[Federal Register Volume 59, Number 73 (Friday, April 15, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-9078]


[[Page Unknown]]

[Federal Register: April 15, 1994]


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FEDERAL COMMUNICATIONS COMMISSION
47 CFR Part 76

[MM Docket No. 93-215, CS Docket No. 94-28; FCC 94-39]

 

Cable Television Act of 1992

AGENCY: Federal Communications Commission.

ACTION: Final rule.

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SUMMARY: The Commission has adopted a Report and Order and a Further 
Notice of Proposed Rulemaking establishing rules to implement the cost 
of service alternative to the primary benchmark/price cap approach to 
setting regulated cable service rates. The Further Notice of Proposed 
Rulemaking (FNPRM) segment may be found elsewhere in this Federal 
Register. The Report and Order sets forth regulatory requirements to 
govern cost-of-service showings for cable operators who elect to 
justify rates above levels determined under benchmark/price cap 
requirements. The Report and Order, summarized here, adopts a 
regulatory model based on the cost-of-service formulation that permits 
cable operators to recover reasonable operating expenses and a fair 
return on investment, while protecting consumers from unreasonably high 
rates. Although the Report and Order adopts requirements designed to be 
consistent with the Commission's telephone ratebase/rate of return 
formula, the requirements are simpler and easier to administer than the 
telephone model and can accommodate individual case review. The Report 
and Order establishes (1) procedural and filing requirements for cost-
of-service showings; (2) rules for determining the cable operator's 
ratebase; (3) rules for determining the appropriate level of 
recoverable expenses; (4) an interim overall return of 11.25% on 
ratebase; (5) accounting and cost allocation requirements; (6) 
accounting and cost allocation requirements for external cost 
treatment; (7) requirements for affiliated transactions; (8) 
streamlined filing requirements for small systems; (9) streamlined 
filing requirements for network upgrades; (10) procedures for emergency 
rate review based on a showing of special circumstances; and (11) an 
experimental Upgrade Incentive Plan.

EFFECTIVE DATE: May 15, 1994.

FOR FURTHER INFORMATION CONTACT:
JoAnn Lucanik (202) 416-1163; Paul D'Ari (202) 416-1166; John Adams 
(202) 416-1165.

SUPPLEMENTARY INFORMATION: The text of this document is available for 
inspection and copying during normal business hours in the FCC 
Reference Center (Room 239), 1919 M Street, NW., Washington, DC 20554, 
and may be purchased from the Commission's copy contractor, 
International Transcription Service, (202) 857-3800, 2100 M Street, 
NW., Washington, DC 20037.

Synopsis of the Report and Order

    The Commission began its implementation of the 1992 Cable Act with 
an initial Notice of Proposed Rulemaking (Notice of Proposed Rulemaking 
in CC Docket No. 93-215, FCC 93-353, 58 FR 40762, released July 30, 
1993), and established initial rules to implement the Cable Act of 1992 
in the Rate Order.\1\ The Commission adopted a benchmark and price cap 
approach to serve as the primary regulatory mechanism for setting 
initial regulated rates and for governing rates on a going forward 
basis. The Commission also concluded in the Rate Order that the 
benchmark/price cap framework might not produce fully compensatory 
rates in all cases, and accordingly decided to permit cable systems to 
establish rates based on costs pursuant to individual cost-of-service 
showings. The cost-of-service approach was to serve as a backup to the 
benchmark/price cap mechanism which a cable operator could invoke if it 
believed that the maximum rate under the benchmark/price cap formula 
would not enable the operator to recover costs that it reasonably 
incurred in the provision of regulated cable services.
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    \1\Implementation of Sections of the Cable Television Consumer 
Protection and Competition Act of 1992, Rate Regulation, Notice of 
Proposed Rulemaking in MM Docket No. 92-266, 58 FR 48, released 
January 4, 1993; (NPRM); Report and Order and Further Notice of 
Proposed Rulemaking, 58 FR 29736, released May 21, 1993 (Rate 
Order); Second Further Notice of Proposed Rulemaking in MM Docket 
No. 92-266, 58 FR 41042, released August 18, 1993 (Second Notice); 
First Reconsideration Order, Second Report and Order, and Third 
Further Notice of Proposed Rulemaking in MM Docket No. 92-266, 58 FR 
4678, released Sept. 29, 1993 (First Rates Reconsideration); Third 
Report and Order in MM Docket No. 92-266, 58 FR 60141, released 
November 15, 1993.
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    The Rate Order concluded that the use of the benchmark/price cap 
approach as the primary regulatory mechanism, and the use of a cost-of-
service safety valve as a supplemental mechanism, for regulating cable 
services is fully consistent with the applicable statutory 
requirements. However, the record in MM Docket 92-266 did not provide 
sufficient information to allow for development of detailed cost-of-
service rules for the cable industry. Accordingly, the Commission 
indicated that general cost of service principles would apply for cost-
of-service showings for the time being, and the present proceeding was 
initiated by issuing a Notice of Proposed Rulemaking that invited 
comment on the adoption of cost-of-service goals and rules, and on the 
role that a cost-based approach to ratemaking should play in our 
regulation of cable service rates.\2\
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    \2\Notice of Proposed Rulemaking in MM Docket No. 93-215, FCC 
93-353, 58 FR 40762, released July 30, 1993 (Notice).
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    This Report and Order establishes rules implementing a cost of 
service alternative to our primary benchmark and price cap approach to 
setting regulated cable service rates.\3\ In this Report and Order the 
following regulatory requirements to govern cost-of-service showings 
are adopted:
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    \3\In a separate decision, the Commission is adopting 
significant modifications to the benchmark and price cap approach to 
setting regulated cable service rates. Implementation of Sections of 
the Cable Television Consumer Protection and Competition Act of 
1992: Rate Regulation, MM Docket 92-266, Second Order on 
Reconsideration, Fourth Report and Order, and Fifth Notice of 
Proposed Rulemaking, FCC 94-38 (Benchmark Order).
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    The regulatory requirements adopted in the Report and Order are on 
an interim basis, pending completion of cost studies of the cable 
industry as described elsewhere in the FNPRM. The interim rules, which 
apply only in cases where the cable operator elects to rely on a cost-
of-service showing rather than on benchmark/price cap requirements, 
will apply to rates charged or to be charged after the effective date 
of the cost rules; general cost of service principles will govern rates 
in effect prior to the effective date of these rules. Thus, to the 
extent that a franchising authority's examination of basic rates 
relates to both periods, it would apply the appropriate rules to each 
period. The Commission will take a similar approach to resolve cable 
programming complaints that cover both periods. Subsequent cable 
programming service complaint proceedings or basic tier proceedings 
relating to rates while the interim rules remain effective will be 
determined in accordance with the interim rules if the cable operator 
elects to justify rates as cost-based. If the permanent rules differ 
from the interim rules, the permanent rules will apply to proceedings 
relating to rates after their effective date.

