banks which have failed; revenue, expense, and income items held in suspense; amounts paid for options pending final disposition. (b) This account shall include the cost of preliminary surveys, plans, investigation, etc., made for construction projects under contemplation. If the projects are carried out, the preliminary costs shall be included in the cost of the plant constructed. If the projects are abandoned, the preliminary costs shall be charged to the Nonoperating Income and Expense account. (c) This account shall include also the cost of evaluations, inventories, and appraisals taken in connection with the acquisition or sale of property. If the property is subsequently acquired, the preliminary costs shall be accounted for as a part of the cost of acquisition, or if it is sold, such costs shall be deducted from the sale price in accounting for the property sold. If purchases or sales are abandoned, the preliminary costs included herein (including options paid, if any) shall be charged to the Nonoperating Income and Expense account. ÀÀ 76.1133 Instructions for cable services plant accounts. (a) Purpose of cable services plant accounts. (1) The cable services plant accounts (1134 to 1138 inclusive) are designed to show the investment in the reporting company's tangible and intangible cable services plant which ordinarily has a service life of more than one year, including such plant whether used by the company or others in providing cable service. (2) The cable services plant accounts shall not include the cost or other value that cable plant contributed to the company. Contributions in the form of money or its equivalent toward the construction of cable services plant shall be credited to the accounts charged with the cost of such construction. Amounts of non-recurring reimbursements based on the cost of plant or equipment furnished in rendering service to a customer shall be credited to the accounts charged with the cost of the plant or equipment. Amounts received for construction which are ultimately to be repaid wholly or in part, shall be credited to the Other Deferred Credits account; when final determination has been made as to the amount to be returned, any unrefunded amounts shall be credited to the accounts charged with the cost of such construction. Amounts received for the construction of plant, the ownership of which rests with or will revert to others, shall be credited to the accounts charged with the cost of such construction. (b) Cable services plant acquired. (1) Property, plant and equipment acquired from an entity, whether or not affiliated with the accounting company, shall be accounted for at original cost. (2) The accounting for property plant and equipment to be recorded at original cost shall be as follows: (i) The amount of money paid (or current money value of any consideration other than money exchanged) for the property (together with preliminary expenses incurred in connection with the acquisition) shall be charged to the Deferred Charges account. (ii) The original cost, estimated if not known, of cable services plant, governmental franchises and other similar rights acquired shall be charged to the applicable cable services plant accounts, Cable Services Plant Under Construction, and Property Held for Future Use as appropriate, and credited to the Deferred Charges account. When the actual original cost cannot be determined and estimates are used, the company shall be prepared to furnish the Commission with the particulars of such estimates. (iii) Depreciation and amortization of plant acquired shall be credited to the Accumulated Depreciation account, the Accumulated Depreciation-Held for Future Cable Services Use account, the Accumulated Amortization--Tangible account, the Accumulated Amortization--Capitalized Leases account, the Accumulated Amortization--Leasehold Improvements account, the Accumulated Amortization--Intangibles account and the Accumulated Amortization--Other account, and debited to the Deferred Charges account. (iv) Any amount remaining in the Deferred Charges account, applicable to the plant acquired, shall, upon completion of the entries provided in paragraphs (b)(2)(i), (ii) and (iii) of this section, be debited or credited, as applicable to the Goodwill account, or the Plant Adjustment account, as appropriate. (3) A memorandum record shall be kept showing the amount of contributions in aid of construction applicable to the property acquired as shown by the accounts of the previous owner. (c) Cost of construction. (1) Cable services plant represents an economic resource which will be used to provide future services, the cost of which will be allocated in a rational and systematic manner to the future periods in which it provides benefits. In accounting for construction costs, the reporting company shall charge to the cable services plant accounts, where applicable, all direct and indirect costs. (2) Direct and indirect costs shall include, but not be limited to the following: (i) "Labor," which includes the wages and expenses of employees directly engaged in or in direct charge of construction work. It includes expenses directly related to an employee's wages, such as worker's compensation insurance, payroll taxes, benefits and other similar items of expense. (ii) "Engineering," which includes the portion of the wages and expenses of engineers, draftsmen, inspectors, and their direct supervision applicable to construction work. It includes expenses directly related to an employee's wages, such as worker's compensation insurance, payroll taxes, benefits and other similar items of expense. (iii) "Material and supplies," which includes the purchase price of material used at the point of free delivery plus the costs of inspection, loading and transportation, and an equitable portion of provisioning expense. In determining the cost of material used, proper allowance shall be made for unused material, for material recovered from temporary structures used in performing the work involved, and for discounts allowed and realized in the purchase of material. This item does not include construction material that is stolen or rendered unusable due to vandalism. Such material should be charged to the applicable plant specific operations expense accounts. (iv) "Transportation," which includes the cost of transporting employees, material and supplies, tools and other work equipment to and from the physical construction location. It includes amounts paid therefor to other companies or individuals and the cost of using the company's own motor vehicles or other transportation equipment. (v) "Contract work," which includes amounts paid for work performed under contract or other agreement by other companies, firms or individuals; engineering and supervision applicable to such work; cost incident to the award of contracts; and the inspection of such work. The cost of construction work performed by affiliated companies and other details relating thereto shall be available from the work in progress and supporting records. (vi) "Protection," which includes the cost of protecting the company's property from fire or other casualties and the cost of preventing damages to others or the property of others. (vii) "Privileges, Permits and Rights of Way," which includes such costs incurred in obtaining these privileges, permits, or rights of way in connection with construction work, such as for use of private property, streets or highways. The cost of such privileges and permits shall be included in the cost of the work for which the privileges or permits are obtained, except for costs includable in the Land account and the Intangibles account. (viii) "Taxes," which includes taxes properly includable in construction costs before the facilities are completed for service, which taxes are assessed separately from taxes on operating property or under conditions that permit separate identification of the amount chargeable to construction. (ix) "Special machine service," which includes the cost of labor expended, materials and supplies consumed and other expenses incurred in the maintenance, operation and use of special and other labor saving machines (other than transportation equipment) such as trenching equipment, cable plows and pole setting trucks. Also included are expenditures for rental, maintenance and operation of such machines owned by others. When a construction job requires the purchase of special machines, the cost thereof, less the appraised or salvage value at the time of release from the job, shall be included in the cost of construction. (x) "Insurance," which includes premiums paid specifically for protection against loss and damage in connection with the construction of cable services plant due to fire or other casualty, injury to or death of employees or others, damages to property of others, defalcations of employees and agents, and the nonperformance of contractual obligations of others. (xi) "Construction services," which includes the cost of cable, electricity, power, construction quarters, office space and equipment directly related to the construction project. (xii) "Indirect construction costs," which includes indirect costs such as general engineering, supervision and support. Such costs, in addition to direct supervision, shall include indirect plant operations and engineering supervision up to, but not including, supervision by executive officers whose pay and expenses are chargeable to the Executive and Planning account. The records supporting the entries for indirect construction cost shall be kept so as to show the nature of the expenditures, the individual jobs and accounts charged, and the bases of the distribution. The amounts charged to each plant account for indirect costs shall be readily determinable. The instructions contained herein shall not be interpreted as permitting the addition to plant of amounts to cover indirect costs based on arbitrary allocations. (xiii) The cost of construction shall not include any amounts classifiable as Corporate Operations Expense. ÀÀ 76.1134 Cable services plant in service. This account shall include the original cost of the investment included in Accounts 1139 through 1151. ÀÀ 76.1135 Property held for future use. (a) This account shall include the original cost of property owned and held for no longer than two years under a definite plan for use in cable service. If at the end of two years the property is not in service, the original cost of the property shall be transferred to the Nonoperating Plant account. (b) Subsidiary records shall be maintained to show the character of the amounts carried in this account. ÀÀ 76.1136 Cable services plant adjustment. (a) This account shall include amounts determined in accordance with ÀÀ 1133(b) of this subpart representing the difference between (1) the fair market value of the cable services plant acquired, plus preliminary expenses incurred in connection with the acquisition; and (2) the original cost of such plant, governmental franchises and similar rights acquired, less the amounts of reserve requirements for depreciation and amortization of the property acquired. If the actual original cost is not known, the entries in this account shall be based upon an estimate of such costs. (b) The amounts recorded in this account with respect to each property acquisition (except land and artworks) shall be disposed of, written off, or provision shall be made for the amortization thereof, as follows: (1) Debit amounts may be charged to,in whole or in part, or amortized over a reasonable period through charges to the Other Nonoperating Income Account. When the provisions of paragraph (b)(3) of this section apply, debit amounts shall be amortized to the Amortization Expense--Other account. (2) Credit amounts shall be disposed of in such manner as this Commission may approve or direct, except for credit amounts referred to in paragraph (b)(3) of this section. (3) Within one year from the date of inclusion in this account of a debit or credit amount with respect to a current acquisition, the company may dispose of the total amount from an acquisition of cable services plant by a lump-sum charge or credit, as appropriate, to the Amortization Expense - Other account without further approval of this Commission, provided that such amount does not exceed $100,000 and that the plant was not acquired from an affiliated company. ÀÀ 76.1137 Nonoperating plant. (a) This account shall include the company's investment in regulated property which is not includable in the plant accounts as operating cable services plant. It shall include the company's investment in cable services property held for sale. (b) Subsidiary records shall be maintained to show the character of the amounts carried in this account. ÀÀ 76.1138 Goodwill. This account shall include any portion of the plant purchase price that cannot be assigned to specifically identifiable property acquired and such amount should be identified as "goodwill". ÀÀ 76.1139 Land. (a) This account shall include the original cost of all land held in fee and of easements, and similar rights in land having a term of more than one year used for purposes other than the location of outside plant. It shall also include special assessments upon land for the construction of public improvements. (b) When land, together with buildings thereon, is acquired, the original cost shall be fairly apportioned between the land and the buildings and accounted for accordingly. If the plan of acquisition contemplates the removal of buildings, the total cost of the land and buildings shall be accounted for as the cost of the land, and the salvage value of the buildings when disposed of shall be deducted from the cost of the land so determined. (c) Annual or more frequent payments for use of land shall be recorded in the rent subsidiary record category for the Land and Building Expense. (d) When land is acquired for which there is not a definite plan for its use in cable service, its costs shall be included in the Nonoperating Plant account. (e) When land is acquired in excess of that required for cable purposes, the cost of such excess land shall in included in the Nonoperating Plant account. (f) Installments of assessments for public improvement, including interest, if any, which are deferred without option to the company shall be included in this account only as they become due and payable. Interest on assessments which are not paid when due shall be included in the Interest and Related Items account. ÀÀ 76.1140 Buildings. (a) This account shall include the original cost of buildings, and the cost of all permanent fixtures, machinery, appurtenances and appliances installed as a part thereof. It shall include costs incident to the construction or purchase of a building and to securing possession and title. (b) When land, together with the buildings thereon, is acquired, the original cost shall be fairly apportioned between the land and buildings, and the amount applicable to the buildings shall be included in this account. The amount applicable to the land shall be included in the Land account. (c) This account shall not include the cost of any cable services equipment or wiring apparatus for generating or controlling electricity for operating the cable system. ÀÀ 76.1141 Head End Equipment. This account shall include the original cost of head end equipment. It shall include the original cost of towers and antennas comprising the headend tower assemblies or arrays, headend receiving and signal processing equipment, all power supply and distribution equipment serving as or associated with the prime source of power used in headend operations, and miscellaneous equipment devoted to general station use. ÀÀ 76.1142 Distribution system. (a) This account shall include the following: (1) The original cost installed of towers and poles together with appurtenant fixtures used for supporting overhead distribution conductors and service wires; (2) The original cost installed of underground conduit and tunnels used for housing distribution cables or wires. (3) The original cost installed of conductors and devices for distribution purposes. (4) The original cost of all power supply and distribution equipment