if a periodic reconciliation occurred, the inherent difficulties in forecasting would mean that any deviations between forecasted and actual use might be explainable by exogenous factors, raising a legitimate question of to what extent the carrier should be held accountable. In such an environment, the Commission would be reluctant to take any action. An administrative law judge and an attorney in the Policy and Program Planning Division saw it as merely a lack of will on the Commission's part. Without a mechanism to induce accountability FCC is likely to continue to experience difficulties with forecasting since the incentive to manipulate forecasts will not be reduced.

The second major flaw has to do with a process known as "trial balancing. The essence of AT&T's implementation of the FDC-7 costing methodology is the building up of costs to be allocated to services through a rather complex process. 1/ This process, however, is not the same process which is used to determine the aggregate costs AT&T may recover from its total interstate operations. This latter process is known as separations

procedures. 2/

As the costing methodology was being implemented, it was found that the total costs derived through the FDC-7 process were significantly less than the total costs derived through separations. This led AT&T to use a "trial balancing" process to adjust costs created through FDC-7 with the total costs assigned to interstate service through separations. The amount of the shortfall was about $2 billion. How this amount was distributed among the services could significantly affect the costs assigned to these services; therefore, another opportunity for cross-subsidy was created. AT&T argued that "most of the difference" was due to differences in the two methodologies. Competing carriers, along with FCC, expressed the view that the differences were due to the complex costing process and errors in forecasting.

1/Briefly, this process involves taking the forecasts of demand for service and generating the quantity of plant necessary to fill that demand through the use of "translators" or other factors. The cost of the needed facilities is the result of multiplying the projected plant quantities by the unit costs of the various facilities. These unit costs, however, are developed from "special studies" of the cost and characteristics of plant currently in use. Once the cost of plant has been allocated, the allocation of operating expenses is made based primarily on the allocation of plant.

2/Because many of the costs of providing service are common costs, some procedure had to be developed to allocate these costs for regulatory purposes to either interstate (FCC regulated) or intrastate (State public utility commission regulated) jurisdictions. AT&T is allowed to recover its total interstate costs through its various interstate services. (See p. 77.)

The Chief of the Common Carrier Bureau at the time of the Docket 18128 decision told us that he recognized that FDC-7 developed costs, and separations costs were probably not going to be the same. He stated that it was his intention to revise separations procedures to attempt to resolve this problem; however, this was never done. Consequently, the problem of trial balancing remained along with the attendant opportunities to manipulate the outcome of the costing process.

FCC did not follow through with the implementation of FDC-7

The pattern of problem recognition and inaction was not confined to the forecasting and trial balancing area. FCC did not follow through in the development of the Uniform System of Accounts (USOA)--a key area which would have enhanced FDC-7's opportunity for success. FCC also did not exert effective control over the implementation process of FDC-7.

As noted above, a major aspect of AT&T's implementation of the FDC-7 methodology involved the use of special studies. FCC staff experienced considerable difficulty with these studies, finding them extremely complex, difficult to understand and verify, and thus, in their view, beyond their ability to meaningfully review. This view was reinforced in the initial decision in Docket 20814 where the administrative law judge was highly critical of AT&T's cost studies to the point that he felt that their deficiencies alone were a basis for rejecting the tariffs.

The need for these special studies flows, in large part, from the inadequacies in the current USOA. The current system of accounts collects data on an aggregate, companywide basis and as such cannot provide the detail needed for service-by-service costing. The Commission recognized these difficulties and in June 1978 began a proceeding to revise the USOA. The Common Carrier Bureau Chief, at the time of the Docket 18128 decision, told us that the cost manual was viewed as an interim approach and once the revised USOA had been developed which provided the necessary detailed costing information, the manual could have been abandoned.

As will be discussed in detail in chapter 5, FCC over the last 3 years has made virtually no progress in revising the USOA. We recognize, however, that revision of the USOA will not obviate the need for all special studies. Further, had FCC made satisfactory progress in revising the USOA it is conjectural whether the project would be complete and implemented as of this date. Nevertheless, this situation has meant that the need for extensive special studies and the attendant problems of review and verification remain and will continue for the foreseeable future.

