An allocation of AT&T's depreciation reserve to plant accounts must occur as a first step in determining depreciation reserve deficiencies. Without it FCC will lose control over depreciation ratesetting. FCC, through its January 1981 Notice is moving in this direction. This allocation, if based on actual

debits and credits to the various plant accounts, may allow FCC to identify the reserve deficiencies. The difference between the actual reserves by plant account from this allocation and the reserves from the carrier's theoretical reserves would represent the deficiencies. 1/

Once these differences are identified then FCC could be in a position to treat separately the reserve deficiencies by plant account and the plant account's remaining net book costs. Such an approach would allow FCC to (1) define the extent of reserve deficiencies to be recovered, (2) set forth a specific method for their recovery, 2/ and (3) establish a baseline for determining asset value to be transferred to nonutility accounts or a separate subsidiary.

CONCLUSIONS

FCC's current process of setting depreciation rates has three elements which we believe are essential for its regulatory oversight of depreciation expenses. First, FCC has a legislative mandate to prescribe depreciation rates. We see no reason to alter this mandate for those carriers the Commission considers dominant. This is consistent with our recommendations contained in Chapter 2. The Commission through its analysis and prescription of depreciation rates and its opportunities for changes based on revised assumptions provides the regulatory overview of an expense item which is one of the largest parts of a carrier's revenue requirement.

Second, for depreciation rate-setting purposes FCC has a legislative mandate to obtain the views of the State commissions. Absent a similar mandate in other regulatory areas, as we have pointed out in chapter 3, FCC has done little to coordinate and interact with the State regulatory commissions. We believe State commission review and participation in the depreciation ratesetting process provides an early and clear opportunity for FCC and the State commissions to express their views for, and basis

1/From our illustration on page 148, the actual book reserves in figure 1 of $10 for A, $5 for B, and $5 for C would be subtracted from the theoretical reserves in figure 2 of $12 for A, $12 for B, and $6 for C.

2/FCC could, for example, amortize the deficiencies over a period of time, or treat them, as its rules permit, as extraordinary retirements (47 CFR 31.02-83).

of, prescribing depreciation rates. Such an opportunity, we believe, provides FCC with timely input on the impact depreciation changes will have on the ratepayer and the carrier.

Third, the process provides for Commission review and approval, while at the same time allows for interim approval. This provides visibility and regulatory oversight by the Commission while at the same time not constraining the carrier's implementation of depreciation rates.

FCC's changes to its methods and practices for setting depreciation rates can have an impact, however, on both the efficiency of future regulatory oversight and the competitiveness of a developing customer premises equipment market. In this regard, uncertainties in implementing the provisions of Dockets 20188, 79-105, and FCC's Computer II Decision have not been resolved. --Methods to implement ELG have not been developed. --Depreciation reserves by vintage are not required for carriers implementing ELG because the USOA does not now require plant investment to be maintained by vintage. --Prescribing remaining life depreciation rates for all jurisdictions in 1981 will not allow for FCC and State commission verification and review.

--AT&T's depreciation reserve account has not been allocated to plant accounts--essential for future FCC actions. --Division of the station connections account will be based on carrier submissions.

--Requirements for setting depreciation rates for the
outside plant of the station connections account
have not been developed.

--Carriers incentives in establishing depreciation rates
for embedded CPE, when new CPE will be deregulated on
March 1, 1982, may prevent competitive development.

Before proceeding in a piecemeal fashion, we believe FCC must resolve these uncertainties. This will place FCC in a position to avoid accepting and approving depreciation rates with less than the rigorous review needed, permit active participation by the State commissions, and will enhance the development of competition.

RECOMMENDATIONS TO THE CHAIRMAN, FCC

We recommend that the Commission before prescribing depreciation rates based on changes adopted in Dockets 20188 and 79-105

--Develop specific procedures for evaluating and monitoring a carrier's depreciation rates based on ELG.

--Require depreciation reserves by vintage for a carrier's implementing ELG.

--Identify the retirement units and methods for depreciating the outside plant of station connections.

--Audit, through random selection, the carrier's division
of the station connections account.