Cost of Service Rates Effective

    The Report and Order requires that the rate established in a cost-
of-service proceeding is the permitted rate, even if it is lower than 
the rate that would have been determined under the benchmark/price cap 
approach. Once a rate is established through a cost-of-service 
proceeding, the rate will be governed by the price cap mechanism.
(1) Procedural and Filing Requirements
    Two year interval and election by cable operator only. The Report 
and Order requires that after setting initial regulated rates under 
either the benchmark or cost-of-service approach, absent a special 
showing, operators may not file a cost-of-service showing to justify a 
new rate for two years. This two-year period will be measured from the 
effective date of the rates set in a local or Commission decision. The 
Report and Order finds that a period of two years is a reasonable 
frequency limitation and will adequately reflect changes in both cost 
and revenue. A two-year period will also allow for the development of 
regulatory stability, and the reduction of regulatory burdens. This 
approach will lessen the administrative burdens of duplicative cost-of-
service showings, while furnishing operators a reasonable opportunity 
to recoup the costs of providing regulated cable services. Although the 
rules adopted in the Report and Order do not foreclose a cable 
operator's presenting new cost-of-service data to justify a rate that 
exceeds the capped rate after a two-year period, multiple cost-of-
service showings should be rare, since future adjustments to rates are 
provided for under the price cap mechanism. The Commission may find it 
reasonable, following a cost-of-service showing, to set rates that 
include a scheduled reduction or other adjustment; or may establish 
rates that are not expected to change, other than under the price cap, 
pending subsequent cost-of-service showings.
    The Report and Order does not allow for local franchising 
authorities to initiate cost-of-service proceedings or general data 
collections. Any benefits that might be derived from such a provision 
would be outweighed by the cost, and could conflict with the statutory 
requirement to minimize the administrative burdens of rate regulation. 
Moreover, the primary benchmark/price cap approach to setting rates 
will assure that rates for regulated cable service are reasonable. 
Accordingly, the election to choose to set rates pursuant to a cost-of-
service showing remains with the cable operator, the Report and Order 
does not provide for local authorities to initiate cost of service 
regulation.
    Presumptive standards. While the rules adopted in the Report and 
Order are of general applicability, the rules establish presumptive 
standards that operators may seek to overcome in individual 
proceedings. Thus, in certain circumstances, as described further in 
the Report and Order, operators can present evidence seeking to justify 
higher rates than would otherwise be permitted under the cost rules. 
This provision assures that application of the cost rules will not 
adversely impact the cable industry, and achieves the goal of assuring 
that cable operators can recover reasonable costs of providing service 
in high cost areas. Thus, the cost of service alternative provides a 
safeguard for the industry from possible adverse effects in individual 
cases of the primary, benchmark/price cap approach and from any adverse 
effects resulting from general applicability of the cost rules.
    Cost of service form. The Report and Order adopts the use of a 
uniform cost of service form. Use of a form will lessen administrative 
burdens for industry and regulators by providing uniformity in 
presentation and review of cost information. The cost of service form 
will provide a clear standard for the cost support required from 
operators, and permit easy comparison with previously filed 
information. The Report and Order adopts a general cost of service form 
and a simplified cost of service form for small systems; operators 
seeking to justify rates based on cost of service are required to use 
one of these two forms. Form 1220 is the general cost of service form 
in hard copy; Form 1225 is the simplified version of the cost of 
service form, for small systems, in hard copy. The forms are being 
released as separate documents. Operators may attach additional 
worksheets to explain form entries or unusual circumstances. In 
addition, cable operators must submit with their cost of service form, 
FCC Forms 1200, 1210, 1211, and 1215 to show the rate that will be 
permitted under the benchmark/price cap approach.
    For purposes of evaluating proposed rates in pending cost-of-
service proceedings for the period that commences after the effective 
date of these new cost rules, the Report and Order requires that all 
cable operators with pending cost-of-service proceedings for any 
regulated tier file the cost of service forms that are being adopted 
with this Report and Order by July 14, 1994.
(2) Rules for Determining Ratebase
    The Report and Order adopts the used and useful and prudent 
investment standards to govern amounts that may be included in the 
ratebase. The used and useful and prudent investment standards allow 
into the ratebase portions of plant that directly benefit the 
ratepayer, and exclude any imprudent, fraudulent, or extravagant 
outlays.
    Valuation of ratebase at original cost. The Commission considered 
various approaches to determining the value of plant included in the 
ratebase, including: Market value, original cost, replacement cost, 
reproduction cost, a combination of these approaches, and other 
approaches that were proposed by commenters. The Report and Order notes 
that under applicable judicial precedent, regulators have wide 
discretion to select a methodology for purposes of valuating ratebase, 
provided that the end result is reasonable, and the approach selected 
should be the one that best implements the goals for cost-based rates 
of cable service.
    The Report and Order concludes that an original cost approach is 
most likely to produce fair and reliable valuations of plant in 
service, and allows the best opportunity for balancing operators' 
reasonable recovery of costs with consumers' payment of rates that 
reflect only costs reasonably incurred in providing regulated service. 
The Report and Order goes into considerable detail addressing the other 
methods proposed by commenters for valuation of the ratebase, and finds 
that none of the other valuation approaches provides the same 
reliability and fairness as the original cost valuation approach.
    For purposes of the cable cost-of-service rules, the Report and 
Order defines original cost as the actual money cost (or the money 
value of any consideration other than money) of property at the time it 
was first used to provide cable service. Costs for both constructed and 
purchased systems will be subject to scrutiny by the appropriate 
regulatory authority to determine whether the investment was prudent 
and the plant is used and useful.\4\
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    \4\The regulator may examine whether the construction costs were 
reasonable, whether plant is operating at a reasonable level of 
capacity, and whether costs are properly apportioned between 
regulated and nonregulated activities. In this respect the 
Commission requires operators subject to regulation under section 
623 of the Communications Act, 47 U.S.C. 543, to keep, maintain and 
protect records subject to regulations adopted in this Report and 
Order for a period of not less than 5 years. The Commission has 
authority to take this action under sections 4(i) and 623 of the 
Communications Act, 47 U.S.C. 4(i) and 543.
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    The Report and Order notes that original cost is the normal, now 
traditional method used for public utility valuation, and is the method 
this Commission has long used for telephone companies. By relying on 
actual expenditures rather than speculative or contentious valuation 
methods, original cost is far more likely to achieve the desired 
result: Reasonable rates for customers, a fair opportunity for a 
reasonable return for operators, and reduce administrative burdens. The 
practical benefits of original cost valuation in general are that it is 
less administratively burdensome on all involved, and well understood.
    Thus, unlike the other valuation approaches, original cost does not 
require estimates of current values that may be difficult or expensive 
to determine, and that are in any event likely to be largely matters of 
opinion. Unlike market-based valuation methods, it does not present the 
problem of circularity, where the valuation method chosen itself 
affects the value that the market is likely to place on the system. It 
is also not constantly changing as the economy, technology, and 
customer needs change. Original cost valuation is also recognized and 
defined, and used for financial accounting purposes, as part of 
Generally Accepted Accounting Principles (GAAP). Indeed, it has been 
the Commission's policy in recent years to bring its regulatory 
accounting into conformance with GAAP as far as possible.\5\ Use of 
original cost for cable systems will help implement this policy and 
minimize regulatory accounting burdens.
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    \5\See, e.g., Revision of Uniform System of Accounts, Classes A, 
B, and C Telephone Companies, CC Docket No. 78-196, Report and 
Order, 51 FR 43498, Dec. 2, 1986. Continuing this Commission's 
reliance on GAAP, the Commission directs that GAAP shall generally 
apply in our regulation of cable rates, unless specifically noted 
otherwise.
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    The Report and Order took note of the numerous comments arguing 
that original cost is often simply unascertainable, and found that 
there is validity in this argument in some cases for purchased systems. 
The Report and Order acknowledges that use of an estimated original 
cost when actual original cost is not available is provided for under 
telephone regulation, 47 CFR 32.2000(b)(2)(ii). Because this approach 
creates the need for individual scrutiny not only of the estimated 
original cost but also of underlying ``particulars,'' this is not a 
preferred alternative to original cost for cable services regulation. 
However, the Report and Order determines that in the event that an 
operator does not possess adequate records of original cost, the 
operator will be permitted to estimate original cost. The operator will 
be required to show the basis for the estimate with supporting 
documentation. In addition, the Report and Order permits valuation of 
tangible plant in service at the book value recorded by the operator at 
the time of acquisition, if the operator can demonstrate that book 
value approximates original cost. All cost showings for acquired 
systems must include the book value of tangible plant in service as 
recorded at the time of acquisition, as required on Forms 1220 and 
1225.
    The Report and Order recognizes that original cost valuation, like 
any valuation methodology, has theoretical limitations--in this case, 
that it is a backward-looking approach to costs. However, these 
limitations do not prevent it from being a practical, workable 
foundation for establishing the value of tangible plant in service. To 
the extent that use of original cost for computing the ratebase affects 
the risks that investors may assign to cable systems, the Report and 
Order takes account of such risks in determining a reasonable rate of 
return that will allow the system to operate successfully and attract 
the necessary capital. Thus, in setting the rate of return, the 
Commission has adopted a rate toward the high end of the zone of 
reasonable returns, as a cautious approach to assure continued 
incentives for future investment.
    Accumulated start-up loses. The Report and Order concludes that 
some accumulated start-up losses, to the extent that they reflect 
operating losses in the early years of the system, should be included 
in the ratebase. These losses could be considered to meet the used and 
useful standard in that it is frequently necessary for businesses 
during a start-up phase to sustain a period of losses prior to 
profitability. As such, the losses benefit customers because it is 
necessary for the operator to incur them in order to bring future 
service to subscribers. There is a concern, however, that current 
customers not be burdened with excessive or unreasonable costs from 
previous periods of operation; that cable operators' recovery of these 
costs not be unlimited in time, especially after the losses have been 
recouped; and that subscribers not pay for losses incurred in 
expectation of recovery of future supra-competitive profits.
    The Report and Order relies on Financial Accounting Statements 
Board Standard No. 51 (``FASB 51'') which suggests that a two-year 
period is a reasonable and representative start-up time for cable 
systems. Based on the record, the Report and Order determines that this 
period would permit recovery of losses necessary for start-up of a 
cable system, and that a subscriber base is likely to be well 
established by the end of the second year of operation. Therefore, an 
allowance is made for recovery in the ratebase of accumulated start-up 
losses that are equal to the lesser of the first two years of operating 
costs or accumulated losses incurred until the system reaches the end 
of its prematurity stage as defined by FASB 51. The Commission believes 
that losses incurred during this period are most directly linked to the 
creation of the system that is currently providing services to 
subscribers.
    Cable operators are, of course, free to make a showing that 
demonstrates the appropriateness of a practical adjustment to this rule 
in light of their particular circumstances. Operators are also free to 
present evidence to rebut disallowance of other accumulated losses. In 
challenging this or any presumptive disallowance, the operator must 
present detailed evidence demonstrating that the cost has produced a 
tangible benefit for subscribers that would not have existed but for 
the cost; and that the relevant plant is used and useful in the 
provision of regulated cable service, and represents a prudent 
investment. The operator may present evidence that allowance is 
necessary for compensatory rates. In making its determination, the 
regulatory authority should take into account the effect that allowance 
of these will have on the operator's rates in comparison to rates that 
would have developed in a competitive environment, and whether 
allowance of these costs will produce reasonable rates.
    The Report and Order finds that these accumulated start-up losses 
may be included in the ratebase, and the operator may earn on them the 
reasonable rate of return as defined below. However, these accumulated 
losses must be amortized over a reasonable period. The Report and Order 
finds that presumptively this amortization period should not be longer 
than fifteen years. The Report and Order requires the cable operator to 
submit detailed evidence of the effect the amortization period has on 
rates in comparison to competitive rates of similar systems. The Report 
and Order allows the regulatory authority, after careful scrutiny, to 
revisit the amortization period if it will produce unreasonable rates. 
The Report and Order holds that, unless otherwise provided by this 
Commission, amortization, for purposes of the rules adopted in this 
proceeding, shall be computed on the straight-line method, i.e., equal 
amounts shall be recovered in each year of the amortization period. 
This approach has been applied successfully in common carrier 
regulation; see 47 CFR Sec. 32.2000(h). Finally, recovery of these 
costs is permitted only to the extent that they are recorded on the 
company's books as such. The amortization of allowed start-up losses 
must begin at the end of the prematurity phase of operation, and should 
generally be completed during the service life of the longest-lived 
depreciable assets.
    Other losses. The Report and Order concludes that other losses are 
presumptively excluded from the ratebase: These include continuing 
operating losses after the system reaches maturity (for these purposes 
a system reached maturity as defined by FASB 51, i.e., presumptively 
within two years), and accumulated losses associated with amortization 
of disallowed goodwill or interest expenses associated with disallowed 
goodwill. This treatment is appropriate because these costs presumably 
benefited past subscribers, or were incurred in the expectation of 
monopoly profits or profits from nonregulated activities, and thus 
should not be borne by current and future subscribers.
    Cable operators have the opportunity of making a showing to 
overcome this presumption. Such a showing would demonstrate that these 
costs benefit both current and future ratepayers, and that they were 
prudently invested in plant that is used and useful in the provision of 
regulated services. Operators may also present evidence that allowance 
is necessary to produce compensatory rates.
    Treatment of intangibles. The Report and Order addresses the 
treatment of intangibles in the ratebase. In instances where there is a 
lack of effective competition, as in the period prior to the adoption 
of the Cable Act of 1992, the Report and Order finds that acquisition 
prices are likely to include amounts paid in expectation of supra-
competitive profits and growth premiums for unregulated services. 
Traditional principles of ratemaking and the policies embodied in the 
Cable Act of 1992 also warrant disallowance of costs that do not 
represent reasonable costs of providing regulated services to 
customers, equivalent to the costs that would be incurred under 
competition. This generally includes acquisition costs recorded as 
goodwill. The Report and Order makes clear that disallowance of these 
costs, contrary to some parties' assertions, is not a penalty but part 
of the normal and proper balancing of the interests of investors and 
ratepayers.
    However, the Report and Order finds that operators are correct in 
pointing out that some intangible costs do represent cost of providing 
service that are legitimately included in the operator's ratebase or 
revenue requirement. This is true whether the operator is an original 
owner or a purchaser of an established system. Further, such allowance 
is consistent with the Commission's Part 32 rules, which allow 
telephone companies to recover intangible costs related to ``organizing 
and incorporating the company, original costs of franchise rights, 
patent rights, and other intangible property having a life of more than 
one year.'' (47 CFR 32.2690). These costs produce assets that provide 
benefits to subscribers and are reasonably recoverable from 
subscribers.
    To balance investors' and ratepayers' interests fairly, the Report 
and Order holds that in some cases intangible costs are presumptively 
allowed in the ratebase. Intangible costs that are generally reasonable 
costs of providing service, that would be incurred under competition, 
and that are used and useful in the provision of regulated services, 
are properly recoverable in rates. In some cases intangible costs may 
be included in the ratebase; in other cases, they may be treated as an 
expense, and amortized over a period of years. The Report and Order 
holds that other intangible costs, including goodwill, will be 
presumptively excluded.
    Organizational costs. The Report and Order finds that 
organizational costs are presumptively allowed into the ratebase to the 
extent they are prudently invested and are useful in the provision of 
regulated cable service. Organizational costs typically consist of the 
cost of organizing and incorporating the company. They will ordinarily 
have been incurred by the entity originally providing cable service in 
the franchise area in question. These organizational costs should 
represent costs that benefit customers, in that they must necessarily 
be incurred for the entity to be able to provide service. See 47 CFR 
32.2690. The Report and Order however presumptively disallows from this 
category stock given to the organizer the value of which is in excess 
of reasonable salary.
    The Report and Order allows operators to continue to recover their 
capitalized organizational costs based on GAAP through amortization 