serving as or associated with the prime source of power used in signal distribution. This account shall include also the cost of power rectifieres or motor generator installations (not forming an integral part of the transmitting or head end stations) that are provided as a source of power for the distribution system. ÀÀ 76.1143 Drops This account shall include the original cost of overhead and underground conductors leading from the pressure tap to the point of connection with the customers outlet or wiring. This account includes conduit used for underground service conductors. ÀÀ 76.1144 Production equipment. This account shall include the original cost of all production equipment owned by the reporting company that is used for the production of programming, including public, educational, and governmental access and local origination programming. ÀÀ 76.1145 Customer premises equipment. This account shall include the original cost of equipment on customers' premises, leased or loaned to customers, but not including property held for sale. This account also shall include the cost installed of equipment on customer's premises when the reporting company incurs such cost and when the reporting company retains title to and assumes full responsibility for maintenance and replacement of such property. ÀÀ 76.1146 Maintenance and warehouse equipment. (a) This account shall include the original cost of the following: (1) Motor vehicles of the type which are designed and routinely licensed to operate on public streets and highways. (2) Special purpose vehicles. (3) Tools and equipment used to maintain items included in subsection (1), (2) and (4) of this section. (4) Power operated equipment, general purpose tools and other items of work equipment. ÀÀ 76.1147 Furniture. This account shall include the original cost of furniture in offices, storerooms, shops, and all other quarters. This account shall also include the cost of objects which possess aesthetic value, are of original or limited edition, and do not have a determinable useful life. The cost of any furniture attached to and constituting a part of a building shall be charged to the Buildings account. ÀÀ 76.1148 Office equipment. This account shall include the original cost of office equipment in offices, shops and all other quarters. The cost of any equipment attached to and constituting a part of a building shall be charged to the Building account. ÀÀ 76.1149 Capital leases. (a) This account shall include all property acquired under a capital lease. A lease qualifies as a capital lease when one or more of the following criteria is met: (1) By the end of the lease term, ownership of the leased property is transferred to the leasee. (2) The lease contains a bargain purchase option. (3) The lease term is substantially (75% or more) equal to the estimated useful life of the leased property. However, if the beginning of the lease term falls within the last 25% of the total estimated economic life of the leased property, including earlier years of use, this criterion shall not be used for purposes of classifying the lease. (4) At the inception of the lease, the present value of the minimum lease payments, excluding that portion of the payments representing executory costs to be paid by the lessor, including any profit thereon, equals or exceeds 90% or more of the fair value of the leased property. However, if the beginning of the lease term falls within the last 25% of the total estimated economic life of the leased property, including earlier years of use, this criterion shall not be used for purposes of classifying the lease. (b) All other leases are operating leases. (c) The amounts recorded in this account at the inception of a capital lease shall be equal to the original cost, if known, or to the present value not to exceed fair value, at the beginning of the lease term, of minimum lease payments during the lease term, excluding that portion of the payments representing executory costs to be paid by the lessor, together with any profit thereon. ÀÀ 76.1150 Leasehold improvements. (a) This account shall include the original cost of leasehold improvements made to cable services plant held under a capital or operating lease, which are subject to amortization treatment. This account shall also include those improvements which will revert to the lessor. (b) Improvements to leased cable services plant which are of a relatively minor cost or short life or for which the period of the lease is one year or less shall be charged to the account chargeable with the cost of repairs to such plant. (c) Amounts contained in this account shall be amortized over the term of the related lease. ÀÀ 76.1151 Intangibles. (a) This account shall include the cost of organizing and incorporating the company, the original cost of government franchises, the original cost of patent rights, and other intangible property having a life of more than one year and used in connection with the company's cable operations. (b) Subsidiary records for this account shall include a description of each class of intangible property. (c) The cost of other intangible assets having a life of one year or less shall be charged directly to the Amortization Expense--Intangible account. Such intangibles acquired at small cost may also be charged to the Amortization Expense - Intangibles account, irrespective of their term of life. (d) This account shall not include any discounts on securities issued, nor shall it include costs incident to negotiating loans, selling bonds or other evidences of debt, or expenses in connection with the authorization, issuance, sale or resale of capital stock. (e) When charges are made to this account for expenses incurred in mergers, consolidations, or reorganizations, amounts previously included in this account on the books of the various companies concerned shall not be carried over. (f) Franchise taxes payable annually or more frequently shall be charged to Operating Taxes account. (g) This account shall not include the cost of plant, material and supplies, or equipment furnished to municipalities or other governmental authorities when given other than as initial consideration for franchises or similar rights. (h) This account shall not include the original cost of easements, rights of way, and similar rights in land having a term of more than one year. Such amounts shall be recorded in the Land account, or in the appropriate outside plant account. ÀÀ 76.1152 Accumulated depreciation. (a) This account shall include the accumulated depreciation associated with the investment contained in Cable Services Plant in Service account. (b) This account shall be credited with depreciation amounts concurrently charged to the Depreciation Expense--Cable Services Plant in Service account. (c) At the time of retirement of depreciable operating cable services plant, this account shall be charged with the original cost of the property, retired plus the cost of removal and credited with the salvage value and any insurance proceeds recovered. (d) This account shall be credited with amounts charged to the Deferred Maintenance and Retirements account This account shall be credited with amounts charged to the Depreciation Expense - Cable Services Plant in Service account with respect to other than relatively minor losses in service values suffered through terminations of service when charges for such terminations are made to recover the losses. ÀÀ 76.1153 Accumulated depreciation held for future use. (a) This account shall include the accumulated depreciation associated with the investment contained in the Property Held for Future Use account. (b) This account shall be credited with amounts concurrently charged to the Depreciation and Amortization Expenses account. ÀÀ 76.1154 Accumulated depreciation--non-operating. (a) This account shall include the accumulated amortization and depreciation associated with the investment contained in the Nonoperating Plant account. (b) This account shall be credited with amortization and depreciation amounts concurrently charged to the Nonoperating Income and Expense account. (c) When nonoperating plant not previously used in cable service is disposed of, this account shall be charged with the amount previously credited hereto with respect to such property and the book cost of the property so retired less the amount chargeable to this account and less the value of the salvage recovered or the proceeds from the sale of the property shall be included in the Nonoperating Income and Expense account. In case the property had been used in cable service previous to its inclusion in the Nonoperating Plant account, the amount accrued for depreciation thereon after its retirement from cable service shall be charged to this account and credited to the Accumulated Depreciation account, and the accounting for its retirement from the Nonoperating Plant account shall be in accordance with that applicable to cable services plant retired. ÀÀ 76.1155 Accumulated amortization--capitalized leases. (a) This account shall include the accumulated amortization associated with the investment contained in the Capital Leases account. (b) This account shall be credited with amounts for the amortization of capital leases concurrently charged to the Amortization Expense--Tangible account. (Note also the Accumulated Depreciation--Nonoperating account.) (c) When any item carried in the Capital Leases account is sold, is relinquished, or is otherwise retired from service, this account shall be charged with the cost of the retired item. Remaining amounts associated with the item shall be debited to the Nonoperating Income and Expense account. ÀÀ 76.1156 Accumulated amortization--leasehold improvements. (a) This account shall include the accumulated amortization associated with the investment contained in the Leasehold Improvements account. (b) This account shall be credited with amounts for the amortization leasehold improvements concurrently charged to the Amortization Expense-- Tangible account. (Note also the Accumulated Depreciation--Nonoperating account.) (c) When any item carried in the Leasehold Improvements account is sold, is relinquished, or is otherwise retired from service, this account shall be charged with the cost of the retired item. Remaining amounts associated with the item shall be debited to the Nonoperating Income and Expense account. ÀÀ 76.1157 Accumulated amortization--intangible. (a) This account shall include the accumulated amortization associated with the investment contained in the Intangibles account. (b) This account shall be credited with amortization amounts concurrently charged to the Amortization Expense--Intangible account. (Note also the Accumulated Depreciation--Nonoperating account.) (c) When any item carried in the Intangibles account is sold, relinquished, or otherwise retired from service, this account shall be charged with the cost of the retired item. Remaining amounts associated with the item shall be debited to the Nonoperating Income and Expense account. ÀÀ 76.1158 Accumulated amortization--other. (a) This account shall include the accumulated amortization associated with the investment contained in the Plant Adjustment account. (b) This account shall be credited with amortization amounts concurrently charged to the Amortization Expense--Other. (Note also the Accumulated Depreciation--Nonoperating account.) (c) When any item carried in the Plant Adjustment account is sold, relinquished, or otherwise retired from service, this account shall be charged with the cost of the retired item. Remaining amounts associated with the item shall be debited to the Nonoperating Income and Expense account. ÀÀ 76.1159 Accounts payable. (a) This account shall include all amounts currently due to others for recurring trade obligations, and not provided for in other accounts, such as those for material and supplies, repairs to cable services plant, matured rents, and interest payable under monthly settlements on short-term loans, advances, and open accounts. It shall also include amounts of taxes payable that have been withheld from employees' salaries. (b) Subsidiary record categories shall be maintained for this account in order that the company may separately report the amounts contained herein that relate to nonaffiliates and affiliates. (c) There shall be included herein accounts payable arising from sharing of revenues. ÀÀ 76.1160 Notes payable. (a) This account shall include the face amount of notes, drafts, and other evidences of indebtedness issued or assumed by the company (except interest coupons) which are payable on demand or not more than one year or less from date of issue. (b) Subsidiary record categories shall be maintained for this account in order that the company may separately report the amounts contained herein that relate to nonaffiliates and affiliates. (c) If any part of an obligation, otherwise includable in this account matures more than one year from date of issue, it shall be included in the Funded Debt account, the Advances from Affiliated Companies account, or other appropriate account. (d) The records supporting the entries to this account shall be kept so that the company can furnish complete details as to each note, when it is issued, the consideration received, and when it is payable. ÀÀ 76.1161 Advance billing and payments. This account shall include the amount of advance billing creditable to revenue accounts in future months; also advance payments made by prospective customers prior to the establishment of service. Amounts included in this account shall be credited to the appropriate revenue accounts in the months in which the service is rendered or cleared from this account as refunds are made. ÀÀ 76.1162 Customers' deposits. (a) This account shall include the amount of cash deposited with the company by customers as security for the payment for cable services. (b) Advance payments made by prospective customers prior to the establishment of service shall be credited to the Advance Billing and Payments account. ÀÀ 76.1163 Current maturities--long-term debt. This account shall include the amount (including any obligations for premiums) of long-term debt matured and unpaid without any specific agreement for extension of maturity, including unpresented bonds drawn for redemption through the operation of sinking and redemption fund agreements. ÀÀ 76.1164 Current maturities--capital leases. This account shall include the current portion of obligations applicable to property obtained under capital leases. ÀÀ 76.1165 Income taxes--accrued. (a) This account shall be credited or charged with the offsetting amount of current year income taxes (Federal, state and local) accrued during the period or adjustments to prior accruals. (b) If significant, current year income taxes paid in advance shall be reclassified to the Prepayments account. ÀÀ 76.1166 Other taxes--accrued. (a) This account shall be credited or charged and the Operating Taxes account, or the Nonoperating Taxes account, or, for payroll related costs, the appropriate expense accounts shall be charged or credited for all taxes, other than Federal, State and local income taxes, accrued or adjusted for previous accruals during the period. Among the taxes includable in this account are property, gross receipts, franchise, capital stock, social security and unemployment taxes. (b) Taxes paid in advance of the period in which they are chargeable to income shall be included in the Prepayments account or the Other Noncurrent Assets account, as appropriate. ÀÀ 76.1167 Net current deferred operating income taxes. (a) This account shall include the balance of income tax expense related to current items from regulated operations which have been deferred to later periods as a result of the normalized method of accounting for tax differentials authorized by this Commission and not provided for elsewhere. (b) As regulated assets or liabilities which generated the deferred income tax are reclassified from long-term or noncurrent status to current, the appropriate deferred income tax shall be reclassified from the Net Noncurrent Deferred Operating Income Taxes account, to this account. (c) This account shall be debited or credited