[Federal Register Volume 61, Number 47 (Friday, March 8, 1996)]
[Rules and Regulations]
[Pages 9361-9367]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-5427]



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FEDERAL COMMUNICATIONS COMMISSION
47 CFR Part 76

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


Cable Television Rate Regulation; Cost of Service Rules

AGENCY: Federal Communications Commission.

ACTION: Final rule.

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SUMMARY: The Commission has adopted the Second Report and Order and 
First Order on Reconsideration in MM Docket 93-215 to refine existing 
cost of service rules and to create final rules governing standard cost 
of service showings filed by cable operators seeking to justify rates 
for regulated cable services. By refining these rules, the Commission 
brings greater practicality to cost of service filing procedures and 
allows operators and regulatory officials increased flexibility in 
defining the actual costs of providing regulated cable services.

EFFECTIVE DATE: This final rule contains information collection 
requirements and will not become effective until approval by the Office 
of Management and Budget, but no sooner than 30 days after publication 
in the Federal Register. The Commission will publish a document 
specifying the effective date.

FOR FURTHER INFORMATION CONTACT: Tom Power, Cable Services Bureau, 
(202) 416-0800.

SUPPLEMENTARY INFORMATION: This is a synopsis of the Second Report and 
Order, First Order on Reconsideration and Further Notice of Proposed 
Rulemaking in MM Docket No. 93-215, FCC 95-502, adopted December 15, 
1995 and released January 26, 1996.
    This Second Report and Order and First Order on Reconsideration 
contains modified information collections subject to the Paperwork 
Reduction Act of 1995 (``PRA''), Pub. L. No. 104-13. It has been 
submitted to the Office of Management and Budget (``OMB'') for review 
under Section 3507(d) of the PRA. OMB, the general public, and other 
Federal agencies are invited to comment on the modified information 
collections contained in this proceeding.
    The complete text of this Second Report and Order, First Order on 
Reconsideration and Further Notice of Proposed Rulemaking is available 
for inspection and copying during normal business hours in the FCC 
Reference Center (room 239), 1919 M Street, NW., Washington, DC, and 
also may be purchased from the Commission's copy contractor, 
International Transcription Services, Inc. (``ITS Inc.'') at (202) 587-
3800, 2100 M Street, NW., Suite 140, Washington, DC 20017.

I. Second Report and Order and First Order on Reconsideration

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

    1. In general, except as described below, we make permanent our 
interim rules regarding ratebase issues. We clarify that used and 
useful plant is plant that is actually used to send signals to 
customers. Plant which is not currently used and useful, however, is 
excess capacity, and operators may include this excess capacity in the 
ratebase only if it is fully constructed plant that will be used to 
provide regulated service within 12 months. The Commission clarifies 
that there are two types of excess capacity. First, where plant is 
being used but not to its full capacity, the portion of the plant 
allocated to the unused channels is excess capacity. For example, where 
a system provides programming over 36 channels but is capable of 
transmitting 48 channels of programming, the plant associated with the 
12 channels not currently being used is excess capacity. In other 
words, in this example, the operator may only include 75% of the cost 
of the plant in the ratebase as used and useful plant, and may include 
the other 25% as excess capacity only if the 12 channels will be 
activated within one year. Second, excess capacity is fully constructed 
plant that is not being used at all, such as where the cable operator 
has extended its distribution line into an unserved portion of the 
franchise area, is ready and able to provide service to that area, but 
is not yet providing such service. The operator may include such plant 
in its ratebase to the extent it intends to place the plant into 
service within 12 months. However, the operator must make a 
corresponding adjustment to its subscriber count to include a 
reasonable estimate of the number of subscribers it expects to serve 
with that plant by the end of the 12 month period.
    2. The Commission also clarifies that plant in service must be 
allocated between regulated and unregulated services based on a 
reasonable measure of the current usage of that plant. Section 
76.922(g)(6)(i) of our rules currently uses the phrase ``used and 
useful in the provision of cable services,'' but does not specify that 
such cable services must be regulated cable services. Since our 
authority to determine cable rates extends only to regulated services 
as defined by the Communications Act, only plant used and useful in the 
provision of regulated services should be included in the ratebase. 
Accordingly, for our final rules, we will make this point explicit 

[[Page 9362]]
and will amend the interim rule to specify that tangible plant must be 
used and useful in the provision of regulated cable services in order 
to be included in the ratebase. This will ensure that the ratebase for 
regulated cable service only includes plant used for such regulated 
cable service, and that subscribers to regulated tiers are not forced 
to subsidize plant that is used solely for premium services.
    3. In addition, we recognize that what constitutes a reasonable 
measure of the current usage of the tangible plant depends on the 
circumstances. We believe that in many cases a reasonable measure would 
be a straight channel ratio. In other words, if an operator provides 
programming over a total of 40 channels, 32 of which are BST and CPST 
channels and eight of which are premium and pay-per-view channels, the 
operator must allocate 80% of its plant in service to regulated cable 
service and 20% to unregulated service. We do not believe, however, 
that the channel ratio should be weighted by customer. The cost of 
physical plant is directly related to the provision of cable channels 
and the amount of channel capacity which exists on a particular cable 
system. The cost of that plant does not vary depending on how many 
subscribers receive each channel. It would be inappropriate to weight 
the channel ratio by subscriber use when such use does not affect the 
cost of the plant.
    4. With regard to the time period within which excess capacity must 
be used and useful in order to be included in ratebase, we adopt the 
interim rule of one year as our final rule. For business purposes, 
operators commonly project how much capacity will be used within the 
given year as part of their annual operating budgets. We believe that 
the 12 month period therefore permits plant associated with all 
reasonably foreseeable improvements in or additions to service to be 
included in ratebase.