over a reasonable period, subject to scrutiny by the appropriate 
regulatory authority as to the reasonableness of rates produced by the 
recovery period. However, the Report and Order notes that it is not 
necessarily the case that the time period until renewal of a franchise 
is the appropriate capitalization period for organizational costs, 
because generally there is an expectation of franchise renewal. 
Proponents of some period other than the franchise period should 
support their proposal.
    Franchise costs. The Report and Order concludes that the original 
costs associated with a government franchise are allowed into the 
ratebase if the costs: (1) Are associated with the costs of winning the 
franchise; and (2) in the case of purchased systems, are costs that 
were directly borne by the seller. The Report and Order finds that 
these costs are presumptively allowed to the extent they are prudently 
invested and are useful in the provision of regulated cable service. 
The Report and Order notes that original costs of government franchises 
are often allowed into the ratebase under traditional cost-of-service 
principles, because they must necessarily be incurred for the entity to 
be able to provide service. (See 47 CFR 32.2690). The Report and Order 
holds that operators will be allowed to continue to recover their 
capitalized franchise right based on GAAP through amortization over a 
reasonable period, subject to scrutiny by the appropriate regulatory 
authority as to the reasonableness of rates produced by the recovery 
period.
    Customer lists. The Report and Order finds that customer lists, 
too, are presumptively allowed into the ratebase, to the extent that 
they reflect costs capitalized during prematurity, as defined by FASB 
51, and are prudently invested and useful in the provision of regulated 
cable service. Operators will be allowed to continue to recover these 
costs through amortization over a reasonable period based on GAAP, 
subject to scrutiny by the appropriate regulatory authority as to the 
reasonableness of rates produced by the recovery period.
    Acquisition costs. The issue of whether the acquisition costs of 
cable systems should be considered or accepted for computing ratebases 
and revenue requirements overlaps to a degree with the question of the 
plant valuation method that should apply. But the Report and Order 
emphasizes that the two matters are distinct, especially under the 
particular circumstances presented by the reimposition of cable service 
rate regulation by the Cable Act of 1992. Regardless of the valuation 
method that might be applied now and in the future, the issue cable 
operators raise is whether the cost-of-service methodology should 
recognize the prices paid for cable systems in the past, especially 
during the period when systems were unregulated. The Report and Order 
concludes that the prices paid for cable systems, especially during the 
period when those systems possessed market power, are not a reliable or 
reasonable basis for ratemaking, and that excess acquisition costs, or 
``goodwill'', are therefore from ratebase.
    The Report and Order defines ``goodwill'' as the portion of plant 
purchase price that cannot be assigned specifically to identifiable 
property acquired and that is not recorded on the operators' books of 
account as accumulated losses, subscriber lists, franchise rights, 
patent rights or organizational costs. The Report and Order concludes 
that ``goodwill,'' including going-concern value, should be 
presumptively disallowed from the ratebase because it is likely to 
represent expectations of supra-competitive profits and other outlays 
that should not be borne by regulated service customers.
    The Report and Order recognizes the importance and controversy that 
this issue generates, both for operators and customers, because many 
cable systems changed hands during the years when cable service was 
essentially unregulated, and in many cases the prices paid exceeded the 
original cost or the book value of the purchased cable system's 
tangible assets. These costs to the buyer, termed ``excess acquisition 
costs,'' are generally recorded as ``goodwill''. The Report and Order 
addresses the many arguments made by cable operators for recognition of 
acquisition costs for computing costs of service. Cable operators 
claim, variously, that the price paid is either a measure of the fair 
value of the system, or the proper valuation for assets brought into 
regulation, or a proper exception to the usual valuation rules to 
recognize the need for a transition tailored to the characteristics of 
the cable industry, or a constitutional requirement to prevent 
confiscation.
    The Report and Order sustains the Commission's belief that the 
prices paid for cable systems, especially during the period when those 
systems possessed market power, are not a reliable or reasonable basis 
for ratemaking, and that their use is not required or supported by 
public utility practice, the purposes of the Cable Act of 1992, or the 
Constitution. The Report and Order notes that on the FCC's own analysis 
conducted as part of the development of governing rates set under the 
benchmark approach, and the study submitted in support of the use of 
acquisition prices, the Kolbe/Vitka Study, by Viacom, one of the 
largest cable operators, in reaching the conclusion that acquisition 
prices often include some expectation of supra-competitive profits that 
the market power of cable systems operating in a less than fully 
competitive environment could expect to generate. The Report and Order 
notes that the magnitude of this expectation probably varied over time, 
increased by the growing list of cable channels that could be obtained 
only by subscribing to cable service, and discounted by investors' 
assessment of the risks of competitive entry and re-regulation. Buyers 
and sellers negotiating acquisition prices clearly took into account 
the competitive status of cable systems and their consequent market 
power. Individual investors purchasing shares in cable companies no 
doubt also included this factor.
    The Report and Order further notes that it is likely that 
acquisition prices included assessments of the profits that might be 
gained from emerging cable services that remain unregulated but could 
be expected to experience more rapid growth and penetration than those 
services that were made subject to regulation. Premium services such as 
HBO and Showtime, pay-preview services, interactive services such as 
home shopping, and other offerings all represent newer sources of 
profit with greater potential for expansion. System prices can 
reasonably be expected to include the potential earnings for these 
actual and planned offerings. Moreover, it is certainly possible that 
even arm's-length transactions resulted in prices that were simply too 
high; transactions were based upon overly optimistic projections of 
growth, the direction of the economy, and the buyer's ability to reduce 
operating costs or increase the value to customers. The Report and 
Order finds that acceptance of these prices as a fair measure of the 
value of the facilities used to provide regulated services would 
require customers for those services to act as guarantors of the 
recovery of those prices, regardless of how inflated they might have 
been. Such allowance would not be appropriate or reasonable or in the 
public interest.
    The Report and Order points out that traditionally, such excess 
acquisition costs have been partly or wholly excluded from the ratebase 
of regulated concerns, because these costs are seen as inappropriate 
costs for ratepayers to bear. (E.g., 47 CFR 32.2005, 32.2007; San Diego 
Land & Town Co. v. National City, 174 U.S. 739, 757-758 (1899); Simpson 
v. Shepard (Minnesota Rate Cases), 230 U.S. 352, 454 (1913)). This is 
because these costs typically benefit the seller, not the ratepayer; 
they do not contribute to the plant supporting regulated service. The 
Report and Order also notes that disallowance of goodwill for monopoly 
cable systems is consistent with findings of the United States Tax 
Court in Tele-Communications, Inc. v. Commissioner of Internal Revenue, 
95 T.C. No. 36 (1990).
    The Report and Order holds that the decision to disallow 
acquisition costs, to the extent they include capitalized supra-
competitive profits, is consistent with, if not indeed compelled by, 
the theory and purposes of the Cable Act of 1992. The Act does not 
instruct the consideration of acquisition costs or the prices 
individual shareholders paid for cable companies before the adoption of 
the Act. The language and legislative history of the Cable Act of 1992 
demonstrate a primary concern with preventing the undue market power of 
cable operators subject to neither regulation nor effective competition 
from setting supra-competitive rates. The Report and Order concludes 
that allowance of the acquisition price of cable systems as part of the 
costs of service would present a substantial probability of passing on 
to customers costs that reflect neither the costs of providing service 
nor the costs that would be incurred under competition.
    Operating efficiencies provide rebuttable presumption. The Report 
and Order recognizes that there may be sales of cable systems, as some 
commenters claim, that benefit subscribers by generating operating 
efficiencies that are unobtainable by the seller. The Report and Order 
finds that it is appropriate to consider whether these efficiency gains 
warrant inclusion of some part of the goodwill in the rate calculation. 
However, in any such case, the Report and Order requires that the 
operator clearly rebut the presumption against including goodwill by 
demonstrating the nature and value of the net efficiency gains and, 
most importantly, that these gains resulted in concrete, tangible 
benefits to subscribers, especially in the form of better and more 
varied regulated services. Efficiency gains that permitted the buyer to 
improve its margins but did not benefit subscribers will not lay the 
foundation for allowing goodwill to be included in the rates 
subscribers pay.
    The Report and Order requires that operators wishing to overcome 
the presumption that goodwill is excluded from inclusion in the 
ratebase demonstrate that allowance of these costs will result in 
reasonable rates, that the costs are the result of an arm's-length 
transaction, and that the goodwill has produced for subscribers 
concrete benefits that would not have been realized otherwise. To the 
extent that the operator seeks to justify rates above competitive 
levels based on inclusion of goodwill, there is a heavy presumption 
against inclusion of these costs. Operators making such a showing will 
be required to show the nature of each cost they are seeking to justify 
for inclusion in the ratebase, and should provide all pertinent data 
relating to the acquisition. At a minimum, this includes the purchase 
price of plant, its book value, a description of plant, the effect on 
subscribers, the results of a valuation study, and the results of any 
request for franchise approval.
    The Report and Order provides that in reviewing such showings, the 
franchising authority or the Commission is to scrutinize the extent to 
which inclusion of these costs will produce rates above competitive 
levels. To the extent that they do, the operator will need to 
demonstrate why its particular situation justifies inclusion of these 
costs in the ratebase.
    Plant under construction. The Report and Order adopts the 
capitalization method to govern ratemaking treatment of plant under 
construction. The capitalization method is the traditional method for 
considering plant under construction. Under this approach, plant under 
construction is excluded from the ratebase, but the operator calculates 
an allowance for funds used during construction (AFUDC) and includes 
this allowance in the cost of construction. As construction is 
completed and the plant is placed into service, the cost of 
construction (including AFUDC) is included in the ratebase and 
recovered through depreciation. This method has been used by various 
regulatory authorities to provide reasonable rates for utilities. 
Further, this method will allow operators to recover interest from the 
construction period only after the plant is placed in service. Interest 
is to be computed at prime rate or at the operator's demonstrated cost 
of the funds used for the construction. AFUDC is allowed only to the 
extent the related costs are not already included in start-up losses.
    Cash working capital. The Report and Order adopts a presumption of 
a zero allowance for cash working capital. The Report and Order finds 
that cable subscribers are generally billed in advance for regulated 
cable services, and billed in arrears for nonregulated services such as 
pay-per-view. Cable operators generally pay vendors, employees, and 
taxing authorities in arrears. The Report and Order also notes that it 
is possible, where receipts lead outlays, to establish a negative cash 
working capital allowance. Given these circumstances, the Report and 
Order finds it appropriate to adopt a presumption that a zero allowance 
is needed to support the regulated cable services. A cable operator may 
rebut the presumption by establishing that its operations do not fit 
the industry mold, and that it requires the establishment of a cash 
working capital allowance.
    Excess capacity. The Report and Order concludes that operators are 
allowed to include in the ratebase any excess capacity that will be 
used within a twelve-month period. As with start-up losses, recovery of 
these costs is allowed only to the extent that they are recorded on the 
company's books as such. The amortization of allowed costs must begin 
at the end of the prematurity phase of operation, and should generally 
be completed during the service life of the longest-lived depreciable 
assets. This will generally be no longer than fifteen years.
    The Report and Order notes that the price cap adjustment and 
network upgrade plans (discussed below) make adequate provision for the 
addition of channels and capacity. Thus, while there is an allowance in 
the ratebase for any facilities that are not currently used and useful, 
but will be used and useful within one year, if they are included in 
the ratebase, they may not in any part be reflected in annual operating 
expenses or in any price cap adjustment. This will assure that no 
double or excessive recovery of costs, and no double payment for 
capacity, can occur.
    Cost overruns. The Report and Order determines that cost overruns 
should be presumptively disallowed from the ratebase. Subscribers 
should not bear the burden for unnecessary, extravagant, or imprudent 
expenses, which cost overruns may be. At the same time, however, the 
Report and Order recognizes that cable operators should be able to 
recover the costs of overruns that have occurred through no fault of 
the operator. Therefore, cable operators may overcome this presumption 
on a case-by-case basis by showing that the costs were prudently 
invested. In reviewing such showing, factors that will be considered 
include whether the overrun was preventable, who was responsible for 
the overrun, and whether including the overrun in the ratebase will 
produce reasonable rates.
    Premature abandonments. The Report and Order finds that the cost of 
premature abandonments should be a recoverable operating expense rather 
than an element in the ratebase. In removing prematurely abandoned 
plant from the ratebase, a cable operator must bring plant to full 
recovery before retiring it. Plant that has never entered into service 
cannot be retired and expensed, but is disallowed. To retire plant, the 
operator must remove both plant and accumulated depreciation reserve 
from the balance sheet. Once the plant is retired, an operator may 
amortize the unrecovered investment (i.e., the original cost less 
accumulated depreciation) over a term equal to the remainder of the 
original expected life.
(3) Rules for Determining Recoverable Expenses
    Operating expenses. The Report and Order permits recovery of all 
operating expenses normally incurred by cable operators in the 
provision of regulated cable service. Thus cable operators may recover 
fully the reasonable costs of providing regulated service, and 
subscribers are protected from paying rates that reflect costs not 
reasonably associated with regulated services. The Report and Order 
affirms the decision to exclude from recovery those operating expenses 
and other costs unrelated to the provision of regulated cable service. 
Generally, costs incurred in the provision of regulated cable service 
are recoverable if legitimate and reasonable. The Report and Order 
directs that the Commission and local franchising authorities review 
operating expenses in each cost showing to assure that they are in 
conformance with the cost standards.
    The Report and Order also adopts the tentative conclusion that 
certain special expenses (47 CFR 76.924 (f) and (g)) are presumptively 
excluded from recovery as not reasonably related to the provision of 
regulated cable services. Cable subscribers should not be responsible 
for reimbursing cable operators for unreasonable costs. Further, the 
Report and Order concludes that GAAP should guide the determination of 
what costs are to be expensed and what capitalized.
    Depreciation. The Report and Order declines to adopt the tentative 
conclusion to prescribe depreciation rates. The Report and Order finds 
that prescription of depreciation rates is unnecessary, at least 
pending completion of the cost study and analysis that the Cable Bureau 
is to undertake. See, FNPRM elsewhere in this Federal Register. 
Further, the Report and Order finds that a depreciation prescription 
requirement would impose unjustified burdens without providing a 
balancing benefit to subscribers. Instead, the Report and Order directs 
regulators to monitor industry depreciation practices closely, and to 
review depreciation showings in individual cost proceedings carefully 
to assure that these depreciation practices are reasonable. In 
addition, the Report and Order notes that the Commission and local 
franchising authorities will examine depreciation practices of 
operators in individual cases to assure that resulting rates are 
reasonable.
    Taxes. The Report and Order develops a method of income tax 
treatment that permits recovery of income taxes regardless of the form 
of ownership of the regulated cable service enterprise. The Report and 
Order maintains the principle that taxes related to the provision of 
regulated service may be recovered from subscribers, but taxes on 
dividends paid to owners may not. The Report and Order affirms the 
tentative conclusion that Chapter C corporations will be allowed to 
include in annual expense calculations all taxes on the provision of 
regulated cable service. For other ownership forms of cable operators--
subchapter S corporations, partnerships, sole proprietors--the income 
tax allowance is to be determined as follows: The permitted rate of 
return on the ratebase is first calculated; this amount is adjusted to 
remove any portion of the previous year's distributions after 
adjustment for capital contributions and interest paid; the resulting 
sum, the amount retained in cable operations, will constitute the cable 
operator's earnings subject to the income tax calculation. The allowed 
income tax will be calculated by applying the grossed-up federal and 
state statutory corporate tax rates (as opposed to individual tax 
rates) to the amount calculated as subject to the income tax 
calculation, regardless of the actual business form. The calculated tax 
amount may then be included in calculating the total revenue 
requirement.
    The Report and Order notes that while traditional cost-of-service 
regulation allows for recovery of allowable tax expense on an annual 
basis, it is possible that cable rates set by cost of service will not 
be reviewed, nor any further cost support submitted, for a substantial 
period of time. Retained earnings depend closely upon the cable 
system's current financial requirements. Because this is a showing the 
Commission does not intend to revisit, proposed tax expense in a cable 
cost-of-service showing should incorporate an adjustment of retained 
earnings to reflect likely changes. The following illustration of tax 
calculation methodology adjusts retained earnings over a three-year 
period:

------------------------------------------------------------------------
                                      Year 1       Year 2       Year 3  
------------------------------------------------------------------------
1. Ratebase......................     1000000      1000000      1000000 
2. Allowed Return (@ 11%)........      110000       110000       110000 
3. Less Interest Expense.........      (10000)      (10000)      (10000)
4. Tax Gross-up:                                                        
5.Allowed Taxable Return.........      100000       100000       100000 
6.Distributions..................       50000        25000       160000 
7.Capital Contributions..........           0        25000        10000 
8. Amount Subject to Tax calc....       50000       100000       (50000)
9. Tax allowed at corp. rate (@                                         
 estimate 34% grossed up)........       25758        51515       (25758)
10. Revenue Requirement:                                                
11.Allowed Return................      110000       110000       110000 
12.Tax Allowed...................       25758        51515       (25758)
13.Expenses......................      500000       500000       500000 
14. Total Revenue Requirement....      635758       662515       584242 
15. Cumulative Tax Allowed:                                             
16.Beginning Balance.............           0        25758        77273 
17.Current Provision.............       25758        51515       (25758)
18.Ending Balance\6\.............       25758        77273        51515 
------------------------------------------------------------------------
\6\Explanation of terms and calculations:                               
1. Line 3: An eleven percent rate of return is used only for purposes of
  illustration.                                                         
Line 6: A portion of distributions made must be associated with the     
  provision of regulated cable services.                                
Line 7: A portion of contributions made must be associated with the     
  provision of regulated cable services.                                
Line 8: Tax allowed is determined by subtracting distributions from     
  allowed return and adding the amount of capital contributions. The    
  amount of contributions added shall be no more than the amount of     
  distributions for the period, however.                                
Line 9: The rate used in this illustration is a federal tax rate grossed
  up as follows: (.34/(1-.34))=.51515)                                  
2. Lines 8-9 of Year 3 demonstrate that, where distributions offset the 
  total of allowed return and capital contributions, the amount subject 
  to the tax calculation may be negative. In effect, this calculation   
  would require operators to pay back to subscribers the tax benefits   
  associated with earnings that had been achieved previously but were   
  distributed in the current period. Since no annual adjustment will be 
  made, this offset should be reflected in an operator's one-time       
  showing.                                                              