with the amount being debited or credited to the Provision for Deferred Operating Income Taxes--Net account. (d) The classification of deferred income taxes as current or noncurrent shall follow the classification of the asset or liability that gave rise to the deferred income tax. If there is no related asset or liability, classification shall be based on the expected turnaround of the tax timing difference. (e) Subsidiary record categories shall be maintained in order that the company may separately report the amounts contained herein that are property related and those that are nonproperty related. ÀÀ 76.1168 Net current deferred nonoperating income taxes. (a) This account shall include the balance of income tax expense resulting from comprehensive interpreted tax allocation which has been deferred to later periods. (b) As other assets or liabilities which generated the deferred income tax are reclassified from long-term or noncurrent status to current, the appropriate deferred income tax shall be reclassified from the Net Noncurrent Deferred Nonoperating Income Taxes account, to this account. (c) This account shall be debited or credited with the amount being credited or debited to the Provision for Deferred Nonoperating Income Taxes-- Net account. (d) This account shall also include the balance of the income taxes (Federal, state and local) related to current extraordinary items which have been deferred to later periods resulting from comprehensive interperiod tax allocation. (e) As the extraordinary item which generated the deferred income tax becomes current, the appropriate deferred income tax shall be reclassified from the Net Noncurrent Deferred Nonoperating Income Taxes account, to this account. (f) This account shall be debited or credited with the amount being credited and debited to the Extraordinary Items account. (g) The classification of deferred income taxes as current or noncurrent shall follow the classification of the asset or liability that gave rise to the deferred income tax. If there is no related asset or liability, classification shall be based on the expected turnaround. (h) Subsidiary record categories shall be maintained in order that the company may separately report the amounts contained herein that are property related and those that are nonproperty related. ÀÀ 76.1169 Other accrued liabilities. (a) This account shall include the amount of wages, compensated absences, interest on indebtedness of the company, dividends on capital stock, and rents accrued to the date for which the balance sheet is made, but not payable until after that date. (b) This account shall be maintained so as to show separately the amount and nature of the items accrued to the date of the balance sheet. (c) Matured rents, dividends and interest shall be included in the Accounts Payable account. (d) Interest payable under monthly settlements on short-term loans, advances, and open accounts shall be included in the Accounts Payable account. ÀÀ 76.1170 Other current liabilities. This account shall include liabilities of current character which are not includable in Accounts 1160 through 1169. ÀÀ 76.1171 Funded debt. (a) This account shall include the total face amount of unmatured debt, maturing more than one year from date of issue, issued by the company and not retired, and the total face amount of similar unmatured debt of other companies, the payment of which has been assumed by the company, including funded debt the maturity of which has been extended by specific agreement. (b) This account shall include such items as mortgage bonds, collateral trust bonds, income bonds, convertible debt, debt securities with detachable warrants and other similar obligations maturing more than one year from date of issue. (c) In the case of debt securities with detachable warrants this account shall include only the face amount of the security at the time of issuance. The value of detachable warrants shall be charged to either the Premium on Long-Term Debt account, or the Discount on Long-Term Debt account, as appropriate, and credited to the Additional Paid-in Capital account, in the case of capital stock warrants or retained in this account as a separately identifiable amount in the case of detachable long-term debt warrants. No similar allocation shall be made for the issuance of either convertible debt or debt securities with non-detachable warrants. (d) Subsidiary records shall be maintained for each issue. (e) Securities maturing in one year or less, including securities maturing serially, shall be included in the Current Maturities--Long-Term Debt account. (f) Investment advances, including those represented by notes, shall be included in the Other Long-Term Debt account. ÀÀ 76.1172 Premium on long-term debt. (a) This account shall include the premium associated with all classes of long-term debt. Premium, as applied to securities issued or assumed by the company, means the excess of the current money value received at their sale over the sum of their book or face amount and interest or dividends accrued at the date of the sale. (b) Amounts included in this account shall be amortized monthly by the interest method and credited to the Interest and Related Items account. (c) Subsidiary records shall be maintained to identify the premium attributable to each issue. ÀÀ 76.1173 Discount on long-term debt. (a) This account shall include the discount associated with all classes of long-term debt. Discount, as applied to securities issued or assumed by the company, means the excess of the book or face amount of the securities plus interest or dividends accrued at the date of the sale over the current money value of the consideration received at their sale. (b) Amounts included in this account shall be amortized monthly by the interest method and charged to the Interest and Related Items account. (c) Subsidiary records shall be maintained to identify the discount attributable to each issue. ÀÀ 76.1174 Reacquired debt. This account shall include the face amount of debt reacquired prior to maturity that has not been retired. Gain or loss shall be recognized at the time of reacquisition by credits or charges to the Nonoperating Income and Expense account, except that material gains or losses shall be treated as extraordinary. (See Extraordinary Income Credits account and Extraordinary Items account.) ÀÀ 76.1175 Obligations under capital leases. (a) This account shall include the noncurrent portion of obligations applicable to property obtained under capital leases. (b) Amounts subject to current settlement shall be included in the Current Maturities--Capital Leases account. ÀÀ 76.1176 Advances from affiliated companies. (a) This account shall include the amount of advances from affiliated companies. (b) Amounts due affiliated companies which are subject to current settlement shall be included in the Notes Payable account or the Accounts Payable account, as appropriate. ÀÀ 76.1177 Other long-term debt. This account shall include long-term debt not provided for elsewhere. ÀÀ 76.1178 Other long-term liabilities. (a) This account shall include amounts accrued to provide for such items as unfunded pensions (if actuarially determined), death benefits, deferred compensation costs and other long-term liabilities not provided for elsewhere. (b) Subsidiary records shall be maintained to identify the nature of the items included herein. ÀÀ 76.1179 Unamortized operating investment tax credits--net. (a) This account shall be credited and the Operating Taxes account shall be debited with investment tax credits generated from qualified expenditures related to regulated operations which the company defers rather than recognizes currently in income. (b) This account shall be debited and the Operating Taxes account credited with a proportionate amount determined in relation to the period of time used for computing book depreciation on the property to which the tax credit relates. ÀÀ 76.1180 Unamortized nonoperating investment tax credits--net. (a) This account shall be credited and the Nonoperating Taxes account, shall be debited with investment tax credits generated from qualified expenditures related to other operations which the company has elected to defer rather than recognize currently in income. (b) This account shall be debited and the Nonoperating Taxes account credited with a proportionate amount determined in relation to the useful book life of the property to which the tax credit relates. ÀÀ 76.1181 Net noncurrent deferred operating income taxes. (a) This account shall include the balance of income tax expense related to noncurrent items from regulated operations which have been deferred to later periods as a result of comprehensive interperiod tax allocation related to timing differences that arise from regulated operations. (b) This account shall be credited or debited, as appropriate, and the Operating Taxes account shall reflect the offset for the tax effect of revenues and expenses from regulated operations which have been included in the determination of taxable income, but which will not be included in the determination of book income or for the tax effect of revenues and expenses from regulated operations which have been included in the determination of book income prior to the inclusion in the determination of taxable income. (c) As regulated assets or liabilities which generated the prepaid income tax or deferred income tax are reclassified from long-term or noncurrent status to current status, the appropriate deferred income tax shall be reclassified from this account to the Net Current Deferred Operating Income Taxes account. (d) The classification of deferred income taxes as current or noncurrent shall follow the classification of the asset or liability that gave rise to the deferred income tax. If there is no related asset or liability, classification shall be based on the expected turnaround of the tax timing difference. (e) Subsidiary record categories shall be maintained in order that the company may separately report the amounts contained herein that are property related and those that are nonproperty related. ÀÀ 76.1182 Net noncurrent deferred nonoperating income taxes. (a) This account shall include the balance of income tax expense (Federal, state and local) that has been deferred to later periods as a result of comprehensive interperiod tax allocation related to nonoperating timing differences. (b) This account shall be credited or debited, as appropriate, and the Nonoperating Taxes account, shall reflect the offset for the tax effect of revenues from other operations and extraordinary items and nonoperating expense which have been included in the determination of taxable income, but which will not be included in the determination of book income or for the tax effect of nonoperating expenses and extraordinary items and nonoperating income which have been included in the determination of book income prior to the inclusion in the determination of taxable income. (c) As other assets or liabilities which generated the prepaid income tax or deferred income tax are reclassified from long-term or non-current status to current status, the appropriate deferred income tax shall be reclassified from this account to the Net Current Deferred Nonoperating Income Taxes account. (d) This account shall also include the balance of the income tax effect (Federal, State and local) related to noncurrent extraordinary items which have been included in the determination of taxable income in a period different from when it is included in the determination of book income, that is, more than one year. (e) This account shall be charged or credited with the contra amount recorded to the Extraordinary Items account. (f) As the extraordinary item which generated the deferred income tax becomes current, the appropriate deferred income tax shall be reclassified from this account to the Net Current Deferred Nonoperating Income Taxes account. (g) The classification of deferred income taxes as current or noncurrent shall follow the classification of the asset or liability that gave rise to the deferred income tax. If there is no related asset or liability, classification shall be based on the expected turnaround of the tax timing difference. (h) Subsidiary record categories shall be maintained in order that the company may separately report the amounts contained herein that are property related and those that are nonproperty related. ÀÀ 76.1183 Other deferred credits. This account shall include the amount of all deferred credits not provided for elsewhere, such as amounts awaiting adjustment between accounts; and revenue, expense, and income items in suspense. ÀÀ 76.1184 Capital stock (a) This account shall include the par value, stated amount, or in the case of no-par stock, the amount received for capital stock issued and outstanding. (b) Subsidiary records shall be maintained so as to show separately each class of stock. (c) This account shall be charged with the book amount of any stock retired. ÀÀ 76.1185 Additional paid-in capital. (a) This account shall include the difference between the net proceeds (including discount, premium and stock issuance expense) received from the issuance of capital stock and the amount includable in the Capital Stock account, unless such difference results in a debit balance for that class of stock, in which case the amount shall be charged to the Retained Earnings account. (b) This account shall also include gains arising from the retirement and cancellation of capital stock. Losses from the retirement and cancellation of capital stock shall be charged to this account to the extent that there exist credits in this account for the same class of stock; otherwise to the Retained Earnings account. ÀÀ 76.1186 Treasury stock. This account shall include the cost of the company's own capital stock which has been issued and subsequently reacquired but not retired or resold. ÀÀ 76.1187 Other capital. This account shall include amounts which are credits arising from the donation by stockholders of the company's capital stock, capital recorded upon the reorganization or recapitalization of the company and temporary declines in the value of marketable securities held for investment purposes. ( See also the Investment in Affiliated Companies account.) ÀÀ 76.1188 Retained earnings. (a) This account shall include the undistributed balance of retained earnings derived from the operations of the company and from all other transactions not includable in the other accounts appropriate for inclusion of stockholders' equity. (b) Subsidiary records shall be maintained wherein are recorded all entries to retained earnings during the year such that the detail of the entries may be disclosed to the Commission. ÀÀ 76.1189 Instructions for Revenue Accounts. (a) Purpose of revenue accounts. The revenue accounts are intended to include the actual cash inflows (or equivalents) that have or will occur as a result of the company's ongoing major or central operations during the period. They will include the revenues which arise from furnishing regulating cable services such as basic cable services, cable programming services, equipment and installation, and nonregulated cable services such as pay per view, and pay per channel services. (b) Deductions from revenue. Corrections of overcharges, authorized refunds of overcollections previously credited to revenue, authorized refunds and adjustments on account of failure in service, and other corrections shall be charged to the revenue account previously credited with the amounts involved. (c) Commissions. Commissions paid to others or employees in place of compensation or salaries for services rendered shall be charged to the Customer Services account, and not to the revenue accounts. (d) Revenue recognition. Credits shall be made to the appropriate revenue accounts when such revenue is actually earned. When the billing cycle encompasses more than one accounting period, adjustments are necessary to properly recognize the revenue applicable to the current accounting period under report. Revenues recorded under the terms of two-tier contracts or other variable payment plans should be deferred, if necessary, and recognized ratably with expenses over the term of related contract. Any amounts deferred shall be credited to the Other Deferred Credits account. (e) Structure of revenue accounts. (1) The revenue section of the system of accounts shall be organized by revenue group summary account, account and subsidiary record category (if required). (2) The revenue section of this system of accounts shall be comprised of five major groups--Basic Service Revenues, Cable Programming Service Revenues, Equipment and Installation Revenues, Nonregulated Cable Programming Service Revenues, Other Cable Revenues, Noncable Revenues, and Uncollectible Revenues. (3) Summary accounts within revenue groups shall be used to describe aggregations of two or more accounts having a certain commonality. ÀÀ 76.1190 Basic service tier revenues. (a) This account shall report all revenues derived from the provision basic cable service as defined by ÀÀ 76.901(a) of this Part. These revenues shall include: (1) Revenues derived from subscriptions to basic cable; (2) Revenues derived from advertising on channels carried on the basic cable service tier; and (3) Other revenues derived from basic cable services. ÀÀ 76.1191 Cable programming services revenues. (a) This account shall report all revenues derived from the provision cable programming services as defined by ÀÀ 76.901(b) of this Part. These revenues shall include: (1) Revenues derived from subscriptions to cable programming services; (2) Revenues derived from advertising on channels carried on the cable programming services tiers; and (3) Other revenues derived from cable programming services. ÀÀ 76.1192 Equipment and installation revenues. (a) This account shall include all revenues derived from the following activities: (1) Customer service installation fees. (2) Lease of basic converters. (3) Lease of one-way addressable converters. (4) Lease of two-way addressable converters. (5) Lease of remotes. 