B. Ratebase--Intangibles

    5. Previously, we had concluded that one reason we should not rely 
on acquisition prices for ratemaking was that it appeared that those 
prices often include an expectation of supra-competitive profits that 
market power of cable systems not operating in a fully competitive 
market might expect to generate.
    6. We continue to reject the argument that operators are entitled 
to include 100% of their intangible costs in the ratebase. Exclusion of 
some amount of these costs from the ratebase does not result in an 
impermissible taking without just compensation in violation of the 
Fifth Amendment. We have no constitutional duty to ensure full recovery 
of these acquisition costs, we must only ensure that the end result of 
our ratemaking decisions here is reasonable.
    7. We continue to believe that the ratebase should not include 
costs resulting from any expectation of monopoly profits or expectation 
of a return on emerging and unregulated services, which we believe the 
presumptive exclusion of such acquisition costs ensures. However, upon 
further reflection and based upon our review of cost of service 
filings, we believe this presumption can be modified, without 
sacrificing this conclusion.
    8. Therefore, we have created a new rule, applicable to systems 
conveyed prior to the effective date of the interim cost rules, with 
respect to the treatment of intangible assets. We find the model in 
which 34% of the purchase price of a system is presumed to be 
attributable to monopoly expectations, to be the one best suited to 
these goals.
    9. Our final rule presumes, rebuttably, that 34% of the purchase 
price associated with regulated services of systems purchased prior to 
regulation represents monopoly expectations and must be removed from 
the regulated ratebase. Put differently, the ratebase presumptively 
shall not exceed 66% of that portion of the system price allocable to 
assets used to provide regulated services. The 34% adjustment must be 
applied to the entire purchase price associated with regulated 
services, not just the portion of the price allocable to intangibles, 
because cable operators derive revenues, including monopoly revenues, 
from the employment of both tangible and intangible assets. Applying 
the 34% adjustment to all assets associated with regulated services, 
rather than only to the associated intangibles, should remove all 
expectations of monopoly profits.
    10. As noted, we recognize that this approach necessarily involves 
the use of industry-wide averages with respect to certain variables 
that, while reasonable, will not always reflect with perfect accuracy 
the circumstances of particular operators. To the extent the 34% 
adjustment is inexact for certain operators, we are particularly 
concerned that this adjustment could be used to raise rates 
unreasonably, given our statutory mandate to guard against unreasonable 
rates. Therefore, we will allow use of the 34% adjustment only for the 
purpose of justifying rates in effect as of the effective date of these 
rules. We believe that this represents a reasonable compromise between 
the overall integrity of the analysis used to arrive at the 34% 
adjustment and the concern we have that in some cases this adjustment 
could prove overly generous to operators. Accordingly, in cost of 
service cases to which the 34% adjustment is applicable, the operator 
may include in the ratebase up to 66% of the purchase price allocable 
to assets used to provide regulated services, but only to the extent 
necessary to justify rates in effect as of the effective date of these 
rules. If the current rate can be justified by including in the 
ratebase less than the 66% amount, then in no event shall the operator 
seek to use a higher percentage for purposes of any cost of service 
showing.
    11. This adjustment shall be applied only to the purchase price of 
systems sold prior to May 15, 1994, the effective date of the Report 
and Order and Further Notice of Proposed Rulemaking, MM Docket 93-215, 
9 FCC Rcd 4527 (1994) (``Cost Order'' or ``Further Notice''). The 
interim rule is made permanent with respect to systems sold after this 
date. Operators who acquired systems after May 15, 1994 were aware of 
the interim rule strictly limiting the ability to recover the cost of 
intangible assets. Thus, to the extent such operators recorded 
substantial intangibles, we presume those intangibles are associated 
with investment in unregulated services. As such, they cannot be 
included in the regulated ratebase.
    12. Generally, operators using the cost of service to justify 
current rates for the first time, will be able to do so using the 34% 
adjustment. In some rare cases, however, this adjustment may not be 
adequate. For instance, if an operator acquired a system with tangible 
assets equal to 70% of the purchase price, obviously allowing a 
ratebase equal to 66% of the purchase price may not allow the operator 
to recover reasonably incurred costs. Similarly, if the tangible assets 
represent 64% of the purchase price, the remaining 2% may not 
adequately compensate the operator for reasonably incurred intangible 
assets. Therefore, where the tangible assets approach 66% of the 
purchase price, the operator may justify rates using 100% of the 
tangible assets and such intangible assets as are permissible using the 
interim rules.
    13. We further believe it appropriate to adjust our interim rule 
concerning deferred income taxes. We will now require operators to 
deduct deferred income taxes from the ratebase only to the extent that 
such taxes accrued after 

[[Page 9363]]
the date the operator became subject to rate regulation.