    The Report and Order does not require the three-year calculation 
shown above. However, it does require that cost-of-service showings 
that include a tax allowance show some calculation of likely changes in 
retained earnings.
    The Report and Order also adopts the Commission's tentative 
conclusion that cable operators may include state and federal taxes, 
such as property and sales taxes, incurred on the provision of 
regulated cable service as an operating expense regardless of business 
form.
    Test year methodology. The Report and Order adopts the use of an 
adjusted historic test year. The test year may be adjusted for ``known 
and measurable'' changes that have occurred by the time the rates take 
effect. The Report and Order further finds that the historic test year 
should be the operator's fiscal year. Thus, cost-of-service showings 
must be based upon the operator's most recently completed fiscal year. 
In the case of a cost-of-service showing arising in response to a 
complaint, the fiscal year should be the one most recently completed at 
the time of the filing of the complaint. In the case of new systems, 
for which no historic data are available, projected data may be used, 
but careful scrutiny shall be paid to the assumptions used.
(4) Use of Unitary 11.25% Rate of Return
    A major component of the ratemaking methodology for cable operators 
that elect cost-of-service regulation is the rate of return those 
operators will be given an opportunity to earn on their allowed 
ratebase. The Report and Order prescribes an interim, overall rate of 
return of 11.25% for use in cable cost-of-service proceedings.
    Uniform rate of return. The Report and Order finds that the record 
confirms that the burden of establishing an individualized rate of 
return for each cable operator that elects cost-of-service regulation 
would be substantial. Such an undertaking would require cable operators 
to present, and franchising authorities or the Commission to review, 
analyses of matters such as the risks individual cable systems 
encounter in providing regulated cable service and the sources of 
capital available to finance those risks. Not persuaded that it is 
necessary for cable operators and regulators to undertake such analyses 
to ensure that cable operators can attract the capital needed to 
provide regulated cable service, the Report and Order defines a uniform 
rate of return for use by all cable operators in cost-of-service 
showings.
    Presumptive. The Report and Order acknowledges that some cable 
operators may believe that the overall rate of return is inadequate to 
compensate them for the risks they encounter in providing regulated 
cable service. Similarly, consumers may find this overall rate 
excessive, given the individual operator's specific circumstances. To 
ensure the reasonableness of all rates set in cable cost-of-service 
proceedings, the Report and Order states that parties to such 
proceedings are not foreclosed from attempting to justify different 
rates of return. Parties that seek rates of return different from the 
prescribed interim rate of return, or any subsequently prescribed rate 
of return, bear a heavy burden. In particular, each cable operator 
seeking a higher rate of return is required to show exceptional facts 
and circumstances that make its cost of capital for regulated cable 
services exceed the prescribed rate of return, and must demonstrate 
that those facts and circumstances will persist. All necessary 
supporting information shall be included in the challenging cable 
operator's initial cost-of-service showing. Similarly, local 
franchising authorities may collect and consider evidence that the 
operator's cost of capital for the individual system is lower than the 
prescribed rate. The Commission will review all evidence relied upon by 
local franchising authorities in setting rates of return different from 
the prescribed rate.
    General methodology. The Report and Order determines to use the 
weighted average cost of capital as the methodology for establishing 
the rate of return. The Report and Order describes in detail each of 
the components: Cost of equity, cost of debt, and capital structure. 
This weighted average cost of capital approach assumes a post-tax 
return on equity.
    In applying this methodology, an estimate of the cost of the 
capital contributing to the provision of regulated cable service is 
required, since most cable companies have diverse operations. The 
record provided no company which engaged only in provision of regulated 
cable service. Thus, the Commission selected surrogate firms to 
represent the risks of regulated cable for capital analysis.
    The Report and Order notes that the surrogate firms must operate a 
levels of risks comparable to those of regulated cable service in order 
to be consistent with the fundamental goal of determining the return 
required to compensate investors for the perceived risks of regulated 
cable service and to attract capital to that service. In choosing 
surrogate firms, recognition is given to the limitations imposed by the 
available information. Because different kinds of information are 
available with regard to cost of equity, cost of debt, and capital 
structure, each of these components of the overall cost of capital is 
addressed separately.
    Cost of equity. The Report and Order espouses the principle that 
the ideal cost of equity estimate should accurately reflect investor 
expectations as to the returns, in terms of both capital gains and 
dividends, investors will earn. Since investor expectations are not 
directly measurable, a variety of indirect methods are used. The Report 
and Order reviews the methods used by commenters in this proceeding, 
which fall into three categories: risk premium, discounted cash flow 
(DCF), and comparable earnings. Commenters submitted four studies, 
using the capital asset pricing model (CAPM) version of the risk 
premium method, one study relying upon the DCF method to analyze the 
Standard & Poors 400 (S&P 400), and one applying the comparable 
earnings methodology. In Attachment D to the Report and Order, these 
three methods of estimating the cost of equity are described and 
analyzed.
    The Report and Order concludes that the DCF methodology will be 
applied to the S&P 400 to develop the cost of equity for companies 
providing regulated cable service. The Report and Order and the 
separate attachment present the basis for rejecting commenters' 
arguments against use of the DCF methodology and against the use of the 
S&P 400 as a surrogate, and rejects other approaches suggested in the 
cost of equity studies by commenters. Thus, the Report and Order 
affirms the tentative proposal in the Notice to apply the DCF method to 
the companies composing the S&P 400. (Notice at  52).
    The DCF method, like the other methods the parties advocate, 
requires an assessment of the risks of regulated cable service in 
comparison to those of the chosen surrogate. The record provides little 
definitive analysis of the risks of regulated cable service and thus 
does not make clear which specific subgroup of the S&P 400 regulated 
cable most resembles in terms of risks. Given the paucity of the 
record, the Report and Order determines that the S&P 400 should be 
viewed broadly and a broad zone of reasonableness for the cost of 
equity should be defined. Based on the Vander Weide analysis, estimates 
for the cost of equity for regulated cable service are between 11.80% 
(the midpoint of the DCF cost of equity estimates for the first 
quartile of the S&P 400) and 15.11% (the midpoint of the DCF cost of 
equity estimates for the third quartile). The Report and Order finds 
that these estimates provide reasonable outside bounds for the cost of 
equity for regulated cable service, approximately 12% and 15%. The 
Report and Order adopts use of this range, in combination with other 
elements of the weighted average cost of capital, to develop a zone of 
reasonable rates of return for regulated cable service.
    Cost of debt. The record on the cost of debt includes compilations 
of debt costs for specific cable operators. The information is both 
industry-specific and concrete. The Report and Order concludes that it 
appropriate to rely on this information, instead of S&P 400 data, as a 
surrogate for the cost of debt for regulated cable service, because it 
is industry-specific and provides a sufficient basis for estimating 
that cost of debt. Thus, the tentative conclusion to rely on the cost 
of debt of the surrogate is rejected.
    The cost of debt found by Vander Weide for six cable companies was 
7.8%. AUS found an 8.5% cost of debt based on 1992 data and notes it 
would be lower with more recent data. Several parties suggest higher 
debt costs, but provide no supporting documentation. Adelphia's SEC 
Form 10K for 1993 states that its floating note interest rates ranged 
from LIBOR plus 1.0% to LIBOR plus 1.5%. Its March 31, 1993 average 
debt rate was 8.65%. TCI's SEC Form 10K for 1991 states 55% of its debt 
was fixed rate, with an average cost of 9.9% and 45% percent was 
variable rate, floating at the prime rate. The prime rate on February 
18, 1994, was 6% and LIBOR was 3.56% (90 day) and 3.75% (180 day).
    The Report and Order computes the range for the average cost of 
fixed rate debt established by this information for the most recently 
available period (1992-93) as 7.8% to 8.65%. The Report and Order 
determines that the reasonable estimate of the cost of debt for cable 
is 8.5%. In addition to reflecting historical debt costs, this rate 
allows for an increase in the cost of floating rate debt above current 
rates.
    Capital structure. The Report and Order addresses the 
recommendations of commenters that provided analysis of the capital 
structure for the cable industry as requested in the Notice. The Report 
and Order notes the difficulty encountered in evaluating current cable 
industry practices. The Report and Order evaluates the proposals for 
establishing a capital structure and discusses in detail the problems 
arising with each proposal. The Report and Order further notes that the 
long-term average capital structure of the industry is not clear at 
this time. Thus, instead of adopting a single capital structure, the 
Report and Order finds that a capital structure range, for use in the 
determination of the overall cost of capital for regulated cable 
operations, is appropriate. Based on the record, the Report and Order 
determines that a wide range of capital structures, extending from 40% 
debt to 70% debt, is justified, and is consistent with the range for 
cost of equity estimates and the cost of debt.
    Overall cost of capital. The Report and Order reviews 
recommendations for establishing an overall cost of capital, and 
reflects on requirements of The Cable Act of 1992 that the cable rate 
regulations provide cable operators the opportunity to earn ``a 
reasonable profit'' while ``protecting subscribers * * * from rates * * 
* that exceed what would be charged * * * if such cable system were 
subject to effective competition.'' 46 U.S.C. 623(b)(2)(C)(vii) and 
(b)(1), respectively. Companies regulated under this standard must be 
allowed an opportunity to earn a return sufficiently high to maintain 
financial integrity and attract new capital. At the same time, the 
prescribed return must not produce rates that are unreasonable. The 
courts have recognized that there is a zone of reasonableness within 
which reasonable rates may fall, and that regulatory agencies have 
broad discretion to select a return within that zone.
    Given this standard, the Report and Order develops its 
determination of a reasonable range for the cost of equity for 
regulated cable service, cost of debt, and a reasonable range for the 
capital structure. The following table combines all these elements and 
presents the overall cost of capital implied by these ranges. 