76.1193 Nonregulated cable programming services. (a) This account shall include all revenues from the provision of any cable service other than basic cable service and cable programming service, such as, per-channel or per-program premium services. These revenues shall include: (1) Revenues derived from subscriptions to other cable programming services; (2) Revenues derived from advertising on channels carried on other cable programming services; and (3) Other revenues derived from other cable programming services. 76.1194 Other cable revenues. This account shall include all revenues that are derived from the provision of cable services that are not derived from basic cable services, cable programming services or nonregulated cable programming services. Other cable revenues include revenues from leased access, billing and collection services, studio equipment engineering and rental services, sale of equipment, and maintenance of equipment sold to customers. ÀÀ 76.1195 Uncollectible revenue--cable services. This account shall be charged with amounts concurrently credited to the Receivable Allowances--Cable Services account. ÀÀ 76.1196 Uncollectible revenue--other. This account shall be charged with amounts concurrently credited to the Other Accounts Receivable account or the Accounts Receivable Allowance--Other account, when such allowance is maintained. ÀÀ 76.1197 Instructions for Expense Accounts. (a) Structure of the expense accounts. (1) The expense section of the system of accounts shall be organized by expense group summary account, and subsidiary record category (if required). (2) The expense section of this system of accounts shall be comprised of four major expense groups--Plant Specific Operations, Plant Nonspecific Operations, Customer Operations and Corporate Operations. Expenses to be recorded in Plant Specific and Plant Nonspecific Operations Expense Groups generally reflect cost associated with the various kinds of equipment identified in the plant asset accounts. Expenses to be recorded in the Customer Operations and Corporate Operations accounts reflect the costs of, or all associated with, functions performed by people, irrespective of the organization in which any particular function is performed. (3) Summary accounts within expense groups shall be used to describe aggregations of two or more accounts having a certain commonality. (b) Plant Specific Operations Expense. (1) The Plant Specific Operations Expense Accounts are used to record costs related to specific kinds of cable services plant. (2) The Plant Specific Operations Expense accounts predominantly mirror the cable services plant in service detail accounts and are numbered consistently with them; the first two digit of the expense account being one, eight (18) and the remaining digits being the same as the last two numbers of the related plant account. In classifying Plant Specific Operations expenses, the text of the corresponding plant account should be consulted to ensure appropriateness. (3) The Plant Specific Operations Expense accounts shall include the costs of inspecting, testing and reporting on the condition of cable plant to determine the need for repairs, replacements, rearrangements and changes; performing routine work to prevent trouble, replacing items of plant other than retirement units; rearranging and changing the location of plant not retired; repairing material for reuse; restoring the condition of plant damaged by storms, floods, fire or other casualties (other than the cost of replacing retirement units); inspecting after repairs have been made; and receiving training to perform these kinds of work. Also included are the costs of direct supervision (immediate or first-level) and office support of this work. (4) In addition to the activities specified in paragraph (b)(3) of this section, the appropriate Plant Specific Operations Expense accounts shall include the cost of personnel whose principal job is the operation of plant equipment. However, when the operation of equipment is performed as part of other identifiable functions (such as the use of office equipment, capital tools or motor vehicles) the operators' cost shall be charged to accounts appropriate for those functions. (c) Plant Nonspecific Operations Expense. The Plant Nonspecific Operations Expense accounts shall include expenses related to property held for future use, provisioning expenses, and depreciation and amortization expenses. Accounts in this group shall include the costs of performing activities described in narratives for individual accounts. These costs shall also include the costs of supervision and office support of these activities. (d) Customer Operations Expense. The Customer Operations Expense accounts shall include the cost of performing customer related marketing and services activities described in narratives for individual accounts. These costs shall also include the costs of supervision, office support and training for these activities. (e) Corporate Operations Expense. The Corporate Operations Expense accounts shall include the costs of performing executive and planning activities and general and administrative activities described in narratives for individual accounts. These costs shall also include the costs of supervision, office support and training for these activities. (f) Expense matrix. The expense accounts shall be maintained by the following subsidiary record categories, as appropriate to each account. (1) Salaries and wages. This subsidiary record category shall include compensation to employees, such as; wages, salaries, commissions, bonuses, incentive awards and termination payments. (2) Benefits. This subsidiary record category shall include payroll related benefits on behalf of employees such as the following: Pensions Savings plan contributions (company portion) Worker's compensation required by law Life, hospital, medical, dental, and vision plan insurance Social Security and other payroll taxes (3) Rents. (i) This subsidiary record category shall include amounts paid for the use of real and personal operating property. Amounts paid for real property shall be included in Land and Buildings Expense account. This category includes payments for operating leases but does not include payments for capital leases. (ii) This subsidiary record category is applicable only to the Plant Specific Operations Expense accounts. Incidental rents, e.g., short-term rental car expense, shall be categorized as Other Expenses (see paragraph (f)(4) of this section) under the account which reflects the function for which the incidental rent was incurred. (4) Other expenses. This subsidiary record category shall include costs which cannot be classified to the other subsidiary record categories. Included are material and supplies, including provisioning (note also the Provisioning Expense account); contracted services; accident and damage payments, insurance premiums; traveling expenses and other miscellaneous costs. (5) Clearances. This subsidiary record category shall include amounts transferred to Construction accounts (see ÀÀ 76.1133 (c)(2)(iii)), the Other Plant Specific Operations Expense account, and/or the Accumulated Depreciation account, as appropriate, from the Maintenance and Warehouse Equipment account. (g) Reimbursements. Reimbursements of actual costs incurred in connection with joint operations or projects repairing plant due to damages by others, and obligations to make changes in cable plant (such as highway relocations), shall be credited to the accounts originally charged. ÀÀ 76.1198 Property held for future use expense. This account shall include expenses associated with property held for future use. ÀÀ 76.1199 Land and building expense. This account shall include expenses associated with land and buildings (excluding amortization of leasehold improvements). This account shall also include janitorial service, cleaning supplies, water, sewage, fuel and guard service, and electrical power. ÀÀ 76.1200 Head end equipment expense. This account shall be charged only with expenses incurred in connection with head end equipment. ÀÀ 76.1201 Distribution system expense. This account shall be charged only with expenses incurred in connection with the distribution system. ÀÀ 76.1202 Drops expense This account shall be charged only with expenses incurred in connection with drops. ÀÀ 76.1203 Production equipment expense. This account shall be charged only with expenses incurred in connection with production equipment. ÀÀ 76.1204 Customer premises equipment expense. This account shall be charged only with expenses incurred in connection with customer premises equipment. ÀÀ 76.1205 Maintenance and warehouse equipment expense. (a) This account shall be charged only with expenses incurred in connection with maintenance and warehouse equipment. These expenses shall include: (1) Motor vehicle expenses such as the costs of fuel, lubrications, license and inspection fees, washing, repainting, and minor accessories. Also included are the costs of personnel whose principal job is operating motor vehicles, such as chauffeurs and shuttle bus drivers. The costs of users of motor vehicles whose principal job is not the operation of motor vehicles shall be charged to accounts appropriate for the activities performed. Credits shall be made to this account for amounts transferred to Construction and/or to other Plant Specific Operations Expense accounts. These amounts shall be computed on the basis of direct labor hours. (2) Special purpose vehicles expenses such as the costs of fuel, licenses and inspection fees, washing, repainting, and minor accessories. The costs of operators of this equipment shall be charged to accounts appropriate for the activities performed. Credits shall be made to this account for amounts transferred to Construction and/or to other Plant Specific Operations Expense accounts. These amounts shall be computed on the basis of direct labor hours. (3) Garage work and equipment expenses. (4) Other work equipment expenses. Credits shall be made to this account for amounts transferred to Construction and/or to other Plant specific Operations Expense accounts. These amounts shall be computed on the basis of direct labor hours. ÀÀ 76.1206 Furniture and artworks expense. This account shall include expenses associated with furniture and artworks. ÀÀ 76.1207 Office equipment expense. This account shall be charged only with costs incurred in connection with the office equipment itself. The costs of operators of this equipment shall be charged to accounts appropriate for the activities performed. ÀÀ 76.1208 Basic cable programming expenses. This account shall be used for reporting purposes to summarize Accounts 1209 through 1213. ÀÀ 76.1209 Basic cable satellite programming expenses This account shall include all expenses associated with procuring satellite programming on the basic cable tier. ÀÀ 76.1210 Retransmission consent expenses. This account shall include all expenses associated with retransmission consent on the basic tier. ÀÀ 76.1211 Public, educational, governmental access expense This account shall include all expenses associated with public, educational, and governmental access. ÀÀ 76.1212 Local origination expense. This account shall include all expenses associated with local origination programming. ÀÀ 76.1213 Other basic cable programming expenses. This account shall include all basic cable programming expenses that were not included in Accounts 1209 through 1212. ÀÀ 76.1214 Cable programming service expense. This account shall be used for reporting purposes to summarize Accounts 1215 through 1218. ÀÀ 76.1215 Cable programming service satellite programming expense. This account shall include all expenses associated with procuring satellite programming on the cable programming service tiers. ÀÀ 76.1216 Cable programming service retransmission consent expense. This account shall include all expenses associated with retransmission consent on the cable programming service tiers. ÀÀ 76.1217 Cable programming service local origination expense. This account shall include all expenses associated with local origination programming on the cable programming service tiers. ÀÀ 76.1218 Other cable programming service expense. This account shall include all cable programming service expenses that were not included in Accounts 1215 through 1218. ÀÀ 76.1219 Depreciation and amortization expenses. This account shall summarize for reporting purposes the contents of Accounts 1220 through 1225. ÀÀ 76.1220 Depreciation expense--cable services plant in service. This account shall include the depreciation expense of capitalized costs in Accounts 1139 through 1151, inclusive. ÀÀ 76.1221 Depreciation expense--property held for future cable services use. This account shall include the depreciation expense of capitalized costs included in the Property Held for Future Cable Services Use account. ÀÀ 76.1222 Amortization expense--tangible. This account shall include only the amortization of costs included in the Capital Leases account and the Leasehold Improvements account. ÀÀ 76.1223 Amortization expense--intangible. This account shall include the amortization of costs included in the Intangibles account. ÀÀ 76.1224 Amortization expense--other. (a) This account shall include only the amortization of costs included in the Cable Services Plant Adjustment account. (b) This account shall also include lump-sum write offs of amounts of plant acquisition adjustment. (c) Subsidiary records shall be maintained so as to show that character of the amounts contained in this account. ÀÀ 76.1225 Other property, plant and equipment expenses (a) This account shall include all expenses associated with the following: (1) Property held for future cable use expenses; and (2) Costs incurred in provisioning material and supplies, including office supplies. This includes receiving and stocking, filling requisitions from stock, monitoring and replenishing stock levels, delivery of material, storage, loading or unloading and administering the reuse or refurbishment of material. Also included are adjustments resulting from the annual or more frequent inventory of material and supplies. Credits shall be made to this account for amounts transferred to construction and/or to plant specific