C. Ratebase-Start-Up Losses

    14. We are persuaded that the treatment of prior year losses in the 
Cost Order should be amended. We find that we should not prescribe a 
specific prematurity phase, rather we find that we should define the 
prematurity phase as the actual period during which expenses exceed 
revenues. Although we find that the interim rule should be modified, we 
continue to reject the claims of commenters who argue that the 
wholesale inclusion of start-up losses in the ratebase is warranted. We 
also reject the assertion that we should allow deferred earnings into 
ratebase. To do so would artificially inflate the ratebase.
    15. Thus, we find it appropriate to redefine our current definition 
of prematurity so as to account for the specific circumstances 
experienced by individual operators rather than continuing to use the 
FASB 51 standard. We are persuaded by the arguments that limitations on 
start-up losses should be governed by the history of individual 
operators. For capitalized start-up losses, build and hold operators 
should be permitted to recover reasonably incurred cumulative net 
losses, plus any unrecovered interest expenses connected to funding the 
regulated ratebase, over the unexpired life of the longest lived asset 
in the regulated ratebase, commencing with the end of the loss 
accumulation phase. In most cases, acquired systems will have recorded 
accumulated start-up losses as goodwill or as some other form of 
intangibles. To the extent that purchased systems can demonstrate that 
start-up losses have been recorded as goodwill or some other category 
of intangibles, these losses shall be allowed just as if they had been 
recorded as start-up losses and the system must itemize its assets 
instead of using the 66% purchase price allowance methodology described 
above. In allowing this however, we must emphasize this should not be 
interpreted as authority for the wholesale inclusion of goodwill. The 
burden remains on the operator to demonstrate that any portion of a 
class of assets is derived from start-up losses.
    16. The end of the accumulation phase (i.e., the prematurity phase) 
will vary from system to system, depending upon the experience of the 
particular system at issue. By allowing the recovery to occur over the 
unexpired life of the longest lived asset in the regulated rate base 
rather than the remainder of the franchise life, the amortization 
period for purchased systems will realistically reflect the expected 
period during which the operating losses can be recovered.

D. Ratebase-Tangibles

    17. We continue to believe that original cost is a reliable and 
fair measure of the value of tangible assets. However, our review of 
cost of service filings reveals that in many instances it could be 
difficult, if not impossible, to determine the original cost of a 
tangible asset. To accomodate this reality, for cable systems 
constructed before May 15, 1994, we will allow operators to use the 
book value that was recorded as of May 15, 1994, regardless of whether 
the system was built or acquired by the current operator. We will 
continue to require that original cost be used for cable systems 
constructed after May 15, 1994. Also, an operator that acquires 
individual cable assets, such as converters or remotes, at arms' length 
after May 15, 1994 may use its original cost for those items, rather 
than its seller's original cost.
    18. An exception may apply to the original cost rule in the case of 
assets acquired in an arms-length transaction and without 
subscribership. In such instances, assets may be recorded at fair 
market value. Thus, where a cable operator sells converters, for 
example, to an unaffiliated operator to be used in a different 
franchise location, it is acceptable for the acquiring operator to 
record such converters at fair market value, that is, at the price the 
acquiring operator paid for them.

E. Rate of Return

    19. In the Cost Order, we established a single overall rate of 
return for cable cost of service proceedings. The presumptive rate was 
set at 11.25% after taxes, although operators could seek different 
rates if they believed their circumstances justified different rates. 
The burden of such justification is high, however, and local 
authorities may counter an operator's effort to obtain a higher rate 
with evidence to justify a rate below 11.25%. The presumptive 11.25% 
rate was selected over individualized rates of return to avoid the 
imposition of undue administrative burdens.
    20. The Commission will retain this 11.25% presumptive rate. We are 
guided to this conclusion by the general absence of challenges to the 
presumptive rate and our continued concern that the effort to set an 
appropriate rate of return not be overwhelmed by administrative 
difficulties that individualized rate estimations could entail. We 
recognize, however, that a unitary presumptive rate does not provide 
the most accurate estimation of capital costs for the full range of 
operators seeking to set cable rates in a cost of service filing. The 
Commission is interested in developing a rate of return formula that 
better accommodates capital cost differences among cable operators 
without imposing unreasonable administrative burdens on operators, 
franchise officials and the Commission. We will therefore proceed with 
a further notice of proposed rulemaking to solicit input regarding the 
development of an alternative rate of return formula. An alternative 
formula, if adopted, would serve as an alternative to the current 
presumptive rate method. It would not replace it.