 Calculation of Overall Rate of Return Debt Portion of Capital Structure
------------------------------------------------------------------------
                                                      In percent        
                                             ---------------------------
                                                40     50     60     70 
------------------------------------------------------------------------
Equity estimate (in percent):                                           
    12......................................   10.6   10.3    9.9    9.6
    13......................................   11.2   10.8   10.3    9.9
    14......................................   11.8   11.3   10.7   10.2
    15......................................   12.4   11.8   11.1   10.5
                                             ---------------------------
      Average...............................   11.5   11.0   10.5   10.0
------------------------------------------------------------------------
Debt Cost: 8.50 percent.                                                

    No particular weight is given to any one cell in this table. 
Instead, consideration is given to the averages that are produced, as 
shown on the last row. Based on these averages, the Report and Order 
finds that the overall cost of capital for regulated cable service lies 
within a ``zone of reasonableness'' of 10.0% to 11.5%.
    The Report and Order notes the concerns in selecting a rate within 
this zone, since the record is less than perfect. Also, the risks of 
regulated cable operations are not known with certainty, since those 
risks are dependent in part on the cost-of-service rules and principles 
adopted in this Order and on the revised benchmark methodology. 
Additionally, there is a recognized desire to encourage infrastructure 
development. Thus, the Report and Order determines that prescribing a 
return toward the upper end of the zone of reasonableness will enable 
cable operators to attract the capital needed to provide regulated 
cable service and to expand their regulated offerings. Based on these 
considerations, the Report and Order prescribes an overall cost of 
capital of 11.25%.
    Interim rate. The Report and Order notes that the rate of return 
prescription is an interim one. The FNPRM (published elsewhere in this 
Federal Register) seeks information on the relative risks of cable 
operations given recent actions by the FCC, and further analysis of S&P 
400 companies' costs of capital.
(5) Accounting and Cost Allocation Requirements
    Existing requirements. Under existing rules, regulated cable 
operators are required to maintain their accounts in accordance with 
GAAP. 47 CFR 76.924(b). They are also required to maintain their 
accounts in a manner that will allow for identification of appropriate 
costs and application of cost assignment and cost allocation procedures 
necessary for rate adjustments to reflect changes in external costs and 
for cost-of-service showings. 47 CFR 76.924(c). In addition, for 
accounting purposes, cable operators are generally required to 
aggregate expenses and revenues at either the franchise, system, 
regional or company level in a manner consistent with the practices of 
the operator as of April 3, 1993. 47 CFR 76.924(d). (The initial rules 
erroneously identified this date as April 3, 1992. The rules adopted 
with this Report and Order correct this error). Costs associated with 
franchise fees, franchise requirements, local taxes, and local 
programming must be identified at the franchise level. Id.
    Interim summary level accounts. The Report and Order adopts an 
interim summary accounting system for use by cable operators that elect 
cost of service regulation. This interim summary account system will be 
required until a permanent system of accounts is in place. Cable 
operators that elect cost of service regulation shall identify costs in 
55 summary level accounts contained in FCC Form 1220. This form 
requires that cost-of-service showings include a balance of broad 
summary level investment, expense, and revenue categories.
    The Report and Order expresses concern that even this summary 
accounting approach may be burdensome for some small systems. In order 
to provide further relief to small systems, the summary level of 
accounts that small operators are required to report as a part of the 
cost of service filings are aggregated further. The Report and Order 
thus, adopts the requirement that small cable system operators may 
identify their costs in FCC Form 1225, which contains 32 summary level 
accounts.
    Filing instructions. With regard to the level at which these 
accounting requirements apply, the Report and Order requires that cable 
operators electing cost-of-service regulation identify all amounts 
associated with each revenue and cost category, as provided for in FCC 
Forms 1220 and 1225, at the franchise, system, regional and/or company 
level, depending upon the organizational level at which the operator 
identified revenues and costs for accounting purposes as of April 3, 
1993. (Sec. 76.924(c)). The FNPRM (published elsewhere in this Federal 
Register) will provide for cost studies to explore the extent to which 
operators should be permitted or required to report average costs at 
levels different than those in effect on April 3, 1993.
    Further, the Report and Order requires cable operators to provide 
any additional financial data and explanations reasonably requested by 
franchising authorities and the FCC to substantiate cost-of-service 
showings or other related proceedings. Where a reasonable response is 
not forthcoming, franchising authorities and the Commission are 
authorized to make such disallowance as are appropriate, pending the 
presentation of convincing evidence by cable operators.
    Cost allocation requirements. The Report and Order finds that it is 
necessary to require allocation of costs to nonregulated service 
categories to help ensure that the allocation of costs to regulated 
services is fair and reasonable in relation to the allocation of costs 
to nonregulated services. The current rules require that costs be 
allocated among the basic service tier and each tier of cable 
programming service. 47 CFR 76.924(e)(2). The Report and Order amends 
the rule to require that, in addition to the basic and cable 
programming service tiers, cable operators shall allocate costs to 
nonregulated programming service activities, other cable activities, 
and non-cable activities.
    The Report and Order requires that, after revenues and costs are 
identified at the appropriate organizational level(s), cable operators 
shall allocate costs among the equipment basket (47 CFR 76.923(d)) and 
the following service cost categories: Basic service, cable programming 
services, nonregulated cable programming services, other cable 
activities and non-cable activities. These allocations shall be used 
for cost-of-service showings and for allocating external costs. For the 
purpose of allocating their costs and revenues among the service cost 
categories and the equipment basket in cost-of-service proceedings, 
cable operators shall use FCC Form 1220 or FCC Form 1225 (for use by 
small cable system operators).
    The Report and Order also requires direct assignment of all costs, 
to the extent possible, among the equipment basket and the service cost 
categories. Direct assignment applies when costs are incurred 
exclusively to support the equipment basket or a specific service cost 
category. For example, most programming charges from program suppliers 
relate to specific programming. Those charges should therefore be 
directly assigned to the tier on which the programming is offered. In 
making this determination, the Report and Order modifies the existing 
requirement that, with a few exceptions, cost categories identified at 
the franchise level be generally allocated to the basic tier based on 
the ratio of channels in the basic tier to the total number of channels 
offered in the franchise area, and that costs allocated to each tier of 
cable programming be based on the ratio of channels in each cable 
programming services tier to the total number of channels offered in 
the franchise area. The Report and Order finds that when direct 
assignment is possible, it is preferable to a standard allocator 
because, while cost allocation provides an estimate of the origination 
of certain costs, direct assignment is simpler to apply, and more 
accurately reflects cost causality.
    The Report and Order requires that cable operators allocate among 
the service cost categories and the equipment basket any costs that 
cannot be directly assigned, using methodologies that are consistent 
with the procedures in Sec. 76.924(f)(5). These procedures require 
that, when direct assignment is not possible, operators must first 
attempt to allocate costs through direct analysis of their origin. 47 
CFR 76.924(f)(5)(i). Where direct analysis is not possible, operators 
must attempt to establish cost-causative linkage to other costs 
directly assigned or allocated by direct analysis. 47 CFR 
76.924(f)(5)(ii). Finally, where no direct or indirect linkage can be 
made, operators are required to allocated on the basis of the totals of 
all costs directly assigned and allocated using direct assignment, 
direct analysis and indirect linkage. 47 CFR 76.924(f)(5)(iii). The 
Report and Order requires the Commission and local franchising 
authorities to review the allocators proposed by cable operators on a 
case-by-case basis to determine whether the allocators achieve 
reasonable results.
    The Report and Order maintains the current requirement that cable 
operators allocate costs that were identified at higher levels to the 
franchise level on the ratio of the total number of subscribers at the 
franchise level to the total number of subscribers served at the higher 
level. 47 CFR 924(e)(1). The Report and Order amends the rule, however, 
to specify the particular procedures that must be followed for 
allocating costs to the franchise level. First, recoverable costs that 
have been aggregated at the highest organizational level at which costs 
have been identified are allocated to the next (lower) organizational 
level at which recoverable costs have been identified on the basis of 
the ratio of the total number of subscribers served at the lower level 
to the total number of subscribers served at the higher level. Second, 
this procedure is repeated at every organizational level at which 
recoverable costs have been identified, until all costs have been 
allocated to the franchise level.
(6) Accounting and Cost Allocation Requirements for External Costs
    Definition. External costs are categories of costs that cable 
operators may pass through to subscribers without a cost-of-service 
showing under our price cap rules. Such costs include retransmission 
consent fees, other programming costs, taxes, franchise fees, and costs 
of other franchise requirements. See Sec. 76.922(d)(3).
    Treatment for rate adjustments. To provide for a readily 
ascertainable basis for proposed external cost adjustments, the 
accounting and cost allocation rules adopted in this Report and Order 
will apply to external cost calculations. The Report and Order requires 
that the following external costs be identified at the franchise level: 
Franchise requirements, franchise fees, local taxes and local 
programming. Cable operators are required to identify all other 
external costs at the franchise, system, regional and/or company level, 
depending upon the organizational level at which they identified costs 
for accounting purposes as of April 3, 1993. These costs shall be 
identified on FCC Form 1210. After external costs have been identified 
at the appropriate organizational level(s), cable operators are 
required to allocate such costs among the service cost categories and 
the equipment basket in the manner specified for cost-of-service 
showings.
    With respect to the specific requirements for allocating certain 
external costs, the Report and Order requires that the costs of 
programming and retransmission consent be allocated to the service cost 
category on which the signal or programming is offered. The phrase 
``tier'' on which the programming or broadcast signal at issue is 
offered'' is replaced with the phrase ``service cost category in which 
the programming or broadcast signal at issue is offered.'' See 
Sec. 76.924(f)(1) (emphasis added). The Report and Order also requires 
that the costs of public, educational, and governmental access channels 
carried on the basic tier be directly assigned to basic service cost 
category where possible. The Report and Order modifies the allocation 
requirements for franchise fees. Under the current rule, ``franchise 
fees shall be allocated among equipment and installations, program 
service tiers and subscribers in a manner that is most consistent with 
the methodology of assessment of franchise fees by local authorities.'' 
Consistent with the treatment of Sec. 76.924(f)(1), the phrase 
``program service tiers'' is replaced with the phrase ``service cost 
categories.'' See Sec. 76.924(f)(2). While the franchise fee should be 
allocated among the equipment basket and the service cost categories as 
the rules currently require, the rules should not list subscribers as a 
category to which such costs should be allocated. The equipment basket 
and the service cost categories are the only appropriate categories for 
allocation purposes. As already noted, the cost of franchise fees must 
be identified at the franchise level.
    The Report and Order also modifies existing rules to require that, 
to the extent possible, all external costs be directly assigned among 
the service cost categories. When direct assignment is possible, it is 
preferable to a standard allocator because it is simpler to apply and 
it more accurately reflects cost causality. For those external costs 
that cannot be directly assigned, the Commission requires that cable 
operators propose specific allocators that reasonably allocate costs 
among the service cost categories and the equipment basket. The 
Commission and franchising authorities shall review the allocators 
proposed by cable operators on a case-by-case basis and determine 
whether the allocators achieve reasonable results.
    For the purpose of establishing external costs at the franchise 
level, the Report and Order retains the current requirement that cable 
operators allocate costs that were identified at higher levels to the 
franchise level on the ratio of the total number of subscribers at the 
franchise level to the total number of subscribers served at the higher 
level. However, the Report and Order amends the rules to specify the 
particular procedures that must be followed for allocating costs to the 
franchise level in the case of adjustments to external costs as well as 
cost of service regulation.
(7) Requirements for Affiliate Transactions
    The report and Order adopts rules for affiliate transactions that 
will apply to cable operators who either elect cost-of-service 
regulation or seek to adjust benchmark/price cap rates for affiliated 
programming costs. For those operators electing to use the benchmark/
price cap approach, the affiliate transaction rules will only be 
applicable to affiliate transactions involving programming. In Docket 
No. 92-266, under price caps, cable operators may pass-through 
affiliated programming costs that exceed inflation as long as the 
prices charged to the affiliated cable system operators reflect either 
prevailing company prices offered in the marketplace to third parties 
(where the affiliated program supplier has established such prices) or 
the fair market value of programming. First Order on Reconsideration at 
114.
    Under the rules adopted in the Report and Order, cable operators 
that elect cost-of-service regulation or who seek to adjust benchmark/
price cap rates for affiliated programming costs shall be required to 
apply valuation methods that are similar to those telephone companies 
are now required to apply. Although the rules for telephone companies 
specify the manner of accounting for affiliates transactions, the 
affiliate transaction rules adopted for cable operators in this Report 
and Order do not impose accounting requirements. The affiliate 
transaction rules adopted with this Report and Order merely set the 
limits for inclusion of investment and expense in rates set on a cost-
of-service basis. They will also govern external cost treatment of 
programming cable operators purchase from affiliates. These methods 
distinguish between asset transfers and the provision of services.
    When a cable operator sells assets to an affiliate or buys assets 
from an affiliate, the assets shall be valued at the asset provider's 
prevailing company price, if the provider has sold the same kind of 
asset to a substantial number of third parties at a generally available 
price. Absent a prevailing company price, the cable operator shall 
value the asset at the higher of net book cost and estimated fair 
market value when the regulated cable system is the seller, and at the 
lower of net book cost and estimated fair market value when the 
regulated cable system is the buyer.
    When a cable operator sells services to an affiliate or buys 
services from an affiliate, the services shall be valued at the 
provider's prevailing company price, if the provider has sold the same 
kind of service to a substantial number of third parties at a generally 
available price. When the provider has established no prevailing 
company price, the cable operator must value the service at the service 
provider's cost.
    In determining the prevailing company price, the Report and Order 
requires that it be based on the price at which the provider has sold 
the same kind of asset or service to a substantial number of third 
parties at a generally available price. In determining the cost of both 
assets and services, cable operators shall apply the costing methods 
and the rate of return adopted in the Report and Order for cable cost-
of-service showings, to the extent applicable, and shall otherwise use 
reasonable costing methods. Where there is no prevailing company price, 
affiliate transactions must be carefully scrutinized to ensure that 
costs are calculated accurately and, for asset transfers, that fair 
market value is estimated properly. Therefore, cable operators must be 
prepared to demonstrate that any affiliated transactions costs they 
claim as regulated costs reflect the cost-of-service methodologies 
adopt with the Report and Order.
    For the purpose of evaluating affiliate transactions that involve 
programming, the Report and Order determines to classify programming as 
an asset. Hence, for the purpose of establishing initial costs for 
programming purchased by a cable operator from an affiliate, the cost 
of the programming shall equal the provider's prevailing company price, 
if the provider has sold the same kind of programming to a substantial 
number of third parties at a generally available price. Absent a 
prevailing company price, the cost of the programming shall equal the 
lower of the provider's net book cost and the programming's estimated 
fair market value. Except to the extent that they are relevant for 
estimating fair market value, the Report and Order does not allow for 
the establishment of affiliate prices by reference to the prices 
independent suppliers charge third parties for the same or similar 
products.
    The Report and Order applies the rules adopted in the program 
access proceeding to define affiliated programmers. Rate Order, 8 FCC 
Rcd at 5788, n.601, citing Implementation of Sections 12 and 19 of the 
Cable Television Consumer Protection and Competition and Diversity Act 
of 1992--Development of Competition and Diversity in Video Programming 
Distribution and Carriage, Report and Order, FCC 93-178, 58 FR 27658, 
released May 11, 1993. Under those rules, an affiliated programmer is a 
programmer with an ownership interest of five percent or more, 
including general partnership interests, direct ownership interests, 
and stock interests in a corporation where such stockholders are 
officers or directors or who directly or indirectly own five percent or 
more of the outstanding stock, whether voting or nonvoting. Such 
interests include limited partnership interests of five percent.
    The Report and Order requires cable operators to provide detailed 
disclosure of affiliate transactions so that the Commission and 
franchising authorities can ensure that affiliate transactions are 
treated consistent with the limits of this Report and Order. Where 
cable operators have not demonstrated that their affiliate transactions 
meet the requirements of the affiliate transaction rules, disallowances 
shall be made by the Commission and franchising authorities.
(8) Streamlined Filing and Review for Small Systems
    The Report and Order acknowledges Congress' directive under the 
Cable Act of 1992 to reduce the administrative burdens of, and costs of 
compliance with, cable regulations for small cable systems. 47 U.S.C. 
623(i). The Report and Order adopts an abbreviated cost of service form 
for use by small systems, Form 1225. This will reduce the 
administrative burdens of cost showings for small system operators, 
while retaining the necessary regulatory oversight and assurance of 
reasonable rates. The Report and Order further requires that 
information provided on the abbreviated cost of service form be 
certified by the operator as correct; it will be subject to audit by 
the local franchising authority and by the Commission.
    Independent small systems and small systems operated by small MSO's 
may use Form 1225. Small MSO's are those multiple system operators that 
(1) Serve 250,000 subscribers or less, (2) own only small systems with 
less than 10,000 subscribers, and (3) have an average system size of 
1,000 or fewer subscribers. This is the same standard of eligibility 
that the Commission adopts for other small system administrative relief 
in the Benchmark/price cap Order, which is summarized elsewhere in the 
Federal Register.
    However, The Report and Order does not allow use of this form for 
small operators affiliated with larger systems. The Report and Order 
adopts the same affiliation standards employed for small system 
administrative relief generally. Use of the small system relief form 
(Form 1225) is not permitted by companies in which a larger company 
holds more than a 20 percent equity interest (active or passive) or 
over which a larger company exercises actual working control (such as 
through a general partnership or majority voting shareholder interest). 
This affiliated standard also governs eligibility for the use of the 
abbreviated summary level accounts for small systems.
    Finally, the Report and Order notes that while all cable companies 
that choose to make cost-of-service filings should be subject to the 
uniform accounting requirements as proposed here, at least in 
abbreviated form, such accounting requirements may increase the 
administrative burden on small operators to the point of hardship, and 
small operators may be unlikely to require the same level of regulatory 
oversight as larger entities. Thus, in our Further Notice, comment is 
sought on whether to exempt small systems and/or small operators from 
these requirements entirely. The Commission also is adopting reduced 
accounting requirements for small systems.
(9) Streamlined Filing Requirements for Network Upgrades
    The Report and Order concludes that an abbreviated cost-of-service 
showing for network upgrades, with safeguards, provides an appropriate 
way to implement the goals of the Cable Act of 1992, to promote the 
availability of diverse cable services and facilities, encourage 
economically justified upgrades, and reduce regulatory burdens, while 
ensuring reasonable rates for regulated services.
    The Report and Order notes that for many systems, this option will 
be unnecessary or inapplicable. The benchmark/price cap mechanism is 
already based on the rates of competitive systems, including those with 
upgraded networks. The rates charged by those systems presumably 
recover their capital costs. The benchmark also includes factors 
reflecting the number of channels a system furnishes to customers. 
Nevertheless, there may be cases where the benchmark rates do not 
provide sufficient revenue to attract capital for upgrades because of 
unusual costs associated with capital improvements. For these cases the 
abbreviated cost-of-service showing should provide the ability to 
attract the capital needed for the upgrade.
    The abbreviated cost of service showing for network upgrades is 
available only for significant upgrades requiring added capital 
investment, such as expansion of band width capability and conversion 
to fiber optics, and for system rebuilds. Normal improvements and 
expansions of service will remain subject to the usual rate review 
process. The Report and Order finds that to justify an increase in the 
rates for regulated services, the operator will be required to 
demonstrate that the capital investment actually will benefit 
subscribers through improvements in the regulated services subject to 
the rate increase. The Report and Order also holds that, except to the 
extent provided by our AFUDC policy, the upgrade rate increase should 
not be assessed on customers until the upgrade is complete and 
providing these benefits to customers of the regulated services. This 
is consistent with the general cost-of-service standard that only used 
and useful property should be included in the ratebase. Any costs that 
are not used and useful, will be deducted from total cost. Issues of 
allowable costs can be resolved if raised by comparison with costs of 
similar systems and, in particular, systems subject to competition.
    To assure that the upgrade rate increase is justified by higher 
costs, the Report and Order requires that the operator bear the burden 
of demonstrating the amount of the net increase in costs, taking into 
account current depreciation expense, likely changes in maintenance and 
other costs, changes in revenues, and expected economies of scale. The 
Report and Order requires that the operator must also allocate the net 
increase in costs in conformance with the cost allocation rules for 
cost-of-service showings, to assure that only costs allocable to 
regulated services are imposed on subscribers to those services.
    The Report and Order explains that the permitted rate (based upon 
the showing of the net increase in allowable costs associated with the 
capital improvement) would be provided in two elements. The first 
element is the benchmark rate, as governed by the Rate Order and the 
price cap. The second element is the capital improvement add-on. The 
sum of these two elements yield the maximum allowable rate that might 
be charged to subscribers. The capital improvement add-on is not 
adjusted for inflation but is a fee charged over the useful life of the 
improvement determined in accordance with our cost-of-service 
requirements.
    The Report and Order delegates to the Cable Services Bureau the 
development of appropriate forms for these abbreviated showings.
(10) Hardship Rate Relief for Operators
    The Report and Order recognizes that, in extraordinary cases, the 
cable industry may face special problems as it moves into a regulated 
environment, and that it is conceivable that the particular 
circumstances of an operator could be such that the practical result of 
applying any of these rate options could still be to threaten the 
financial health of the operator and its continued ability to provide 
cable service.
    The Report and Order addresses this possibility, and notes that the 
Commission will consider the need for special rate relief for operators 
in individual cases. To demonstrate eligibility for such extraordinary 
relief, the operator should establish that the rates permitted by the 
benchmark/price cap and cost-of-service mechanisms undermine the 
financial health of the operator so that it is unable to attract 
capital and maintain credit necessary to operate, despite prudent and 
efficient management. The operator should also establish that the 
resulting rates, though higher than those justified by the operator's 
costs, will nevertheless not be unreasonable or exploitative of 
customers. For example, the operator should demonstrate that the rates 
are not excessive in comparison with similarly situated systems, 
particularly systems subject to competition.
    The Report and Order requires that this hardship showing must be 
made for the MSO level, or in any event at the highest level of the 
operator's cable system organization. The operator should provide all 
information and legal authority on which it seeks to rely, and all 
factors it believes the Commission should consider, to demonstrate that 
the end result of the other ratesetting options available to it would 
place the operator in financial difficulty warranting rate relief, and 
that on balance this relief would not result in unreasonable rates for 
customers. If the operator makes an adequate initial showing of facts 
which, if proved, might warrant rate relief, the Commission will 
subsequently provide the operator with an opportunity to prove the 
facts alleged and demonstrate that, balancing the relevant interests of 
investors and ratepayers, rate relief is warranted.
(11) Experimental Upgrade Incentive Plan
    The Report and Order determines that the goal of promoting 
economically justified system upgrades, as well as the goals of the 
Cable Act and of this proceeding, would be furthered by development of 
an incentive regulation approach to upgrading cable services, similar 
to the incentive plans implemented for telephone carriers. The Report 
and Order outlines the incentive approach as follows. Basically, an 
operator would be permitted to enter into a ``social contract'' with 
its customers under which the operator would be given substantial 
flexibility in setting rates for new regulated services it introduces, 
such as new service tiers offering additional program channels. In 
exchange, customers would be guaranteed that rates for current services 
would be kept stable and reasonable, no higher than rates before the 
contract takes effect or the benchmark/price cap rate (which might 
include adjustments for inflation and external cost changes), and that 
this would purchase at least the same program channels, or channels of 
equivalent value to customers. The operator would also commit to 
otherwise maintaining or improving its service quality. The contract 
would be effective for a term of years and would be overseen by this 
Commission, and reviewed before the end of the term.
    The Report and Order notes that a plan such as this, which protects 
the rates and quality of current cable service tiers, while providing 
profit incentives for operators to introduce new and improved regulated 
services, may help carry out the purposes of the Cable Act while also 
being fair to customers of current services, less burdensome on cable 
operators and those responsible for their regulation, and more likely 
to encourage worthwhile investments to upgrade cable service.
    The Report and Order contemplates that this plan will generate a 
strong incentive for the operator to undertake only upgrades that are 
economically justified and that best meet customer needs, and to make 
such upgrades in the most efficient manner possible. In order to profit 
from the planned upgrade, an operator must provide customers with 
additional or upgraded services they want to buy. Marketplace forces, 
not this Commission, will determine which services succeed. A properly 
designed incentive plan for system upgrades should help achieve other 
goals. It should, for example, help encourage operators to provide 
additional tiers of services. An incentive regulation plan should also 
reduce regulatory burdens, even below those likely under the add-on 
rate proposal. Regulatory review should only encompass whether the 
operator is continuing to offer existing services at rates no higher 
and quality no lower than the operator contracted to provide. The 
Commission would not expect to investigate complaints regarding rates 
for additional regulated services unless they were clearly outside a 
wide range of reasonable rates, as evidenced, for example, by similar 
systems.
    Offering substantial rate flexibility may also be appropriate to 
encourage operators to take the entrepreneurial risk of investing in 
the upgrades needed to offer such services, while replicating 
competitive marketplace forces. In competitive markets, entrepreneurs 
offering new and improved services can hope to reap above-market 
profits for some period, at least until competitors catch up, but also 
take the risk that the services will not succeed in the marketplace. 
Permitting cable operators to take the risks and to keep the rewards of 
introducing new and improved services, at least for a reasonable 
period, should have similar benefits when applied to cable operators.
    The Report and Order notes that additional services will be 
indirectly regulated by the price cap on current regulated services. 
The added services and capabilities must effectively compete with the 
other regulated services, whose rates are limited by regulation. 
Customers are likely to subscribe to and pay for the added services and 
capabilities only if they offer additional value at a reasonable price, 
in comparison to those offered by current tiers.
    The Report and Order observes that to generate an incentive plan 
that is effective in encouraging operators to invest in worthwhile 
upgrades, but also fair to customers, the rate limits on existing 
services and the rate flexibility for new services would apply for a 
substantial period, but would be subject to eventual review. For 
instance, in the case of telephone companies, an initial review is made 
during the fourth year of the price cap incentive plan. In view of the 
initial start-up issues for any incentive plan for cable operators, a 
longer period is probably desirable, both to permit operators to 
understand and respond to the plan and to assure strong efficiency 
incentives. Thus, the Report and Order proposes that the Commission 
review the plan in the fifth year of operation.
    The Report and Order adopts the Upgrade Incentive Plan on an 
experimental basis. Cable systems that commit to meet the basic 
obligations of freezing rates for current services that have been 
adjusted to benchmark/price cap or cost of service levels, or 
conforming their rates to the price cap, and maintaining programming 
and service quality that is at least as valued by customers as that 
offered currently, will be permitted substantial rate flexibility in 
the rates they might wish to introduce for additional regulated 
services and capabilities for a term of years, up to five years, from 
the acceptance of the plan. These experimental plans will then be 
monitored and reviewed no later than the fifth year to evaluate their 
performance.
    To gain experience with this approach, the Report and Order states 
that the Commission will consider proposals from cable operators that 
will implement the Upgrade Incentive Plan on an experimental case-by-
case basis, for a limited term of years. Cable operators wishing to 
participate should submit a proposal to the Commission's Cable Services 
Bureau outlining a proposal and explaining how it would implement the 
objectives outlined here. The proposal should also be accompanied by a 
written statement by any certified franchising authority with 
jurisdiction over cable systems affected by the plan of its views 
concerning the proposed agreement.