operations expense. These costs are to be cleared by adding to the cost of material and supplies a suitable loading charge. ÀÀ 76.1226 Cable system operations expenses. (a) This account shall include the following expenses associated with operating the cable system: (1) The cost of electrical power used to operate the cable system. (2) Costs incurred in testing cable services facilities from a testing facility (test desk or other testing system) to determine the condition of plant on either a routine basis or prior to assignment of the facilities; receiving, recording and analyzing trouble reports; testing to determine the nature and location of reported trouble condition; and dispatching repair persons or otherwise initiating corrective action. (3) Costs incurred in the general administration of plant operations. This includes supervising plant operations; planning, coordinating and monitoring plant operations; and performing staff work such as developing methods and procedures, preparing and conducting training (except on-the-job training) and coordinating safety programs. Credits shall be made to this account for amounts transferred to Construction accounts. These amounts shall be computed on the basis of direct labor hours. (4) Costs incurred in the general engineering of the cable services plant which are not directly chargeable to an undertaking or project. This includes developing input to the fundamental planning process, performing preliminary work or advance planning in connection with potential undertakings, and performing special studies of an engineering nature. Credits shall be made to this account for amounts transferred to Construction accounts. These amounts shall be computed on the basis of direct labor hours. ÀÀ 76.1227 Marketing. (a) This account shall include the following expenses associated with establishing and servicing customer accounts: (1) Costs incurred in performing administrative activities related to marketing products and services. This includes competitive analysis, product and service identification and specification, test market planning, demand forecasting, product life cycle analysis, pricing analysis, and identification and establishment of distribution channels. (2) Costs incurred in selling products and services. This includes determination of individual customer needs, development and presentation of customer proposals, sales order preparation and handling, and preparation of sales records. (3) Costs incurred in developing and implementing promotional strategies to stimulate the purchase of products and services. This excludes nonproduct-related advertising, such as corporate image, stock and bond issue and employment advertisements, which shall be included in the appropriate functional accounts. ÀÀ 76.1228 Customer services. (a) This account shall include costs incurred in establishing and servicing customer accounts. This includes: (1) Initiating customer service orders and records; (2) Maintaining and billing customer accounts; (3) Collecting and investigating customer accounts, including collecting revenues, reporting receipts, administering collection treatment, and handling contacts with customers regarding adjustments of bills; (4) Collecting and reporting pay station receipts; and (5) Instructing customers in the use of products and services. ÀÀ 76.1229 Executive and planning. (a) This account shall include the following expenses: (1) Costs incurred in formulating corporate policy and in providing overall administration and management. Included are the pay, fees and expenses of boards of directors or similar policy boards and all board-designated officers of the company and their office staffs, e.g., secretaries and staff assistants. (2) Costs incurred in developing and evaluating long-term courses of action for the future operations of the company. This includes performing corporate organization and integrated long-range planning, including management studies, options and contingency plans, and economic strategic analysis. ÀÀ 76.1230 General and administrative. (a) This account shall include the following expenses: (1) Costs incurred in providing accounting and financial services. Accounting services include payroll and disbursements, property accounting, capital recovery, regulatory accounting (revenue requirements, settlements and corollary cost accounting), non-customer billing, tax accounting, internal and external auditing, capital and operating budget analysis and control, and general accounting (accounting principles and procedures and journals, ledgers, and financial reports). Financial services include banking operations, cash management, benefit investment fund management (including actuarial services), securities management, debt trust administration, corporate financial planning and analysis, and internal cashier services. (2) Costs incurred in maintaining relations with government, regulators, other companies and the general public. This includes: (i) Reviewing existing or pending legislation; (ii) Preparing and presenting information for regulatory purposes; (iii) Performing public relations and non-product-related corporate image advertising activities; (iv) Administering relations, including negotiating contracts, but excluding sales contracts; and (v) Administering investor relations. (3) Costs incurred in performing personnel administration activities. This includes: (i) Equal Employment Opportunity and Affirmative Action Programs; (ii) Employee data for forecasting, planning and reporting; (ii) General employment services; (iii) Occupational medical services; (iv) Job analysis and salary programs; (v) Labor relations activities; (vi) Personnel development and staffing services, including counseling, career planning, promotion and transfer programs; (vii) Personnel policy development; (viii) Employee communications; (ix) Benefit administration; (x) Employee activity programs; (xi) Employee safety programs; and (xii) Nontechnical training course development and presentation. (4) Expenses incurred in providing information management, including costs associated with planning, developing, testing, implementing and maintaining data bases and application systems for computers. (5) Expenses incurred for the provision of legal services. This includes conducting and coordinating litigation, providing guidance on regulatory and labor matters, preparing, reviewing and filing patents and contracts and interpreting legislation. Also included are court costs, filing fees, and the costs of outside counsel, depositions, transcripts and witnesses. (6) Expenses incurred in procuring material and supplies, including office supplies. This includes analyzing and evaluating suppliers' products, selecting appropriate suppliers, negotiating supply contracts, placing purchase orders, expediting and controlling orders placed for material, developing standards for material purchased and administering vendor or user claims. (7) Expenses incurred in making planned search or critical investigation aimed at discovery of new knowledge. It also includes translating research findings into a plan or design for a new product or process or for a significant improvement to an existing product or process, whether intended for sale or use. This excludes making routine alterations to existing products, processes, and other ongoing operations even though those alterations may represent improvements. (8) Costs incurred in performing other general administrative activities not directly charged to the user, and not provided for in other accounts. This includes providing general reference libraries, food services (e.g., cafeterias, lunch rooms and vending facilities), archives, general security investigation services, operating official private branch exchanges in the conduct of the business, and telecommunications and mail services. Also included are payments in settlement of accident and damage claims, insurance premiums for protection against losses and damages, direct benefit payments to or on behalf of retired and separated employees, accident and sickness disability payments, supplemental payments to employees while in governmental service, death payments, and other miscellaneous costs of a corporate nature. This account excludes the cost of office services, which are to be included in the accounts appropriate for the activities supported. ÀÀ 76.1231 Provision for uncollectible notes receivable. This account shall be charged with amounts concurrently credited to the Notes Receivable account, or to the Notes Receivable Allowance account, when such allowance is maintained. ÀÀ 76.1232 Instructions for Other Income Accounts Structure of Other Income Accounts. The Other Income Accounts are designed to reflect both operating and nonoperating income items including taxes, extraordinary items and other income and expense items not properly included elsewhere. ÀÀ 76.1233 Contents of accounts Other Operating Income and Expense accounts are intended to record the results of transactions, events or circumstances during the periods which are incidental or peripheral to the major or central operations of the company. They shall include all items of an operating nature as incidental work performed for others not provided for elsewhere. Whenever practicable the inflows and outflows associated with a transaction, event or circumstances shall be matched and the results shown as a net gain or loss. ÀÀ 76.1234 Other operating income and expenses. (a) This account shall include the following operating income and expenses: (1) Profits realized from custom work (plant construction) performed for others incident to the company's regulated cable services operations. The records supporting the entries in this account shall be maintained with sufficient particularity to identify separately the revenue and costs associated with each undertaking. (2) A return on investment for the use of regulated property plant and equipment to provide nonregulated products and services. (3) All gains and losses resulting from the exchange of foreign currency. Transaction (realized) gains or losses shall be measured based on the exchange rate in effect on the transaction date. Unrealized gains or losses shall be measured based on the exchange rate in effect at the balance sheet date. (4) Gains or losses resulting from the disposition of land or artworks. (5) Gains or losses resulting from transactions, events or circumstances which are of an operational nature, but occur irregularly or are peripheral to the major or central operations of the company and not provided for elsewhere. ÀÀ 76.1235 Operating taxes. (a) The Operating Tax account shall reflect the taxes arising from the central operations of the company. (b) This account shall be charged and the Unamortized Operating Investment Tax Credits--Net account, shall be credited with investment tax credits generated from qualified expenditures related to regulated operations which the company defers rather than recognizes currently in income. (c) This account shall be credited and the Unamortized Operating Investment Tax Credits - Net account shall be charged ratably with the amortization of each year's investment tax credits included in the Unamortized Operating Investment Tax Credits - Net account for investment services for ratemaking purposes. Such amortization shall be determined in relation to the period of time used for computing book depreciation on the property with respect to which the tax credits relate. (d) This account shall be charged and the Income Taxes--Accrued account, shall be credited for the amount of Federal Income Taxes for the current period. This account shall also reflect subsequent adjustments to amounts previously charged. Taxes should be accrued each month on an estimated basis and adjustments made as later data becomes available. Tax credits, other than investment tax credits, if normalized, shall be recorded consistent with the accounting for investment tax credits and shall be amortized to income as directed by this Commission. No entries shall be made to this account to reflect interperiod tax allocations. (e) This account shall be charged and the Income Taxes-- Accrued account, shall be credited for the amount of state and local income taxes for the current period. This account shall also reflect subsequent adjustments to amounts previously charged. Taxes should be accrued each month on an estimated basis and adjustments made as later data becomes available. No entries shall be made to this account to reflect interperiod tax allocations. (f) This account shall be charged and the Other Taxes--Accrued account, shall be credited for all taxes, other than Federal, state, and local income taxes and payroll related taxes, related to regulated operations applicable to current periods. Among the items includable in this account are property, gross receipts, franchise and capital stock taxes; this account shall also reflect subsequent adjustments to amounts previously charged. (g) Special assessments for street and other improvements and special benefit taxes, such as water taxes and the like, shall be included in the operating expense accounts or investment accounts, as may be appropriate. (h) Discounts allowed for prompt payment of taxes shall be credited to the account to which the taxes are chargeable. (i) Interest on tax assessments which are not paid when due shall be included in the Interest and Related Items account. (j) Taxes paid by the company under tax-free covenants on indebtedness shall be charged to the Nonoperating Income and Expense account. (k) Sales and use taxes shall be accounted for, so far as practicable, as part of the cost of the items to which the taxes relate. (l) Taxes on rented telecommunications plant which are borne by the lessee shall be credited by the owners to the Miscellaneous Revenue account, and shall be charged by the lessee to the appropriate Plant Specific Operations Expense account. ÀÀ 76.1236 Nonoperating income and expense. (a) The nonoperating income and expense accounts are intended to record the results of transactions, events and circumstances affecting the company during a period and which are not operational in nature. They shall include such items as nonoperating taxes, dividend income and interest income. Whenever practicable the inflows and outflows associated with a transaction or event shall be matched and the result shown as a net gain or loss. (b) This account shall include dividends on investments in common and preferred stock, which is the property of the company, whether such stock is owned by the company and held in its treasury, or deposited in trust (except in sinking or other funds, or otherwise controlled. These accounts shall not include dividends or other returns on securities issued or assumed by the company and held by or for it, whether pledged as collateral, or held in its treasury, in special deposits, or in sinking or other funds. Dividends on stocks of other companies held in sinking or other funds shall be credited to the this account. Dividends received and receivable from affiliated companies accounted for on the equity method shall be included in the Investments in Affiliated Companies account, as a reduction of the carrying value of the investments. (c) This account shall include interest on securities, including notes and other evidences of indebtedness, which are the property of the company, whether such securities are owned by the company and held in its treasury, or deposited in trust (except in sinking or other funds, see paragraph (d) to this section) or otherwise controlled. It shall also include interest on bank balances, certificates of deposits, open accounts, and other analogous items. There shall be included in this account for each month the applicable amount requisite to extinguish, during the interval between the date of acquisition and date of maturity, the difference between the purchase price and the par value of securities owned, the income from which is includable in this account. Amounts thus credited or charged shall be concurrently included in the accounts in which the securities are carried. This accounts shall not include interest or other returns on securities issued or assumed