We further recommend that the Commission before implementing its Computer II Decision to deregulate new CPE and continue regulating embedded CPE, first identify the depreciation reserve deficiencies by plant account, develop a method for their recovery, and establish a framework for deregulating all CPE. Our recommendations in this regard are associated with our recommendations in chapter 6 for using the separate subsidiary device adopted by FCC in its Computer II Decision.

CHAPTER 8

ENSURING FAIR, NONDISCRIMINATORY ACCESS TO

LOCAL EXCHANGES: CONGRESSIONAL ACTION IS NEEDED

With the introduction of competition in interstate telecommunications, changes in existing procedures used to integrate carrier operations became necessary. The new competitors brought with them the need to interconnect their facilities with those of the telephone industry. Particularly, they required access to local exchange facilities of telephone companies, since such facilities offered virtually the only means for the local distribution of interstate services. Because of the need for such access by the new carriers, it became necessary to formulate procedures which would allow them to interconnect their facilities with those of telephone companies and to determine how telephone companies should be compensated for local exchange access.

In FCC's 1971 Specialized Common Carrier decision, in which FCC opened the door to competitive entry in interstate telecommunications, FCC recognized the need for the new entrants to obtain local exchange access. Since that time FCC has reiterated the need for the establishment of nondiscriminatory access on numerous occasions.

Neither FCC's past actions nor its present proposals, however, resolve the following questions:

--What types and levels of interconnection should telephone companies be required to provide to the new carriers?

--What rates should be charged to new carriers for access to local exchanges?

--What effect would competition have on any subsidies which may have been provided between interstate services and intrastate services?

--Can nondiscriminatory access conditions be assured without major changes in telephone industry structure and procedures?

We believe that congressional action is needed to establish the basic framework for their resolution.

PAST FCC ACTIONS HAVE NOT

RESOLVED ACCESS QUESTIONS

Since 1971 FCC has been involved in a variety of proceedings which were designed to secure adequate access arrangements for the new competitors. For the most part, however, these proceedings were aimed at providing short-term solutions to immediate problems, rather than addressing the fundamental questions needed

to establish fair, nondiscriminatory access terms, conditions, and rates.

Separations and settlements/

division of revenues: a brief overview

AT&T and the other approximately 1,500 independent telephone companies have traditionally operated as "partners" in providing telephone service. Their facilities have been interconnected into a nationwide telephone network which is used to provide both local and long-distance services. For example, under the traditional telephone industry arrangements, three carriers would typically be involved in furnishing interstate long haul MTS service: originating telephone company, AT&T Long Lines, and a terminating company. Many of the facilities used in providing this interstate service would also be used for local or intrastate toll services.

an

Because many of the costs of providing interstate and intrastate services are shared or "common" costs, procedures had to be developed to allocate these costs to either the interstate (FCC regulated) or intrastate (State public utility commission regulated) jurisdiction. 1/ The process which was developed to accomplish this is known as separations and settlements/division of revenues. Separations refers to the allocation or separation of costs between jurisdictions. Settlements/division of revenues is the process of dividing interstate revenues collected among all the carriers involved in providing service. When all of the companies involved are affiliated with AT&T the process is called division of revenues. When AT&T and nonaffiliated companies are involved, it is known as interstate settlements.

Separations

Because regulatory responsibility is divided between FCC and State public utility commissions (see ch. 3), the costs and revenues associated with interstate and intrastate services must be segmented. Since most of the property of telephone companies is used in the joint provision of both interstate and intrastate services and a major portion of expenses is incurred in their joint rendition, this cost and revenue assignment process is a large and complex task.

To carry out this assignment of costs, FCC and the National Association of Regulatory Utility Commissioners, on behalf of the State commissions, in cooperation with the telephone industry, have developed a jurisdictional separations process. Since 1947 separations procedures have been formally set forth in a Separations Manual, which is approved by the FCC-NARUC Cooperative

1/Once costs have been allocated to a jurisdiction, the relevant regulatory agency is responsible for determining how they should be allocated among carrier service offerings. This is done through the tariff review process. (See ch. 4.)