F. Depreciation

    21. We indicated in the Further Notice that industry practices with 
respect to depreciation would shape our ultimate resolution of the 
issue. Since release of the Further Notice, we have had the opportunity 
to review numerous cost of service filings. These filings demonstrate 
that some operators often do not follow any industry standards or other 
specific guidelines in establishing the useful lives of their assets 
for purposes of depreciation, or with respect to other aspects of their 
cost of service filings. As a result, the claimed useful life of a 
particular asset category can vary significantly among cable operators, 
even though they all use the same type of equipment and hence should be 
claiming roughly the same useful life in most instances. Some variation 
in the claimed useful lives is to be expected since, for example, 
management plans to replace equipment will affect its useful life and 
will vary among operators. Thus, when we adopted the interim rules with 
respect to depreciation, we expressly provided for case-by-case review 
of filings. However, we neither intended nor expected the substantial 
variations that the Form 1220s reveal. Our experience since adoption of 
the Cost Order now convinces us that the benefits of standardizing the 
useful lives of assets underlying depreciation rates outweigh any 
resulting burdens.
    22. The absence of specific standards or guidelines with respect to 
useful lives creates uncertainty for operators and regulators alike 
and, at the local level, creates the risk of inconsistent treatment of 
similarly situated operators, given the varying practices of the 
operators and the discretion given to franchising authorities. These 
factors necessitate heightened scrutiny of cost of service cases before 
the Commission, as our 

[[Page 9364]]
staff endeavors to ensure that the rates charged for regulated services 
are the product of reasonable estimations of useful lives. To provide 
for consistent treatment of these issues and to ease burdens on 
operators and regulators, we believe it prudent to establish some 
certainty and uniformity with respect to several issues.
    23. Depreciation schedules. A staff survey of cost of service 
filings reveals significant disparities in the useful lives claimed by 
cable operators with respect to specific assets. Although for each 
particular asset category there are a substantial number of filers 
claiming useful lives within a relatively small range, there are also a 
significant number of outliers whose claimed useful lives appear to be 
inappropriate. With respect to headends, for example, 22% of filers 
claimed a useful life of between seven and nine years while 18% claimed 
between 15 and 16 years. For transmission facilities, 33% of filers set 
the useful life at five to six years, while 23% claimed lives of 
between 15 and 16 years.
    24. The variations in the useful lives of various assets, as 
claimed by cable operators, are due in part to the absence of 
depreciation schedules in the interim cost rules, which forces 
operators to establish the useful lives of their assets on some other 
basis. Thus, it appears that operators do not have a great deal of 
specific guidance from any source in this regard, resulting in the 
variations described above.
    25. Local franchising authorities face a similar lack of guidance 
when they attempt to determine the reasonableness of the useful lives 
that their cable operators claim. And the Commission staff that reviews 
the cost of service filings, in an effort to ensure equal treatment of 
similarly situated cable operators, must attempt to reconcile the 
substantial differences reflected in the individual filings.
    26. To eliminate the uncertainty described above, and to facilitate 
more uniform depreciation practice for use in computing rates for 
regulated cable services, we will adopt a flexible range of useful 
lives for use by cable operators seeking to justify depreciation rates 
in cost of service filings. In general, we have used the data available 
from these filings to develop a range of years defining the useful life 
of each of the relevant asset categories identified in Section C, Item 
9 of Form 1220, as follows:

------------------------------------------------------------------------
                                                             Useful life
                         Category                              (years)  
------------------------------------------------------------------------
a. Headend................................................    8-13      
b. Transmission Facilities and Equipment..................    6-14      
c. Distribution Facilities................................   10-15      
d. Circuit Equipment......................................    7-14      
e. Maintenance Facilities.................................   17-35      
f. Maintenance Vehicles and Equipment.....................     3-7      
g. Buildings..............................................   18-33      
h. Office Furniture and Equipment.........................    9-11      
------------------------------------------------------------------------