by the company and held by or for it, whether pledged as collateral, or held in its treasury, in special deposits, or in sinking or other funds. Cash discounts on bills for material purchased also shall not be included in this account. (d) This account shall include the income accrued on cash, securities issued by other companies, and other assets (not including securities issued or assumed by the company) held in sinking and other funds. There shall be included in this account for each month the applicable amount requisite to extinguish, during the interval between the date of acquisition and the date of maturity, the difference between the purchase price, and the par value of securities held in sinking or other funds. Amounts thus credited or charged shall be concurrently included in the accounts in which the securities are carried. (e) This account shall be credited with such amounts as are charged to the cable services plant accounts for the purpose of recording an allowance for funds used for construction purposes. (f) This account shall include gains or losses resulting from the disposition of gains or losses from the disposition of land or artworks; disposition of plant with traffic; and disposition of nonoperating cable services plant not previously used in the provision of cable services. (g) This account shall include all other items of income and gains or losses, including: (1) Fees collected in connection with the exchange of coupon bonds for registered bonds; (2) Gains or losses realized on the sale of temporary cash investments or marketable equity securities; (3) Uncollectible amounts previously credited to Accounts 7310 through 7350, inclusive; (4) Net unrealized losses on investments in current marketable equity securities; (5) Write-downs or write-offs of the book costs of investment in equity securities due to permanent impairment; (6) Gains or losses of nonoperating nature arising from foreign currency exchange or translation; (7) Gains or losses from the extinguishment of debt made to satisfy sinking fund requirements; (8) Amortization of Goodwill; (9) Company's share of the earnings or losses of affiliated companies accounted for on the equity method; and (10) The net balance of the revenue from and the expenses (including depreciation, amortization and insurance) of property, plant, and equipment, the cost of which is includable in the Nonoperating Plant account. (h) This account shall include the following costs, which are presumed to be excluded from the cost of service in setting rates: (1) Lobbying includes expenditures for the purpose of influencing public opinion with respect to the election or appointment of public officials, referenda, legislation, or ordinances (either with respect to the possible adoption of new referenda, legislation or ordinances, or repeal or modification of existing referenda, legislation or ordinances) or approval, modification, or revocation of franchises, or for the purpose of influencing the decisions of public officials. This also includes advertising, gifts, honoraria, and political contributions. This does not include such expenditures which are directly related to communications with and appearances before regulatory or other governmental bodies in connection with the reporting utility's existing or proposes operations; (2) Contributions for charitable, social or community welfare purposes; (3) Membership fees and dues in social, service and recreational or athletic clubs and organizations; (4) Penalties and fines paid on account of violations of statutes. This account shall also include penalties and fines paid on account of violations of U.S. statutes including judgments arising from a violation of antitrust laws; and (5) Abandoned construction projects. ÀÀ 76.1237 Nonoperating taxes. (a) The Nonoperating Tax accounts shall include taxes arising from activities which are not a part of the central operations of the entity. (b) This account shall be charged and the Unamortized Nonoperating Investment Tax Credits--Net account, shall be credited with investment tax credits generated from qualified expenditures related to other operations which the company has elected to defer rather than recognize currently in income. (c) This account shall be credited and the Unamortized Nonoperating Investment Tax Credits - Net account shall be charged with the amortization of each year's investment tax credits included in such accounts relating to amortization of previously deferred investment tax credits of other property or regulated property, the amortization of which does not serve to reduce costs of service (but the unamortized balance does reduce rate base) for ratemaking purposes. Such amortization shall be determined with reference to the period of time used for computing book depreciation on the property with respect to which the tax credits relate. (d) This account shall be charged and the Income Taxes--Accrued account shall be credited for the amount of nonoperating Federal income taxes for the current period. This account shall also reflect subsequent adjustments to amounts previously charged. Taxes shall be accrued each month on an estimated basis and adjustments made as later data becomes available. Companies that adopt the flow-through method of accounting for investment tax credits shall reduce the calculated provision in this account by the entire amount of the credit realized during the year. Tax credits, other than investment tax credits, if normalized, shall be recorded consistent with the accounting for investment tax credits. No entries shall be made to this account to reflect interperiod tax allocation. (e) This account shall be charged and the Income Taxes--Accrued account should be credited for the amount of state and local income taxes for the current period. This account shall also reflect subsequent adjustments to amounts previously charged. Taxes shall be accrued each month on an estimated basis and adjustments made as later data becomes available. No entries shall be made to this account to reflect interperiod tax allocation. (f) This account shall be charged and the Other Taxes--Accrued account shall be credited for all nonoperating taxes, other than Federal, state and local income taxes, and payroll related taxes for the current period. Among the items includable in this account are property, gross receipts, franchise and capital stock taxes. This account shall also reflect subsequent adjustments to amounts previously charged. ÀÀ 76.1238 Interest and related items. (a) This account shall include the current accruals of interest on all classes of debt the principal of which is includable in the Funded Debt account. It shall also include the interest on funded debt the maturity of which has been extended by specific agreement. It shall not include charges for interest on funded debt issued or assumed by the company and held by or for it, whether pledged as collateral or held in its treasury, in special deposits or in sinking or other funds. Interest expressly provided for and included in the face amount of securities issued shall be charged at the time of issuance to the Other Prepayments accounts and cleared to this account as the term expires to which the interest applies. This account shall also include monthly amortization of balances in the Premium on Long-Term Debt account and the Discount on Long-Term Debt account. (b) This account shall include the interest portion of each capital lease payment. (c) This account shall include the monthly amortization of the balances in the Unamortized Debt Issuance Expense account. (d) This account shall include all interest deductions not provided for elsewhere, including: (1) Advances from affiliated companies; (2) Advances from nonaffiliated companies and other liabilities (3) Assessments for public improvements past due; (4) Bond coupons, matured and unpaid; (5) Claims and judgments; (6) Customers' deposits; (7) Funded debt mature, with respect to which a definite agreement as to extension has not been made; (8) Notes payable on demand or maturing one year or less from date of issue; (9) Open accounts; (10) Tax assessments, past due; and (11) Discount, premium, and issuance expense of notes maturing one year or less from date of issue. ÀÀ 76.1239 Extraordinary items. (a) This accounts is intended to segregate the effects of events or transactions that are extraordinary. Extraordinary events and transactions are distinguished by both their unusual nature and by the infrequency of their occurrence, taking into account the environment in which the company operates. This accounts shall also include the related income tax effect of the extraordinary items. (b) This account shall be credited with nontypical, noncustomary and infrequently recurring gains which would significantly distort the current year's income computed before such extraordinary items, if reported other than as extraordinary items. (c) This account shall be debited with nontypical, noncustomary and infrequently recurring losses which would significantly distort the current year's income computed before such extraordinary items, if reported other than as extraordinary items. (d) This account shall be charged or credited and the Income Taxes-- Accrued account shall be credited or charged for all current income tax effects (Federal, state and local) of items included in subsection (b) and (c) of this section (e) This account shall be charged or credited, as appropriate, with a contra amount recorded to the Net Noncurrent Deferred Nonoperating Income Taxes account or the Net Current Deferred Nonoperating Income Taxes account for the income tax effects (Federal, state and local) of items included in subsection (b) and (c) of this section that have been deferred. ÀÀ 76.1240 Nonregulated net income. (a) This account shall be used by those companies who offer nonregulated activities that do not involve the joint or common use of assets or resources used in the provision of both regulated and nonregulated products and services, and which have not established a separate subsidiary for that purpose. (b) All revenue and expenses (including taxes) incurred in these nonregulated activities shall be recorded on separate books of account for such operations. ÀÀ 76.1241 Glossary of terms. When used in this system of accounts: "Account" means a specific element of a chart of accounts used to record, classify and accumulate similar financial transactions resulting from the operations of the entity. "Accounts" or "these accounts" refer to the accounts of this system of accounts. "Accounting System" means the total set of interrelated principles, rules, requirements, definitions, accounts, records, procedures and mechanisms necessary to operate and evaluate the entity from a financial perspective. An accounting system generally consists of a chart of accounts, various parallel subsystems and subsidiary records. An accounting system is utilized to provide the necessary financial information to users to meet judiciary and other responsibilities. "Affiliated companies" means companies that directly or indirectly through one or more intermediaries, control or are controlled by, or are under common control with, the accounting company. See also Control. "Amortization" means the systematic recoveries, through ratable charges to expense, of the cost of assets. "Associated equipment" means that equipment which functions with a specific type of plant or with two (2) or more types of plant, e.g., switching equipment, network power equipment, circuit equipment, common channel network signaling equipment or network operations equipment. Associated equipment shall be classified to the account appropriate for the type of equipment with which it is predominately used rather than on its own characteristics. "Book cost" means the amount at which property is recorded in these accounts, without deduction of related allowances. "Company" or "the company" when not otherwise indicated in the context, means the accounting entity. "Control" (including the terms "controlling," "controlled by," and "under common control with") means the possession directly or indirectly, of the power to direct or cause the direction of the management and policies of a company, whether such power is exercised through one or more intermediary companies, or alone, or in conjunction with, or pursuant to an agreement with, one or more other companies, and whether such power is established through a majority or minority ownership voting of securities, common directors, officers, or stockholders, voting trusts, holding trusts affiliated companies, contract, or any other direct or indirect means. "Cost," except as applied to cable services plants, franchises, and patent rights, means the amount of money actually paid (or the current moneyvalue of any consideration other than money exchanged) for property or services. See also Original Cost. "Cost of removal" means the cost of demolishing, dismantling, removing, tearing down, of otherwise disposing of cable services plant and recovering the salvage, including the cost of transportation and handling incident thereto. "Depreciation" means the loss not restored by current maintenance, incurred in connection with the consumption or prospective retirement of cable services plant in the course of service from causes which are known to be in current operation, against which the company is not protected by insurance, and the effect of which can be forecast with a reasonable approach to accuracy. Among the causes to be given consideration are wear and tear, decay, action of the elements, inadequacy, obsolescence, changes in technology, changes in demand and requirements of public authorities. "Intangible property" means assets that have no physical existence but instead have value because of the rights which ownership confers. "Minor items," as applied to depreciable cable services plant, means any part or element of such plant, which when removed, (with or without replacement) does not initiate retirement accounting. "Original cost" or "cost," as applied to cable services plant, rights of way and other intangible property, means the actual money cost of (or the current money value of any consideration other than money exchanged for) property at the time when it was first dedicated to use by a cable operator, whether the accounting company or by predecessors. For the application of this definition to property acquired from predecessors see ÀÀ 76.1600(b)(1). Note also the definition of Cost in this section. "Plant retired" means plant which has been removed, sold, abandoned, destroyed, or otherwise withdrawn from service. "Retirement units," as applied to depreciable cable services plant, means those items of plant which when removed (with or without replacement) cause the initiation of retirement accounting entries. "Salvage value" means the amount received for property retired, if sold, or if retained for reuse, the amount at which the material recovered is chargeable to the Material and Supplies account or other appropriate account. "Subsidiary record" means accumulation of detailed information which is required by this Commission to be maintained in support of entries to the accounts. "Subsidiary record categories" means those segregations of certain regulated costs, expenses and revenues which must be maintained and are subject to specific reporting requirements of this Commission. "Subsystems, parallel mechanisms" means processes or procedures which augment the use of a chart of accounts in the financial operation of the entity. These subsystems operate on and/or process account and subsidiary record information for specific purposes. "Time of installation" means the date at which cable services plant is placed in service. "Time of retirement" means the date at which cable services plant is retired from service. "Tangible property" means assets characterized by physical existence, such as land, buildings, equipment, furniture, fixtures and tools. Attachment D Cost of Equity Analysis 1. Commenters submit studies by four experts. CATA presents a capital asset pricing model (CAPM) study analyzing cable surrogates and cable companies prepared by Peter K. Pitsch (Pitsch). Cablevision Industries also submits a CAPM study prepared by the Brattle Group (Brattle). Bell Atlantic submits a discounted cash flow (DCF) analysis of the S&P 400 as a cable surrogate prepared by James H. Vander Weide (Vander Weide). Comcast and COA submit a comparable earnings study prepared by AUS Consultants (AUS). A. Cost of Equity Approaches 2. Risk premium analysis. Risk premium analyses estimate the cost of equity by adding a risk premium to the yield on alternative relatively risk-free investments such as bonds. The risk premium is usually based on a comparison of historic realized returns on stocks and bonds. The current yield on a bond provides an easily determined reference point for current investor expectations on inflation and the general state of the economy. 