Regulatory Flexibility Analysis

Final Regulatory Flexibility Analysis for the Report and Order

    Pursuant to the Regulatory Flexibility Act of 1980, 5 U.S.C. 
Sections 601-12, the Commission's final analysis with respect to the 
Report and Order is as follows:
    Need and purpose of this action: The Commission, in compliance with 
sections 3 and 14 and those portions of section 9 of the Cable 
Television Protection and Compliance Act of 1992 (the Act) pertaining 
to rate regulation, adopts rules and procedures intended to ensure 
cable subscribers of reasonable rates for cable services with minimum 
regulatory and administrative burdens on cable entities.
    Summary of issues raised by the public comments in response to the 
Initial Regulatory Flexibility Analysis (IRFA): The Chief Counsel for 
Advocacy of the United States Small Business Administration (``Office 
of Advocacy'') offers several remarks in response to the IRFA. The 
Office Advocacy expresses concern that numerous small cable operators 
cannot operate profitably, if at all, under the constraints imposed by 
the benchmark. It agrees with the Commission that some other process 
must be developed to permit small cable operators to demonstrate the 
reasonableness of rates. The Office of Advocacy believes the 
Commission's experience with regulation of common carriers may prove 
beneficial in developing mechanisms that balance the need for 
exactitude with administrative simplicity.
    First, the Office of Advocacy opines that the 1,000 subscriber 
standard in the 1992 Act does not provide an adequate definition of 
small operator. It recommends defining small cable operators at those 
with less than $7.5 million in gross revenues, a standard roughly 
equivalent to 20-25,000 subscribers. Within this category it recommends 
separate tiers at 1,000, 3,500, and 10,000 subscribers.
    Second, the Office of Advocacy commends the Commission for its 
compliance with the Regulatory Flexibility Act and its extensive 
examination of alternative regulatory regimes. It supports the 
Commission's proposal to streamline cost of service showings for 
smaller firms, if a relatively simple form can be developed to show 
what these costs are. It also supports the Commission's proposal of an 
abbreviated cost showing for significant capital expenditures. The 
Office of Advocacy also suggests that the Commission consider use of 
average cost schedules, maintained by an organization of cable 
operators to provide the same functions for the cable industry that the 
National Exchange Carrier Association performs for local telephone 
companies. It opposes use of 1986 rates adjusted for inflation and 
productivity as an alternative.
    Third, the Office of Advocacy also supports considering exemptions 
for small cable operators, provided certain principles are maintained, 
including a Commission finding that exempt operators' rates are 
reasonable.
    The Commission also is adopting its proposals for streamlined cost 
of service studies for small companies, based on a simplified form, and 
abbreviated cost of service showings for significant capital 
expenditures. The Commission is also seeking the information needed to 
consider development of average cost schedules. The Upgrade Incentive 
Plan that the Commission is adopting on an experimental basis, and 
seeking comment on, may also be an attractive alternative form of 
regulation, with substantially reduced administrative burdens, for 
small operators.
    The Commission agrees with the Office of Advocacy that we must 
ensure that rates for regulated services are reasonable for all cable 
operators. We are also willing to consider proposals for pooling cable 
system costs and revenues in a manner similar to that employed for 
small telephone companies. It is unclear to us, however, that cable 
operators are sufficiently interested in such an approach to make its 
adoption worthwhile. Our consideration of average cost schedule 
approaches in the Further Notice may provide insight on this matter.
    The Commission has also considered the other comments and proposals 
regarding small cable operators, as we discuss in more detail in the 
body of the Report and Order. For example, in response to a proposal in 
comments from Small Systems, we have broadened the definition of small 
systems for purposes of the cost of service mechanisms to include MSOs 
with 250,000 or fewer subscribers, who do not own any system with more 
than 10,000 subscribers, and whose average system size is 1,000 
subscribers or less. Interested persons will also have the opportunity 
to submit further comments on these interim rules in the Further Notice 
so that we may consider appropriate revisions before these rules become 
final.

Paperwork Reduction Act

    The proposal contained herein has been analyzed with respect to the 
Paperwork Reduction Act of 1980 and found to impose a new or modified 
information collection requirement on the public. Implementation of any 
new or modified requirement will be subject to approval by the Office 
of Management and Budget as prescribed by the Act.

Ordering Clauses

    Accordingly, It is ordered That, pursuant to sections 4(i), 4(j), 
612, 622(c) and 623 of the Communications Act of 1934, as amended, 47 
U.S.C. 154(i), 154(j), 532, 542(c) and 543, the rules, requirements, 
and policies discussed in the foregoing Report & Order are adopted, and 
that part 76 of the Commission's rules, 47 CFR part 76, is amended as 
set forth below.
    It is further ordered that, the rules, policies, and requirements 
adopted herein shall be effective May 15, 1994.
    It is further ordered That, the Secretary shall send a copy of this 
Report and Order, including the certification, to the Chief Counsel for 
Advocacy of the Small Business Administration in accordance with 
paragraph 603(a) of the Regulatory Flexibility Act. Public Law 96-354, 
94 Stat. 1164, 5 U.S.C. 601 et seq. (1981).
    It is further ordered That authority is delegated to the Chief, 
Cable Services Bureau to conduct cost studies in conjunction with this 
proceeding and to develop forms necessary and appropriate to implement 
this Order.
    It is further ordered Pursuant to sections 4(i) 4(j), 623(b), and 
623(c) of the Communications Act, 47 U.S.C. 154(i), 154(j), 543 (b) and 
(c), that the Upgrade Incentive Plan described herein is adopted on an 
experimental basis. Authority is delegated to the Chief, Cable Services 
Bureau to implement this plan.

List of Subjects in 47 CFR Part 76

    Cable television.

Federal Communications Commission.
William F. Caton,
Acting Secretary.

Rule Changes

    Part 76 of title 47 of the CFR is amended as follows:

PART 76--CABLE TELEVISION SERVICE

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

    Authority: Secs. 2, 3, 4, 301, 303, 307, 308, 309, 48 Stat., as 
amended, 1064, 1065, 1066, 1081, 1082, 1083, 1084, 1085, 1101: 47 
U.S.C. 152, 153, 154, 301, 303, 307, 308, 309, 532, 533, 535, 542, 
543, 552, as amended, 106 Stat. 1460.

    2. Section 76.922 is amended by adding paragraphs (g) through (k) 
to read as follows:


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

* * * * *
    (g) Cost of service charge. (1) For purpose of this section, a 
monthly cost-of-service charge for a basic service tier or a cable 
programming service tier is an amount equal to the annual revenue 
requirement for that their divided by a number that is equal to 12 
times the average number of subscribers to that tier during the test 
year, except that a monthly charge for a system or tier in service less 
than one year shall be equal to the projected annual revenue 
requirement for the first 12 months of operation or service divided by 
a number that is equal to 12 times the projected average number of 
subscribers during the first 12 months of operation or service. The 
calculation of the average number of subscribers shall include all 
subscribers, regardless of whether they receive service at full rates 
or at discounts.
    (2) A test year for an initial regulated charge is the cable 
operator's fiscal year preceding the initial date of regulation. A test 
year for a change in the basic service charge that is after the initial 
date of regulation is the cable operator's fiscal year preceding the 
mailing or other delivery of written notice pursuant to Sec. 76.932. A 
test year for a change in a cable programming service charge after the 
initial rate of regulation is the cable operator's fiscal year 
preceding the filing of a complaint regarding the increase.
    (3) The annual revenue requirement for a tier is the sum of the 
return component and the expense component for that tier.
    (4) The return component for a tier is the average allowable test 
year ratebase allocable to the tier adjusted for known and measurable 
changes occurring between the end of the test year and the effective 
date of the rate multiplied by the rate of return specified by the 
Commission or franchising authority.
    (5) The expense component for a tier is the sum of allowable test 
year expenses allocable to the tier adjusted for known and measurable 
changes occurring between the end of the test year and the effective 
date of the rate.
    (6) The ratebase may include the following:
    (i) Prudent investment by a cable operator in tangible plant that 
is used and useful in the provision of cable services less accumulated 
depreciation. Tangible plant in service shall be valued at the actual 
money cost (or the money value of any consideration other than money) 
of property at the time it was first used to provide cable service. The 
actual money cost of plant may include an allowance for funds used 
during construction at the prime rate or at the operator's actual cost 
of funds used during construction. Cost overruns are presumed to be 
imprudent investment in the absence of a showing that the overrun 
occurred through no fault of the operator.
    (ii) An allowance for start-up losses, if any, that is equal to the 
lesser of the first two years of operating costs or accumulated losses 
incurred until the system reached the end of its prematurity stage as 
defined in Financial Accounting Standards Board Standard 51 (``FASB 
51'') less straight-line amortization over a reasonable period not 
exceeding 15 years that commences at the end of the prematurity phase 
of operation. FASB 51 is available from: Financial Accounting Standards 
Board, 401 Merritt 7, P.O. Box 5116, Norwalk, CT 06856-5116.
    (iii) Intangible assets less amortization that reflect the original 
costs prudently incurred by a cable operator in organizing and 
incorporating a company that provides regulated cable services, 
obtaining a government franchise to provide regulated cable services, 
or obtaining patents that are used and useful in the provision of cable 
services.
    (iv) The cost of customer lists if such costs were capitalized 
during the prematurity phase of operations less amortization.
    (v) An amount for working capital to the extent that an allowance 
or disallowance for funds needed to sustain the ongoing operations of 
the regulated cable service is demonstrated.
    (vi) Other intangible assets to the extent the cable operator 
demonstrates that the asset reflects costs incurred in an activity or 
transaction that produced concrete benefits or savings for subscribers 
to regulated cable services that would not have been realized otherwise 
and the cable operator demonstrates that a return on such an asset does 
not exceed the value of such a subscriber benefit.
    (vii) The portion of the capacity of plant not currently in service 
that will be placed in service within twelve months of the end of the 
test year.
    (7) Deferred income taxes shall be deducted from items included in 
the ratebase.
    (8) Allowable expenses may include the following:
    (i) All regular expenses normally incurred by a cable operator in 
the provision of regulated cable service, but not including any 
lobbying expense, charitable contributions, penalties and fines paid on 
account of violations of statutes or rules, or membership fees in 
social, service, recreational or athletic clubs or organizations.
    (ii) Reasonable depreciation expense attributable to tangible 
assets allowable in the ratebase.
    (iii) Reasonable amortization expense for prematurely abandoned 
tangible assets formerly includable in the ratebase that are amortized 
over the remainder of the original expected life of the asset.
    (iv) Reasonable amortization expense for start-up losses and 
capitalized intangible assets that are includable in ratebase.
    (v) Taxes other than income taxes attributable to the provision of 
regulated cable services.
    (vi) An income tax allowance.
    (h) Network upgrade rate increase. (1) Cable operators that 
undertake significant network upgrades requiring added capital 
investment may justify an increase in rates for regulated services by 
demonstrating that the capital investment will benefit subscribers.
    (2) A rate increase on account of upgrades shall not be assessed on 
customers until the upgrade is complete and providing benefits to 
customers of regulated services.
    (3) Cable operators seeking an upgrade rate increase have the 
burden of demonstrating the amount of the net increase in costs, taking 
into account current depreciation expense, likely changes in 
maintenance and other costs, changes in regulated revenues and expected 
economies of scale.
    (4) Cable operators seeking a rate increase for network upgrades 
shall allocate net cost increases in conformance with the cost 
allocation rules as set forth in Sec. 76.924.
    (5) Cable operators that undertake significant upgrades shall be 
permitted to increase rates by adding the benchmark/price cap rate to 
the rate increment necessary to recover the net increase in cost 
attributable to the upgrade.
    (i) Hardship rate relief. A cable operator may adjust charges by an 
amount specified by the Commission for the cable programming service 
tier or the franchising authority for the basic service tier if it is 
determined that:
    (1) Total revenues from cable operations, measured at the highest 
level of the cable operator's cable service organization, will not be 
sufficient to enable the operator to attract capital or maintain credit 
necessary to enable the operator to continue to provide cable service;
    (2) The cable operator has prudent and efficient management; and
    (3) Adjusted charges on account of hardship will not result in 
total charges for regulated cable services that are excessive in 
comparison to charges of similarly situated systems.
    (j) Cost of service showing. A cable operator that elects to 
establish a charge, or to justify an existing or changed charge for 
regulated cable service, based on a cost-of-service showing must submit 
data to the Commission or the franchising authority in accordance with 
forms established by the Commission. The cable operator must also 
submit any additional information requested by franchising authorities 
or the Commission to resolve questions in cost-of-service proceedings.
    (k) Subsequent cost of service charges. No cable operator may use a 
cost-of-service showing to justify an increase in any charge 
established on a cost-of-service basis for a period of 2 years after 
that rate takes effect, except that the Commission or the franchising 
authority may waive this prohibition upon a showing of unusual 
circumstances that would create undue hardship for a cable operator.
    3. Section 76.924 is amended by revising paragraphs (b) (c), (d), 
(e), and (f), redesignating paragraph (g) as paragraph (j), and adding 
new paragraphs (g) and (i) to read as follows:


Sec. 76.924  Cost accounting and cost allocation requirements.