    27. These figures are derived from 600 cost of service filings. 
Such filings, including the depreciation data, are required to be made 
in accordance with generally accepted accounting principles (``GAAP''). 
GAAP does not dictate specific useful lives, but rather provides 
general guidelines. Thus, the useful lives reported on the cost-of-
service filings reflect, to some extent, the subjective judgments of 
the operators making the filings. To the extent certain aspects of 
particular filings raise concerns, we have made adjustments 
accordingly. For example, we excluded from the observation pool as 
facially unreasonable the filings of a number of systems that claimed a 
useful life of one year for all of their assets.
    28. Having made such adjustments, staff arrived at an average 
useful life for each asset category. Staff then established a range, by 
taking one standard deviation from the average useful life for each 
asset category. Each end of the range was then rounded to the nearest 
whole number. We have chosen a range of years, rather than dictating 
the use of a unitary figure, to provide operators with flexibility in 
determining depreciation rates for their particular systems, although 
still within reasonable bounds. By prescribing a range of years, we 
will permit operators to take into account factors that reflect 
characteristics of their individual systems. For example, the useful 
life of a cable distribution system might vary depending upon the 
presence and nature of a competing multichannel video programming 
distributor (``MVPD''). Depending upon whether the competing MVPD 
offers interactivity and other advanced features, the cable operator 
reasonably might determine that these factors will alter the 
obsolescence, and hence change the depreciation period, of the 
operator's assets that do have such features. Thus, while the ranges we 
have prescribed will provide for more consistent depreciation practices 
between cable operators, we do not believe it is necessary or prudent 
to deprive cable operators of all discretion to judge the appropriate 
useful life of their own property. However, operators seeking to 
establish useful lives that fall outside the prescribed ranges will 
have to justify such claims on a case-by-case basis.
    29. Given the number of filings, the requirements of GAAP, the 
ability of operators to adjust for their individual circumstances, and 
the refinements and adjustments made by the staff, we are confident 
that the survey captures a representative sampling of data and produces 
a fair and reasonable range of years for each asset category.
    30. For any asset category, we will presume the reasonableness of 
the useful life claimed by an operator if it falls within the range 
prescribed above. An operator may seek to depreciate assets over a 
period of time other than that which we have prescribed, but in that 
case the operator will have the burden of establishing the 
reasonableness of the period it has chosen. Thus, while furthering the 
goals of certainty and uniformity in the area of depreciation rates, 
our approach will be flexible enough to account for those unique 
circumstances in which an operator can demonstrate the reasonableness 
of a rate that falls outside of the prescribed range.
    31. In addition, we will require the operator to depreciate its 
assets in accordance with the straight-line methodology. Our review of 
the Form 1220s on file with the Commission suggests that some operators 
are using accelerated depreciation methodologies to increase the amount 
of their depreciation expense and thus to increase rates. While there 
are contexts in which accelerated deprecation is a legitimate practice, 
we have been presented with insufficient justification to show that it 
would be appropriate for purposes of establishing rates under our cable 
cost of service rules.
    32. Test-year data. Our cost of service rules establish a maximum 
permitted rate based on the operator's costs and ratebase as 
established during the test year, which is the operator's most recent 
fiscal year. In some instances, an operator will be able to time the 
filing of its 1220 such that the test year will be one in which 
unusually high depreciation write-offs were taken. Higher depreciation 
expenses translate into higher permitted rates, since rates must cover 
expenses. Thus, to the extent the operator can control the timing of 
its filing, it can justify rates that are higher than would be 
permitted were the operator to use data from a more representative 12 
month period. The staff review of the Form 1220s suggests that some 
operators are pursuing precisely this strategy and thus artificially 
inflating rates. 

[[Page 9365]]

    33. Our new rules prescribing depreciation schedules and requiring 
straight-line depreciation should help to curb this practice. Where it 
nevertheless appears that the test-year data include unreasonably high 
depreciation write-offs, the operator should determine the extent to 
which the depreciation claimed for the test year exceeds normal 
depreciation and exclude the excess from the ratebase.
    34. Relevance of Franchise Life in Defining Useful Life of Assets. 
The cost of service filings indicate that operators often claim that 
the useful life of cable system assets cannot exceed the term of the 
cable franchise, based on the proposition that the termination of the 
franchise renders the assets useless. However, this presumes that 
operators generally are unsuccessful at renewing the franchise, a 
premise for which there is no evidence and which conflicts with the 
general experience of the industry. Even in the event of a non-renewal, 
the operator might sell its asset to the new cable franchisee and 
thereby realize the value associated with its actual remaining life. 
For these reasons, we will presume that the term of the franchise is 
not relevant for purposes of determining the useful life of cable 
system assets, again subject to rebuttal by the operator if it can 
show, for example, some threat that its franchise will not be renewed 
and that in the event of non-renewal the operator will not be able to 
recover the value of its assets.

G. Taxes

    35. In the Cost Order, we provided for the recovery in income taxes 
as an expense incurred by operators as a consequence of providing 
regulated cable services. Commenters have argued that capital structure 
assumptions used to calculate the tax expense should parallel the 
capital structure assumptions used to estimate the rate of return.
    36. We agree that use of actual capital structures is the 
appropriate method of estimating the equity portion subject to tax 
recovery when the actual, or individualized, capital structure of an 
operator is used to establish the rate of return. Accordingly, if we 
adopt the proposed alternative to use actual capital structures when 
calculating the rate of return, we will rely on actual capital 
structures derived from the rate of return analysis to determine the 
amount of tax recovery for operators using the alternative to the 
presumptive 11.25% rate. However, when hypothetical structures are used 
to set the rate of return under the initial Cost Order method, we will 
employ the same capital structure assumptions used in such analysis to 
the tax calculation.
    37. With respect to distributions to individual owners of non-
Chapter C entities, we will continue to adjust the income calculation 
for estimating allowed taxes. We recognize that entities other than 
Chapter C corporations may pass through income directly to the 
individual owners and that this income may have been derived from the 
provision of regulated cable services. Nevertheless, we will continue 
to adhere to the traditional principle of adjusting the income tax 
amount to ensure that ratepayers do not pay the taxes of individuals 
who are structurally separate from the entity providing the regulated 
service.