3. The parties submitting risk premium analyses relied upon the CAPM variant of this methodology. CAPM uses a general risk premium, based on the differences in return on a risk-free investment and a diversified portfolio of risk-bearing investments, and adjusts it for the target stock's variance in return relative to that of a diversified portfolio. This adjustment is performed through the following formula: COE = RF + (beta * RP), where COE is the cost of equity estimate, RF is the current yield on risk-free investment, RP is the risk premium that compensates for the difference in the risk of a diversified, risk- bearing portfolio and a risk-free investment, and beta is a measure of a stock's unavoidable variance in return (i.e., non-diversifiable risk). 4. The CAPM beta is based on the widely accepted tenet of finance theory that investors require compensation only for risk (that is, variance in return) that cannot be avoided by holding a diversified investment portfolio. This risk (beta) is often estimated by comparing past variations in the return on the stock and on the stockmarket overall. A CAPM analysis of a portfolio containing all possible investments would produce a beta of one. The S&P 400 is generally assumed to have a beta of one. 5. In a previous proceeding we recognized CAPM's potential as a methodology for estimating the cost of capital. However, we found problems in that proceeding -- unrealistic risk premiums and betas -- that precluded our acceptance of CAPM analyses at that time. 6. DCF Analysis. The Commission has relied upon the DCF method extensively in the past. This was the underlying method proposed in the Notice. The DCF methodology employs dividend and stock price data to estimate the return on equity needed to satisfy investor risk expectations. It does so based on the following equation: Ke = D/P + G, where Ke = the DCF estimate of the cost of equity, D = the expected annual common stock dividend, P = the current price of a share of common stock, and G = the estimated long-term growth rate of earnings. 7. D/P, or the current yield, is estimated by dividing the projected dividend for the next year by the current common stock price. Long-term growth is based on analysis of published estimates of growth such as are available to investors. In the Notice, we cautioned that applying the DCF method to companies with no current dividends requires careful attention from the analyst to ensure a creditable estimate. In practice, most S&P 400 companies provide investors with a mixture of dividends and capital gains (reflecting reinvested earnings). 8. Comparable Earnings Analysis. The comparable earnings method looks at the ratio of reported earnings to the book value of equity for a group of comparable companies. This method assumes either that the earnings of comparable companies equals the regulated company's cost of capital, or, alternatively, that fairness would allow regulated and nonregulated companies the same risk-adjusted rate of return. The main criticisms of this method are that there is no way to determine whether the comparable companies' earned returns are higher or lower than the regulated company's cost of capital, and that an accounting measure of return is generally not the same as the return realized by stockholders. By contrast, the previous two methods are more market-oriented and take into account both earnings and capital gains. B. Cost of Equity Studies 1. Summaries 9. Pitsch (CATA). CATA's consultant, Pitsch, offers three analyses. The first provides CAPM estimates of the cost of equity for two cable companies, four companies with mixed cable and other operations, and the seven Regional Bell Holding Companies (RHCs). Using Value Line betas, risk premiums of 6.9% and 7.5%, and a risk-free rate of 5.8%, the estimates are 15.8% to 18.2% for the two cable companies, 12.4% to 17.8% for the mixed cable companies, and 11.3% to 12.6% for the telephone companies. Pitsch concludes that this analysis supports a cost of equity for cable companies of between 16% and 18%. 10. The second Pitsch analysis adds a 6% "risk premium" to the May 1993 yields on bonds of seven cable operators, seven companies with mixed cable and other operations, and the seven RHCs. The three distinct bond yields reported for the cable and mixed cable companies produce equity estimates of 14.1%, 14.8% and 16.6%. Estimates for the RHCs are 13.6%, 14.1%, and 14.2%. Pitsch concludes that this analysis supports an equity range of 15% to 17%. 11. The third Pitsch analysis applies CAPM to the S&P 400 (assumed beta of 1.0), to a hypothetical stock with a beta of 1.5, and to TCI's stock with a 1993 beta of 1.65. Pitsch calculates a risk premium of 5%, which reflects the risk differential between the lowest two quartiles of S&P 400 DCF cost of equity estimates and "Aa" rated utility bond yields, plus a 1.7% risk differential between bonds and U.S. Treasury bills. Using betas of 1.0, 1.5 and 1.65, and a risk-free rate of 5.8%, Pitsch reports cost of equity estimates of 12.5%, 16%, and 17%, respectively. 12. Pitsch concludes that his analyses produce estimates of the cost of equity of 18%, 16%, and 17%. He recommends that the cost of equity be set at 18%. 13. Brattle (Cablevision Industries). Brattle estimates a cable risk premium add-on to any S&P 400 overall cost of capital estimate. Brattle calculates betas for eleven stocks issued by seven cable operators. The betas range from 0.84 to 2.41. The average beta for 1993 is 1.74. Brattle adopts a CAPM risk premium of 8.2%, stating that this number is supported by considerable evidence. Most of Brattle's analysis attempts to adjust for the capital structure differences between S&P 400 and cable companies. Brattle assumes a "debt beta" of 0.25 for the S&P 400 and 0.5 for the cable industry, based on a calculation that divides yield differences between various grades of long- term bonds and short-term United States Treasury bills by the 8.2%. 14. Brattle attempts to create "unlevered betas" by averaging cable stock betas and the cable "debt beta," weighted by the market value of cable equity and the book value of cable debt. Brattle then "relevers" by averaging the "unlevered betas" and the S&P 400 "debt beta," weighted by an assumed 50% debt/50% capital structure for the S&P 400. Brattle's incremental risk premium is the difference between the average relevered cable beta (1.55) and the average S&P 400 beta (1.0), multiplied by its assumed risk premium, and adjusted by the assumed S&P 400 debt/equity ratio. Brattle does not provide an estimate of the cost of equity. 15. Vander Weide (Bell Atlantic). James H. Vander Weide rejects estimating the cost of capital from cable industry data, maintaining that most cable companies are either closely held, widely diversified, or pay no dividends. To identify a surrogate group with overall risks similar to cable, he considers separately the business and financial risks of cable. He quotes Creditweek: Industry risk remains low, relative to the average industrial company, due to the stability of service demand, continuing subscriber growth, and the predictability of cash-flow generation. Through the recession and slow recovery, a period of low consumer confidence, demand for cable TV service has increased. Vander Weide argues that cable has very low business risk due to its "stability of service demand" resulting from most communities granting a franchise to one company; "continuing subscriber growth" resulting from innovations in cable capacity; and "predictability of cash flow generation" resulting from high market penetration, recession resistance, and low post- construction maintenance costs. Looking at business risk alone, he maintains that cable would be less risky than local telephone companies because cable still faces no multichannel competitor in its local markets. 16. Turning to the financial risk, Vander Weide states that this low business risk is partially offset by cable's reliance on debt financing. He quotes from Creditweek: Easy availability of debt financing through bank borrowings and high-yield debt markets enabled cable operators to acquire smaller players in a market characterized by rising cable system prices and cash flow multiples. Rising asset values and the liquidity of this market gave lenders confidence that, should borrowers experience financial difficulties, a few properties could be sold at a premium to pay down debt. He notes that the combination of easy debt financing and start-up losses have left many cable operators with negative net worth on their books (i.e., with capital structures showing debt exceeding total assets). 17. Based on the cable industry's current high financial risk, Vander Weide recommends that the third quartile of the S&P 400 be used as the surrogate for the cable industry's cost of equity capital. He maintains that the third quartile S&P 400 companies have significantly more business risk than the average cable operator, but that the S&P companies also finance their operations with significantly more equity. Based on business risk alone, however, he would recommend the first quartile of the S&P 400 as the equity return surrogate for cable. 18. Vander Weide estimates the current cost of equity capital for the companies composing the S&P 400 using the DCF method the Commission has applied to the telephone industry. The lowest quartile of the S&P 400, ranked by estimate, has an average cost of equity of 11.80%; the third quartile has an average cost of equity of 15.11%. For the S&P 400 overall, the average cost of equity is 14.58%. 19. In its reply, Comcast attempts to rebut Vander Weide through an analysis prepared by George R. Schink. Schink contends that Vander Weide is incorrect in asserting that cable is less risky than telephone and that cable and telephone are converging. Schink argues that comparisons of size, financial leverage, profits, financial ratios, and stock betas show less risks for the RHCs than for the three assertedly "pure play" cable operators (Cablevision Systems, Comcast, and TCI). Schink asserts that two small independent telephone companies earned higher returns than the RHCs and, thus, that smaller companies have higher costs of equity capital. Schink further contends that smaller telephone operating units earned higher returns in 1991, that cable franchises are smaller than telephone operating companies, and, thus, that cable has a higher cost of capital than telephone. He asserts that the average cable system has 5,026 subscribers, and that the smallest telephone operating unit for which he had data had 7,940 access lines and a return on equity of 20.2% in 1991. 20. AUS (Comcast and COA). AUS prepared a study that was submitted by Comcast and COA with their comments in this proceeding. AUS proposes four groups of firms it believes are comparable to cable, and estimates the cost of capital based on historic and future earnings. 21. The first group consists of seventy S&P industrial companies selected from within the S&P 400 using two criteria that AUS derived from Value Line data on five cable companies for which it publishes data. The first criterion screens out companies having betas more than three standard deviations from the 1.41 average of the five cable betas (0.98 - 1.84). The second criterion screens out companies that do not have the large avoidable risks of the cable companies over the past five years. 22. AUS's remaining three comparable groups consist of firms that AUS asserts compete with cable. AUS's telecommunications group includes the seven RHCs and the five largest independent telephone companies. AUS's broadcast group includes all five Value Line broadcasting companies. AUS's preferred recreation group includes all Value Line movie, local leisure, and vacation/resort service companies. 23. AUS estimates the cost of equity using the Value Line 5-year historic returns on net worth and the Value Line 3-year projected returns. These returns range from 12.5% to 21.1%. AUS subdivides each of its groups into preferred and alternative groups. For AUS's preferred groups, historic and forecast returns average 14.6% and 17.4%, respectively. Based on a table referenced by AUS, the recommended equity return appears to be centered on 16%, with upper and lower bounds of 17.3% and 14.7%. 2. Analysis 24. CAPM Estimates. Brattle, Pitsch, and Economist, Inc. all rely heavily on CAPM and estimates of beta for a small number of cable companies: Adelphia, Cablevision Systems, Century, Comcast, Jones, TCA, and TCI. These analysts all implicitly assume that these betas represent an accurate indicator of the risks associated with the provision of regulated cable service. Based on the record before us, we do not find this implicit assumption to be valid. 25. CAPM assumes a competitive market in which no single investor can affect the price of a stock through his or her buying or selling. It is not clear that any of the analyzed cable stock issues meet that assumption: Adelphia's Class A stock (carries 1 vote and the right to elect 1 director) has 74 holders of record, including officers and key employees. Adelphia's Class B stock (10 votes and the right to elect remaining directors) is held by 7 people, primarily by Rigas family members. Brattle reports Adelphia's stock beta was 1.98 in 1993. Cablevision is controlled by a single shareholder, and insiders own 19% of Class A and 55% of Class B shares. Brattle reports a beta of 1.86. Comcast insiders own 20% and control 80% of its stock. Brattle reports Comcast's Class A common stock beta has risen from approximately 1 between 1987 and 1989 to 1.56 in 1993. Glenn R. Jones owns 89% of Jones Spacelink has its Class A and 100% of its Class B stock owned by . Jones Intercable has 58% of the common stock owned by Glenn R. Jones. Brattle reports 1993 betas of 1.48 for Jones Intercable, 1.93 for Jones Intercable Class A, and 2.41 for Jones Spacelink. TCI insiders control 8.55% of Class A and 68.3% of Class B (carries right to 10 votes) stock. Brattle reports TCI's Class B stock beta rose from 1.05 in 1987 to 1.35, and that the Class A beta rose from 1.35 to 1.74 in the same period. 26. The Value Line reports cited above also list a constant stream of insider decisions to buy, sell, or exercise options. Insider decisions regarding closely-held stock introduce speculative risks for other investors that magnify the underlying business and financial risks of the companies. We believe that betas incorporating these insider decisions overstate the risks of supplying equity capital for regulated cable service. 27. The CAPM presentations all rely on the stock performance of the cable companies over the last five years to estimate beta. The history of the cable industry over the last five years is replete with unique events, not the least of which was the ultimate passage of legislation regulating the industry. By relying on historic betas, these analysts have chosen data that incorporate speculative risks that bear no relationship to the future risks of regulated cable service. Further, we believe that most volatile component investor risk and return expectations for cable services has been the exercise of monopoly market power. Thus, even if the historic beta could be adjusted to provide an accurate estimator of cable, it would still require an additional, downward adjustment for the monopoly profit component of investor expectations. It seems improbable that investor expectations of the risks associated with cable company stocks are accurately portrayed by the mechanical application of the beta formula. In these circumstances, we must conclude that the Brattle and Pitsch analyses fail to measure accurately the cost of equity for regulated cable service. While it is conceivable that those analyses could be reformed to make CAPM a useful tool for determining that cost of equity, the parties have not attempted to analyze what a forward-looking beta might be, nor have they provided the information that would allow us to perform our own analysis. 