* * * * *
    (b) Accounting requirements. Cable operators electing cost-of-
service regulation or seeking rate adjustments due to changes in 
external costs shall maintain their accounts:
    (1) in accordance with generally accepted accounting principles; 
and
    (2) in a manner that will enable identification of appropriate 
investments, revenues, and expenses.
    (c) Accounts level. Except to the extent indicated below, cable 
operators electing cost of service regulation or seeking adjustments 
due to changes in external costs shall identify investments, expenses 
and revenues at the franchise, system, regional, and/or company 
level(s) in a manner consistent with the accounting practices of the 
operator on April 3, 1993. However, in all events, cable operators 
shall identify at the franchise level their costs of franchise 
requirements, franchise fees, local taxes and local programming.
    (d) Summary accounts. (1) Cable operators filing for cost-of-
service regulation, other than small operators, as defined by 
Sec. 76.922(b)(5)(i), shall report all investments, expenses, and 
revenue and income adjustments accounted for at the franchise, system, 
regional and/or company level(s) to the summary accounts listed below:
    (i) Ratebase:
    (A) Net Working Capital.
    (B) Headend.
    (C) Trunk and Distribution Facilities.
    (D) Drops.
    (E) Customer Premises Equipment.
    (F) Construction/Maintenance Facilities and Equipment.
    (G) Programming Production Facilities and Equipment.
    (H) Business Offices Facilities and Equipment.
    (I) Other Tangible Assets.
    (J) Accumulated Depreciation.
    (K) Plant Under Construction.
    (L) Organizational and Franchise Costs.
    (M) Subscriber Lists.
    (N) Capitalized Start-up Losses.
    (O) Goodwill.
    (P) Other Intangibles.
    (Q) Accumulated Amortization.
    (R) Deferred Taxes.
    (ii) Operating Expenses:
    (A) Cable Plant Employee Payroll.
    (B) Cable Plant Power Expense.
    (C) Pole Rental, Duct, Other Rental for Cable Plant.
    (D) Cable Plant Depreciation Expense.
    (E) Cable Plant Expenses--Other.
    (F) Plant Support Employee Payroll Expense.
    (G) Plant Support Depreciation Expense.
    (H) Plant Support Expense--Other.
    (I) Programming Activities Employee Payroll.
    (J) Programming Acquisition Expense.
    (K) Programming Activities Depreciation Expense.
    (L) Programming Expense--Other.
    (M) Customer Services Expense.
    (N) Advertising Activities Expense.
    (O) Management Fees.
    (P) General and Administrative Expenses.
    (Q) Selling General and Administrative Depreciation Expenses.
    (R) Selling General and Administrative Expenses--Other.
    (S) Amortization Expense--Franchise and Organizational Costs.
    (T) Amortization Expense--Customer Lists.
    (U) Amortization Expense--Capitalized Start-up Loss.
    (V) Amortization Expense--Goodwill.
    (W) Amortization Expense--Other Intangibles.
    (X) Operating Taxes.
    (Y) Other Expenses (Excluding Franchise Fees).
    (Z) Franchise Fees.
    (AA) Interest on Funded Debt.
    (BB) Interest on Capital Leases.
    (CC) Other Interest Expenses.
    (iii) Revenue and Income Adjustments:
    (A) Advertising Revenues.
    (B) Other Cable Revenue Offsets.
    (C) Gains and Losses on Sale of Assets.
    (D) Extraordinary Items.
    (E) Other Adjustments.
    (2) Small operators, as defined by Sec. 76.922(b)(5)(i), that file 
for cost of service regulation shall report all investments, expenses, 
and revenue and income adjustments accounted for at the franchise, 
system, regional and/or company level(s) to the following summary 
accounts:
    (i) Ratebase:
    (A) Net Working Capital.
    (B) Headend, Trunk and Distribution System and Support Facilities 
and Equipment.
    (C) Drops.
    (D) Customer Premises Equipment.
    (E) Production and Office Facilities, Furniture and Equipment.
    (F) Other Tangible Assets.
    (G) Accumulated Depreciation.
    (H) Plant Under Construction.
    (I) Goodwill.
    (J) Other Intangibles.
    (K) Accumulated Amortization.
    (L) Deferred Taxes.
    (ii) Operating Expenses:
    (A) Cable Plant Maintenance, Support and Operations Expense.
    (B) Programming Production and Acquisition Expense.
    (C) Customer Services Expense.
    (D) Advertising Activities Expense.
    (E) Management Fees.
    (F) Selling, General and Administrative Expenses.
    (G) Depreciation Expense.
    (H) Amortization Expense--Goodwill.
    (I) Amortization Expense--Other Intangibles.
    (J) Other Operating Expense (Excluding Franchise Fees).
    (K) Franchise Fees.
    (L) Interest Expense.
    (iii) Revenue and Income Adjustments:
    (A) Advertising Revenues.
    (B) Other Cable Revenue Offsets.
    (C) Gains and Losses on Sale of Assets.
    (D) Extraordinary Items.
    (E) Other Adjustments.
    (3) Cable operators shall not be required to report their 
investments, expenses and revenues to the summary accounts listed in 
paragraphs (d)(1) and (d)(2) of this section for purposes of adjusting 
rates based on changes in their external costs.
    (e) Allocation to service cost categories.
    (1) For cable operators electing cost-of-service regulation, 
investments, expenses, and revenues contained in the summary accounts 
identified in paragraph (d) of this section shall be allocated among 
the Equipment Basket, as specified in Sec. 76.923, and the following 
service cost categories:
    (i) Basic service cost category. The basic service category, shall 
include the cost of providing basic service as defined by 
Sec. 76.901(a). The basic service cost category may only include 
allowable costs as defined by Secs. 76.922(g) through 76.922(k).
    (ii) Cable programming services cost category. The cable 
programming services category shall include the cost of providing cable 
programming services as defined by Sec. 76.901(b). This service cost 
category shall contain subcategories that represent each programming 
tier that is offered as a part of the operator's cable programming 
services. All costs that are allocated to the cable programming service 
cost cateogry shall be further allocated among the programming tiers in 
this category. The cable programming service cost category may include 
only allowable costs as defined in Sec. 76.922(g) through 76.922(k).
    (iii) Nonregulated cable programming services cost category. The 
nonregulated cable programming service cost category shall include the 
cost of providing video programming that is not carried on either the 
basic service tier or a cable programming service tier. It includes 
video programming that is offered.
    (A) On a pay-per-channel basis;
    (B) On a pay-per-program basis; or
    (C) As any combination of multiple channels of pay-per-channel or 
pay-per-program video programming offered on a multiplexed or time-
shifted basis so long as the combined service consists of commonly-
identified video programming and is not bundled with any regulated tier 
of service.
    (iv) Other cable activities service cost category. The other cable 
activities service cost category shall include the cost of providing 
all cable services that are not included in the basic service, cable 
programming services, or nonregulated cable programming services 
categories. Other cable activities include leased commercial access, 
billing and collection services, studio and nonregulated equipment 
engineering and rental services, sale of nonregulated equipment, and 
maintenance of nonregulated equipment sold to customers.
    (v) Non-cable activities service cost category. The noncable 
service cost category shall include the cost of providing all 
activities of a cable operator that are not related to the provision of 
cable services.
    (2) Cable operators seeking an adjustment due to changes in 
external costs identified in FCC Form 1210 shall allocate such costs 
among the equipment basket, as specified in Sec. 76.923, and the 
following service cost categories:
    (i) The basic service category as defined by paragraph (e)(1)(i) of 
this section;
    (ii) The cable programming services category as defined by 
paragraph (e)(1)(ii) of this section;
    (iii) The nonregulated cable programming services cost category as 
defined by paragraph (e)(1)(iii) of this section;
    (iv) The other cable activities service costs category as defined 
by paragraph (e)(1)(iv) of this section; and
    (v) The non-cable activities service cost category as defined by 
paragraph (e)(1)(v) of this section.
    (f) Cost allocation requirements. (1) Allocations of investments, 
expenses and revenues among the service cost categories and the 
equipment basket shall be made at the organizational level in which 
such costs and revenues have been identified for accounting purposes 
pursuant to Sec. 76.924(c).
    (2) Costs of programming and retransmission consent fees shall be 
directly assigned or allocated only to the service cost category in 
which the programming or broadcast signal at issue is offered.
    (3) Costs of franchise fees shall be allocated among the equipment 
basket and the service cost categories in a manner that is most 
consistent with the methodology of assessment of franchise fees by 
local authorities.
    (4) Costs of public, educational, and governmental access channels 
carried on the basic tier shall be directly assigned to the basic tier 
where possible.
    (5) All other costs that are incurred exclusively to support the 
equipment basket or a specific service cost category shall be directly 
assigned to that service cost category or the equipment basket where 
possible.
    (6) Costs that are not directly assigned shall be allocated to the 
service cost categories in accordance with the following allocation 
procedures:
    (i) Wherever possible, common costs for which no allocator has been 
specified by the Commission are to be allocated among the service cost 
categories and the equipment basket based on direct analysis of the 
origin of the costs.
    (ii) Where allocation based on direct analysis is not possible, 
common costs for which no allocator has been specified by the 
Commission shall, if possible, be allocated among the service costs 
categories and the equipment basket based on indirect, cost-causative 
linkage to other costs directly assigned or allocated to the service 
cost categories and the equipment basket.
    (iii) Where neither direct nor indirect measures of cost allocation 
can be found, common costs shall be allocated to each service cost 
category based on the ratio of all other costs directly assigned and 
attributed to a service cost category over total costs directly or 
indirectly assigned and directly or indirectly attributable.
    (g) Cost identification at the franchise level. After costs have 
been directly assigned to and allocated among the service cost 
categories and the equipment basket, cable operators that have 
aggregated costs at a higher level than the franchise level must 
identify all applicable costs at the franchise level in the following 
manner:
    (1) Recoverable costs that have been identified at the highest 
organizational level at which costs have been identified shall be 
allocated to the next (lower) organizational level at which recoverable 
costs have been identified on the basis of the ratio of the total 
number of subscribers served at the lower level to the total number of 
subscribers served at the higher level.
    (2) Cable operators shall repeat the procedure specified in 
paragraph (g)(1) of this section at every organizational level at which 
recoverable costs have been identified until such costs have been 
allocated to the franchise level.
* * * * *
    (i) Transactions and affiliates. Adjustments on account of external 
costs and rates set on a cost-of-service basis shall exclude any 
amounts not calculated in accordance with the following:
    (1) Charges for assets purchased by or transferred to the regulated 
activity of a cable operator from affiliates shall equal the invoice 
price if that price is determined by a prevailing company price. The 
invoice price is the prevailing company price if the affiliate has sold 
a substantial number of like assets to nonaffiliates. If a prevailing 
company price for the assets received by the regulated activity is not 
available, the changes for such assets shall be the lower of their cost 
to the originating activity of the affiliated group less all applicable 
valuation reserves, or their fair market value.
    (2) The proceeds from assets sold or transferred from the regulated 
activity of the cable operator to affiliates shall equal the prevailing 
company price if the cable operator has sold a substantial number of 
like assets to nonaffiliates. If a prevailing company price is not 
available, the proceeds from such sales shall be determined at the 
higher of cost less all applicable valuation reserves, or estimated 
fair market value of the asset.
    (3) Charges for services provided to the regulated activity of a 
cable operator by an affiliate shall equal the invoice price if that 
price is determined by a prevailing company price. The invoice price is 
the prevailing company price if the affiliate has sold like services to 
a substantial number of nonaffiliates. If a prevailing company price 
for the services received by the regulated activity is not available, 
the charges of such services shall be at cost.
    (4) The proceeds from services sold or transferred from the 
regulated activity of the cable operator to affiliates shall equal the 
prevailing company price if the cable operator has sold like services 
to a substantial number of nonaffiliates. If a prevailing company price 
is not available, the proceeds from such sales shall be determined at 
cost.
    (5) For purposes of Sec. 76.924(i)(1) through 76.924(i)(4), costs 
shall be determined in accordance with the standards and procedures 
specified in Sec. 76.922 and paragraphs (b) and (d) of this section.
[FR Doc. 94-9078 Filed 4-14-94; 8:45 am]
BILLING CODE 6712-01-M