H. Cost Allocation

    38. While our current cost allocation rules require direct 
assignment of costs, the rules also allow for operator flexibility in 
determining specific allocators and allocation schemes. Accordingly, we 
affirm the Commission's current cost allocation requirements, with the 
exception of our rule which requires cost allocation of non regulated 
costs to specific non regulated service categories, which we remove. We 
also clarifiy that, within our current cost allocation methods which 
are affirmed by the Order, revenues must be matched with underlying 
expenses between related lines on FCC Form 1220, and that allocators 
need to be consistent.
    39. The general propositions upon which we continue to base our 
cost allocation requirements are as follows: (1) costs shall be 
directly assigned among the equipment basket and service cost 
categories whenever possible; (2) costs that cannot be directly 
assigned and which no allocator has been specified by the Commission 
are to be allocated based on direct analysis of the origin of the 
costs, and where allocation based on direct analysis is not possible, 
operators must attempt to make a cost causative linkage to other costs 
directly assigned or allocated to the service cost categories and the 
equipment basket; and (3) for costs that cannot be directly assigned 
and for which no indirect measures of cost allocation can be found, 
such costs shall be allocated to each service cost category based on 
the ratio of all other costs directly assigned and attributed to a 
service cost category over total costs directly or indirectly assigned 
and directly or indirectly attributable.
    40. We eliminate cost allocation of non-regulated costs to specific 
non-regulated service categories. While the requirement may in some 
limited instances enable us to more readily ascertain the bases for 
cost allocations to regulated categories, we believe that it would be 
overly burdensome to continue to include this requirement in our rules. 
Therefore, we amend our rules to remove the requirement that non-
regulated costs must be allocated among the non-regulated programming 
service categories, other cable activities, and non-cable activities 
categories, and replace these categories with a single ``all other'' 
service cost category. Accordingly, operators electing cost of service 
regulation and cable operators seeking an adjustment to external costs 
shall allocate costs among the equipment basket and the following 
service cost categories: (1) BST, (2) CPST, and (3) all other. The 
``all other'' service cost category shall include all costs not 
included in the BST or CPST service cost categories.
    41. We decline to adopt a ``weighted channel'' approach to cost 
allocation. Generally, incremental increases in plant investment are 
driven by the number of channels added, irrespective of subscribership 
to BST channels. The number of subscribers does not impact costs in 
most cable equipment categories. Accordingly, we believe that in most 
cases, a straight channel ratio would be a reasonable approach to the 
allocation of plant costs amongst service baskets.
    42. We also reject the proposition that advertising revenues and 
home shopping services be assigned to the ``other cable services'' 
category. The allocation approach for cost of service showings 
reflected in FCC Form 1220 indicates that revenues received for 
advertising and home shopping on a regulated tier should be allocated 
to that tier, and used as an offset to providing service on that tier. 
We adopted this approach because advertising and home shopping shown on 
regulated channels employ regulated assets and, consequently, these 
revenues should be distributed as offsets to the regulated tier revenue 
requirements.

I. Accounting Requirements

    43. In the Cost Order, we stated that we would adopt a uniform 
system of accounts for those cable operators that elect cost of service 
regulation. We concluded that until a uniform system of accounts could 
be finalized, operators electing cost of service regulation should use 
an interim summary accounting system. Under the interim system that we 
adopted, operators using FCC Form 1220 identify costs in 55 summary 
level accounts, and small operators using FCC Form 1225 identify costs 
in 32 summary level accounts. 

[[Page 9366]]
Operators are required to identify all amounts associated with each 
revenue and cost category at the franchise, system, regional and/or 
company level, depending on the organizational level at which the 
operator identified revenues and costs for accounting purposes as of 
April 3, 1993. Local franchising authorities and the Commission may 
require operators to provide any additional financial data and 
explanations necessary to substantiate a cost of service filing and may 
order appropriate disallowances if an operator fails to provide a 
reasonable response.
    44. We now conclude that a uniform system of accounts would be 
unnecessarily burdensome for cable operators at this time. Our review 
of the cost of service filings has shown that FCC Forms 1220 and 1225 
generally provide a sufficiently detailed basis for evaluating 
operators' rates. The additional detail provided by a uniform system of 
accounts would be of limited value since most of the filing defects we 
have discovered thus far are company-specific and would not have been 
prevented by a uniform accounting system. Our practice of issuing 
deficiency letters when questions arise has proved to be an adequate 
means of clarifying data. Therefore, we agree that investing the time 
required to develop a uniform system would be counter-productive to 
achieving our objective to process cases as expeditiously as possible. 
We are also persuaded that imposing a different accounting system on 
the relatively few systems filing cost of service justifications may 
create administrative inefficiencies for cable operators. Therefore, we 
will not adopt a uniform accounting system but will require operators 
electing cost of service regulation to follow the accounting standards 
required by FCC Forms 1220 and 1225, thus making permanent our interim 
accounting standards.