28. DCF Estimates. This Commission and other agencies have relied upon DCF analyses on numerous occasions to estimate the cost of equity. Most recently, in the 1990 Telco Represcription Order, we used DCF cost of equity estimates for the S&P 400 as a benchmark in establishing a reasonable zone for the cost of equity for LEC interstate access service. We examined criticisms of that method presented by parties that urged higher costs of equity than that indicated by the DCF method. We applied that method to the RHCs, a large group of public utilities, and to the S&P 400. Although we gave the greatest weight to the DCF cost of equity estimates for the RHCs, we gave significant weight to DCF cost of equity estimates for the S&P 400 as a source of benchmarks to determine investor required returns. Vander Weide also relies on DCF cost of equity estimates for the S&P 400. 29. The D.C. Circuit affirmed the 1990 Telco Represcription Order on review. The Court determined that we had acted reasonably in relying on the DCF method. The Court also noted that "[f]inding unregulated companies of comparable risk is an extremely tricky process" and implicitly approved our reliance on DCF cost of equity estimates for the S&P 400. 30. Comparable Group Estimates. AUS's first analysis of proposed comparable firms is its group of seventy industrial companies screened from the S&P 400 using two CAPM concepts, unavoidable risk (as measured by beta) and avoidable risk. The beta screen covers a broad range (0.98 to 1.84) and mainly excludes below-average risk companies. This screen is consistent with the CAPM tenet that unavoidable risk is a key risk factor for investors. AUS used this screen to reflect the historically high betas of a small group of cable stocks. As we have stated, these betas overstate the risks of supplying equity capital for regulated cable service. 31. The avoidable risk screen requires that companies have avoidable risk similar to that of cable companies. AUS used this screen despite CAPM's rejection of avoidable risk as a factor in investor risk calculations since it is readily eliminated by portfolio diversification. AUS offers no rationale for using this screen. Because we perceive no basis for assuming that this screen is a valid method of selecting comparable firms, we decline to rely on this AUS analysis. 32. Further, a key test of a comparable group analysis is whether the selected companies appear to form a roughly homogeneous group with characteristics generally comparable to the target service. The AUS industrial group contains many companies that are neither obviously parallel to cable service nor seemingly similar to each other -- e.g., Avon, Bethlehem Steel, Mattel, and Intel. This lack of comparability confirms the inadequacy of AUS's screens. 33. AUS's remaining three groups consist of companies that assertedly compete with cable. AUS provides no basis for believing that investors see these companies as having the same risks as cable. AUS's preferred recreation group does not seem to be comparable to a regulated monopoly providing cable service. This group includes movie producers (Paramount and Disney), vacation resort operators (Club Med and Carnival Cruise), and a video game producer (Electronic Arts). It also includes companies with unusually high historic and projected returns. (Cedar Fair has 60% historic and projected annual returns; Avon has 55% and 46% historic and projected returns; and King World, which appears in this group and in the industrial group, had a one-year return exceeding 117%.) We find no basis for concluding that these groups' earnings approximate the cost of equity for regulated cable service, or that fairness requires that we allow regulated cable service returns of this magnitude. February 22, 1994 SEPARATE STATEMENT OF COMMISSIONER ANDREW C. BARRETT RE: Implementation of the Cable Television Consumer Protection and Competition Act of 1992 -- Rate Regulation (Fourth Order on Reconsideration, Fourth Report and Order) With today's actions, the Commission revises its cable rate regulations by modifying the benchmark methodology, which serves as the primary approach for regulating cable service rates. In a separate rulemaking, the Commission establishes requirements to govern cost-of-service showings to justify rates above the levels determined by the benchmark approach. The Commission's decision affirms a benchmark methodology and establishes a new competitive differential at 17% relative to September 1992 rate levels to guide rate reductions. Accordingly, the revised rules will require systems to reduce rates by 17% from their September 1992 level, or to the new benchmark, whichever is less. Once systems make their necessary reductions to comply with the new benchmark mechanism, they are permitted to add external costs and to apply a "going forward" adjustments for additional channels or system upgrades. Systems that have reduced rates by 17% (i.e., a prior 10% adjustment under the old benchmark and an additional 7% under the new benchmark), also may make adjustments for inflation. In addition, these revised rules will initiate cost studies to verify cost differences among cable operators in comparison to the competitive differential. Systems that are required to reduce their rate by an amount less than the full 17% competitive differential -- as well as systems with rates below the new benchmark level that are not required to make any immediate reductions -- will be required to engage in future rate actions in accord with the results of the cost studies. As further elements of the cable rate regulation package, the Commission establishes (1) a mechanism to allow "going forward" adjustments for additional channels and system upgrades, and (2) a standard for targeted rate relief, as well as provisions for administrative relief, to small operators. During this proceeding, I have consistently stated that the Commission must implement rate regulations in an orderly and effective manner in order to maintain the integrity of our regulatory process, to avoid creating potential unintended consequences, and to minimize false expectations among the consumer public. I have also stated that the Commission's rate regulation mechanisms must (1) incorporate measures of flexibility in order to balance the concerns of the industry, consumers, and franchising authorities, and (2) minimize the uncertainty that has resulted from the cable rate regulation proceeding so that consumers and the industry may develop realistic expectations and business plans, respectively. I write separately today in order to emphasize that my decision to support this rate regulation package is based on the measure of flexibility built into a benchmark system of regulation, including several of the "going forward" and "cost-of-service" components. Given the lack of complete information on pricing and costs, and our relatively limited sample for competitive and noncompetitive pricing behavior, I believe that a revised benchmark approach exercises the necessary caution in recognizing the variety of cost structures and pricing practices throughout the cable industry. During the reconsideration process, the Commission has revised the benchmarks by correcting the data on competitive and noncompetitive systems as well as refining the statistical procedure for estimating the benchmarks. Therefore, I believe that the benchmark information, although arguably subject to certain shortcomings detailed in this proceeding's record, now forms a better foundation for other components of the rate regulation package, especially the "going forward" allowances for channel additions and upgrades. Next, I believe that the other components in this rate regulation package -- including the "going forward" methodology, the presumptions established to guide decisions regarding "a la carte" practices, and the provisions for a measure of small system relief -- will provide necessary flexibility to allow operators to begin to develop future business plans and to add new programming services. With respect to the "going forward" mechanism, I believe that the allowance for actual programming costs may help to avoid unintended consequences for program services as a result of the revised rate regulations. The opportunity for a streamlined cost-of- service showing also will allow operators to account for new services through upgrades of their systems. In addition, I support today's effort to distinguish legitimate "a la carte" marketing practices for programming services from those practices that could constitute evasions of the Commission's rate regulations. In this regard, I believe that the presumptions regarding "a la carte" practices will enable the Commission to identify legitimate package offerings that increase realistic consumer choices and provide for a reasonable number of programming services at favorable rates. Finally, the Commission has provided for a measure of rate relief for small operators, which will allow certain small operators to make external cost and "going forward" adjustments to rates regardless of where the rates of these systems fall relative to the benchmark. Nonetheless, I remain concerned that some small operators may find that further relief is necessary in order to avoid particular hardship, and I emphasize that the provision for additional hardship relief to certain small operators, as well as the streamlined cost-of-service mechanism, will become important recourse for small operators in such dire situations. The revised rules also will initiate a cost study to verify cost differences among cable operators in comparison to the competitive differential. I believe that this study will provide important information to guide the Commission's analysis of the differences among competitive and noncompetitive operators, as well as the operating distinctions that may exist among small, medium and large operators. I also believe that this detailed cost information will enable the Commission to evaluate the validity of many policy assumptions that have guided our efforts in this proceeding, and therefore, will help to identify whether further adjustments are necessary to these refined rate regulations. As a result, I believe that it is appropriate to postpone rate actions as applied to certain systems, especially to small systems and those systems with rates below the new benchmark level, and to base future rate actions for those systems upon the differential, if any, identified by results of the cost study. I especially am interested in the cable industry's full participation in this cost study in order to resolve a notable void in this proceeding's record. As a consequence, I believe that these studies must be completed as soon as possible before the end of 1994 in order to promote the certainty that will enable all operators to develop future business plans. Based upon my own analysis, I believe that the new competitive differential of 17% as compared to the September 1992 rate levels represents the highest point of what I consider to be an acceptable range for this policy determination. I have previously asked questions regarding the proper procedure for calculating the differential between competitive and noncompetitive rates, especially concerning the effect of the statistical treatment for low penetration and municipal systems on the differential. I am aware that the Commission's revised data and statistical procedures provide analytical support for a 17% differential by focusing primarily on the differences between noncompetitive systems and overbuild systems, while retaining a measured consideration of the low penetration and municipal systems in the competitive sample. Nonetheless, I remain concerned that a more cautious approach for developing a competitive differential would reflect the limited confidence that results from a relatively small sample size and a lack of cost data. Furthermore, I consistently have emphasized the need to consider the effect of the cable rate regulations on industry investment. The freeze on cable revenues and the implementation of the benchmark mechanism have had a negative impact on the cable industry's revenues and kept rates from rising. For example, a recent study states that these actions "have already precipitated more than an estimated $2 billion direct loss of revenues and cash flow," while also citing "the complete foreclosure of growth avenues for cable TV programmers." Therefore, I am concerned about the potential effects of the 17% competitive differential relative to the September 1992 rate level. However, I also believe that the entire cable rate regulation package, including our cost-of-service and "going forward" options, incorporates important elements of flexibility that will allow operators to adjust to the 17% differential, where necessary. For example, all systems are permitted to adjust rates for external costs and "going forward" factors. Systems above the benchmark, which are required to reduce their rates by the full competitive differential, are permitted to make adjustments for inflation as accrued between September 1992 and September 1993. Additionally, I believe that the benefits of the"going forward" mechanism for many operators will occur through the streamlined cost-of-service process, which will be subject to further comments and refinements. Given that this process will affect the incentives for operators to invest toward future system developments and the carriage of new programming services, I am concerned that this streamlined cost showing serve as an important bridge between the benchmark mechanism and the requirements for a full cost-of service showing. The streamlined cost-of- service process will play a critical role within the rate regulation framework, especially through provisions for an incentive-based plan for upgrades and the opportunities to demonstrate separate allocations for improvements to existing regulated services. With respect to the cost-of-service proceeding, I support various aspects of the Order that grant flexibility to operators with unique cost-based circumstances that justify rates above the new permitted benchmark level. Furthermore, the cost-of-service process includes a rate-of-return factor of 11.25% that is reasonable as compared to other regulated industries, especially after tax considerations are included. I believe that necessary flexibility in the cost-of-service process also occurs through the cost allocation mechanism, the procedure for determining the portion of excess acquisition costs that operators may recover, as well as the provisions for treatment of Subchapter S corporations. As a result, I believe that the range of factors considered in the cost-of-service process, including the option for hardship showing, will begin to mitigate some of the consequences for cable operators who may endure the most significant changes as a result of the new 17% competitive differential. Finally, I believe that this decision must be viewed in light of the overall package of elements that affect the rate calculations as well as the rate adjustments and cost showings that will be allowed. Therefore, I encourage the industry to await the release of all final orders before assessing the effects of these decisions on their particular markets. In the end, my goal is to ensure that our decisions in this area are balanced and will permit continued investment to enhance services to the public. These rulemakings on cable rate regulation have involved extremely complex analysis, and I acknowledge the outstanding dedication shown by our Commission staff, my colleagues, and their respective staffs.