J. Affiliate Transactions

    45. In the Cost Order, we promulgated rules for valuing 
transactions between cable operators and affiliated companies. These 
rules were designed to prevent favorable self-dealing between 
affiliated companies in order to manipulate our rate rules. We defined 
an affiliated entity as one that shares a 5% or greater ownership 
interest with the cable system operator. The interim rules require an 
affiliated transaction to be valued at the ``prevailing company 
price,'' if the provider has sold the same kind of asset or services to 
a substantial number of third parties at a generally available price. 
If the provider has not been engaged in similar transactions with a 
substantial number of third parties, the rules distinguish between the 
sale of an asset and the sale of a service (for the purposes of 
evaluating affiliate transactions, programming is considered an asset). 
If the transaction involves an asset, the cable operator is required to 
value the transaction at the higher of cost or fair market value when 
the cable operator is the seller and the lower of cost or fair market 
value when the cable operator is the purchaser. If the transaction 
involves a service and no prevailing company price can be established, 
the cable operator is required to value the service at the service 
provider's cost.
    46. We reject the argument to permit a window for new services, 
i.e., until they can market their services to a substantial number of 
third parties. In a competitive market, programmers would not be able 
to subsidize new services with higher rates for competitive services. 
Similarly, in a regulated industry, programmers cannot expect regulated 
ratepayers to subsidize new programming ventures.
    47. We also requested comment on an appropriate method of valuing 
an asset absent a prevailing company price. Ruling that cable operators 
are permitted to value services at the provider's cost is consistent 
with the current rules for telephone companies and there appears to be 
no reason to distinguish the two industries in this particular context. 
This is especially true in light of the more liberal definition of 
prevailing company price in the cable services regulatory scheme.
    48. We also find that the current definition of ``affiliate'' is 
consistent with the definition used elsewhere in the cable services 
regulatory scheme.
    49. Finally, we requested comment as to whether the interim 
affiliate transaction rules should be incorporated into a uniform 
system of accounts. Since we have found that no need exists at this 
time to adopt a uniform system of accounts, this point is moot.

K. Hardship Rate Relief

    50. In the Cost Order, we recognized that, in certain extraordinary 
cases, rate regulation under either the benchmark or cost of service 
mechanisms would threaten an operator's financial health or ability to 
provide service. In such situations, an operator may obtain special 
rate relief by demonstrating that rate regulation using either of the 
two standard rate-setting options would cause such financial harm that 
the operator would be unable to attract capital or maintain credit 
necessary to operate, despite prudent and efficient management. The 
operator must show that the requested rate relief would not be 
unreasonable or exploitative of customers. In other words, rates cannot 
be excessive compared to competitive rates of similarly situated 
systems. Hardship showings must be made for the MSO level, or the 
highest level of the operator's cable system organization. Operators 
that submit an adequate initial showing of facts which, if proved, 
might warrant special relief, are subsequently given the opportunity to 
prove the facts alleged in the showing.
    51. We now believe that the process could be shortened by 
eliminating the requirement of an initial showing. We will therefore 
allow operators to combine the requirements of the initial factual 
showing and the subsequent evidentiary showing into one pleading.
    52. We continue to believe that we are authorized to consider an 
operator's unregulated revenues when determining eligibility for 
hardship relief. An evaluation of an operator's financial health that 
is based on only a portion of the operator's revenues would be 
incomplete and inaccurate. Similarly, it is appropriate to consider a 
hardship pleading in light of an operator's revenues measured at the 
highest level of the operator's organization. Hardship relief is an 
extraordinary relief measure reserved for operators whose overall 
financial health would be seriously threatened under the standard rate 
regulation mechanisms. It is not designed to bail out struggling cable 
systems that are owned and operated by prosperous MSOs. Lastly, the 
requirement that rates cannot be excessive compared to competitive 
rates of similarly situated systems does not mean that rates cannot 
exceed competitive rates. Rather, we expect operators to show that 
their rates would not exceed competitive rates to a degree that would 
be unreasonable.

II. Regulatory Flexibility Analysis

A. Final Regulatory Flexibility Act Analysis for the Second Report and 
Order and First Order on Reconsideration

    53. Pursuant to the Regulatory Flexibility Act of 1980, 5 U.S.C. 
Secs. 601-12, the Commission's final analysis with respect to the 
Second Report and Order and First Order on Reconsideration is as 
follows:
    54. Need and purpose of this action: The Commission, in compliance 
with Section 3 (b) and (c) of the Cable Television Consumer Protection 
and Competition Act of 1992 pertaining to rate regulation, adopts rules 
and procedures intended to ensure cable subscribers of reasonable rates 
for cable 

[[Page 9367]]
services with minimum regulatory and administrative burden on cable 
entities.
    55. Summary of issues raised by the public in response to the 
Initial Regulatory Flexibility Analysis: There were no comments 
submitted in response to the Initial Regulatory Flexibility Analysis. 
The Chief Counsel for Advocacy of the United States Small Business 
Administration filed comments in the original rulemaking order. The 
Commission addressed these comments in the Rate Order ( MM Docket No. 
92-266, FCC 93-177, 8 FCC Rcd 5631 (1993)). The Chief Counsel for 
Advocacy of the United States Small Business Administration also filed 
comments in response to the Further Notice of Proposed Rulemaking. 
Those comments are addressed herein.
    56. Significant alternatives considered and rejected. Petitioners 
representing cable interests and franchising authorities submitted 
several alternatives aimed at minimizing administrative burdens. In 
this proceeding, the Commission has attempted to accommodate the 
concerns raised by these parties. For example, the revised rules 
regarding action on rate complaints within two years of a cost of 
service showing are designed to reduce burdens on both industry and 
regulators. In addition, the revised rules also reduce burdens on both 
industry and regulators by simplifying certain calculations involved in 
producing and reviewing a cost of service showing.

III. Paperwork Reduction Act

    57. The Requirements adopted herein have been analyzed with respect 
to the Paperwork Reduction Act of 1980 and found to impose a new or 
modified information collection requirement on the public. 
Implementation of any new or modified requirement will be subject to 
approval by the Office of Management and Budget as perscribed in the 
Act.

IV. Ordering Clauses

    58. Accordingly, it is ordered that the Petitions for 
Reconsideration are granted in part, denied in part, and to the extent 
that Petitions raise issues unresolved in this order, they will be 
disposed of in future orders.
    59. It Is further ordered that, pursuant to Sections 4(i), 4(j), 
623 (b) and (c) of the Communications Act of 1934, as amended, 47 
U.S.C. 154(i), 154(j), 543(b) and (c) the rules, requirements and 
policies discussed in this Second Report and Order and First Order on 
Reconsideration are adopted and Sections 76.922 and 76.924 of the 
Commission's rules, 47 CFR 76.922 and 76.924, are amended as set forth 
below.
    60. It is further ordered that the requirements and regulations 
established in this decision shall become effective upon approval by 
the Office of Management and Budget of the new information collection 
requirements adopted herein, but no sooner than thirty (30) days after 
publication in the Federal Register.
    61. It is further ordered that the Secretary shall send a copy of 
this Second Report and Order, First Order on Reconsideration, and 
Further Notice of Proposed Rulemaking, including the Initial Regulatory 
Flexibility Analysis, to the Chief Counsel for Advocacy of the Small 
Business Administration in accordance with paragraph 603(a) of the 
Regulatory Flexibility Act, Pub. L. No. 96-354, 94 Stat. 1164, 5 U.S.C. 
Secs. 601 et seq. (1981).

List of Subjects in 47 CFR Part 76

    Cable television, Reporting and recordkeeping requirements.

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

Rule Changes

    Part 76 of Title 47 of the Code of Federal Regulations is amended 
as follows:

PART 76--CABLE TELEVISION SERVICE

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

    Authority: Sections 2, 3, 4, 301, 303, 307, 308, 309, 48 Stat., 
as amended 1064, 1065, 1066, 1081, 1082, 1083, 1084, 1085, 1101; 47 
U.S.C. 152, 153, 154, 301, 303, 307, 308, 309; 612, 614-615, 623, 
632 as amended, 106 Stat. 1460, 47 U.S.C. 532; 623, as amended, 106 
Stat. 1460; 47 U.S.C. 532, 533, 535, 543, 552.

    2. Section 76.922 is amended by revising paragraphs (i)(6)(i) and 
(i)(7), redesignating paragraphs (i)(6)(ii) through (i)(6)(vii) as 
paragraphs (i)(6)(iii) through (i)(6)(viii) respectively, and adding a 
new paragraph (i)(6)(ii) to read as follows:


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

* * * * *
    (i) * * *
    (6) * * *
    (i) Prudent investment by a cable operator in tangible plant that 
is used and useful in the provision of regulated cable services less 
accumulated depreciation. Tangible plant in service shall be valued at 
the actual money cost (or the money value of any consideration other 
than money) at the time it was first used to provide cable service, 
except that in the case of systems purchased before May 15, 1994 shall 
be presumed to equal 66% of the total purchase price allocable to 
assets (including tangible and intangible assets) used to provide 
regulated services. The 66% allowance shall not be used to justify any 
rate increase taken after the effective date of this rule. The actual 
money cost of plant may include an allowance for funds used during 
construction at the prime rate or the operator's actual cost of funds 
during construction. Cost overruns are presumed to be imprudent 
investment in the absence of a showing that the overrun occurred 
through no fault of the operator.
    (ii) An allowance for start-up losses including depreciation, 
amortization and interest expenses related to assets that are included 
in the ratebase. Capitalized start-up losses, may include cumulative 
net losses, plus any unrecovered interest expenses connected to funding 
the regulated ratebase, amortized over the unexpired life of the 
franchise, commencing with the end of the loss accumulation phase. 
However, losses attributable to accelerated depreciation methodologies 
are not permitted.
* * * * *
    (7) Deferred income taxes accrued after the date upon which the 
operator became subject to regulation shall be deducted from items 
included in the ratebase.
* * * * *
    3. Section 76.924 is amended by revising the section heading, 
removing paragraphs (e)(1)(iv), (e)(1)(v), (e)(2)(iv) and (e)(2)(v), 
and revising paragraphs (e)(1)(iii) and (e)(2)(iii) to read as follows:


Sec. 76.924  Allocation to service cost categories.

* * * * *
    (e) * * *
    (1) * * *
    (iii) All other services cost category. The all other services cost 
category shall include the costs of providing all other services that 
are not included the basic service or a cable programming services cost 
categories as defined in paragraphs (e)(1)(i) and (ii) of this section.
    (2) * * *
    (iii) The all other services cost category as defined by paragraph 
(e)(1)(iii) of this section.
* * * * *
[FR Doc. 96-5427 Filed 3-7-96; 8:45 am]
BILLING CODE 6712-01-P