FCC also did not exert effective control over the FDC-7 implementation process. The Cost Analysis Task Force, as noted earlier, was formed after the Docket 18128 decision. The task

force was charged with

"*** developing, on an expedited basis, rules and
procedures which will ensure that telephone industry
costs are properly allocated and accounted for on a
service-by-service basis."

This was to be accomplished within 3 months. The expectation that the working sessions would develop implementation procedures was reflected in the Docket 18128 decision itself, which as the Chief of the Policy and Program Planning Division stated was long on generalities and short on details regarding how FDC-7 would be implemented.

In contrast to these expectations, when the task force reports and manuals were submitted to the Commission, the Commission while accepting the reports took note of but never officially approved the manuals. The Common Carrier Bureau Chief at the time of the manuals' development told us he advised the Commission not to endorse the manuals. He said that the development of the manual by the task force was in direct conflict with his view of the initial purpose of the task force, which was to simply explain the principles of Docket 18128 to AT&T and allow AT&T to develop implementing procedures. He did not want the task force agreeing with AT&T over implementation procedures because the Bureau simply did not know enough about the special studies, data bases, or forecasting techniques AT&T might use to generate cost of service data to know to what they were agreeing. He favored having AT&T file tariffs implementing the Docket 18128 principles, and through the review and analysis of these tariffs learn what cost data AT&T was using and how the 18128 principles could be implemented.

The apparent conflict between the stated purpose of the task force and the responsible official's expectations contributed to FCC's inability to satisfactorily implement FDC-7. If the purpose of the task force was as publicly stated, then given FCC's lack of knowledge, a deadline of 3 months was, in our view, totally unrealistic. Further, the task force should have been given authority to compel AT&T to reveal the data bases which could have been used to develop an allocation process. Such authority falls within FCC's powers under section 218 of the Communications Act; however, the task force was given no control over the implementation process. 1/ If, as the Bureau Chief suggested, a more passive posture was desired, then setting up the task force with such a specific deadline was clearly not appropriate. The net result we believe was a manual over which FCC did not exert adequate control and which FCC did not fully understand or have confidence in, but

1/Section 218 authorizes FCC to "inquire into the management of the business of all carriers subject to this Act" and to "obtain from such carriers *** full and complete information necessary to enable the Commission to perform its duties *

which having been developed in the working sessions had a certain undeniable legitimacy.

FCC ADOPTS AN INTERIM COST MANUAL WHICH
OFFERS LITTLE IMPROVEMENT OVER FDC-7

After a 4-year struggle with implementing FDC-7, FCC in December 1980 (Docket 79-245) discarded FDC-7 and adopted an Interim Cost Manual which differed sharply in approach from FDC-7. This manual sought to avoid the inherent flaws of FDC-7 and to produce a cost methodology which was more understandable and auditable and which did not create incentives for manipulation by a dominant carrier. The manual was intended only to serve as a stopgap until a more acceptable long-range solution could be developed. Part of this long-range solution apparently includes other "noncost" approaches, such as resale and sharing, to prevent cross-subsidy.

FCC has through the interim manual eliminated the major flaws of FDC-7, but we question whether FCC has produced a more understandable, auditable method for allocating costs. Further, we believe the interim manual does not reduce the incentive to manipulate the costing process. The manual is also, we believe, an ad hoc response to the order of the U.S. Court of Appeals for the District of Columbia Circuit to develop an acceptable WATS tariff. Thus, we see the interim cost manual as just that--an interim solution--which cannot serve as a long-term approach.

The Interim Cost Manual differs from FDC-7 in two major respects--the manner in which costs are allocated among services, and the number of service categories to which costs are allocated. Whereas FDC-7 attempted to build up costs using forecasts and a complex costing process, the Interim Manual incorporates no forecasting. Rather, it takes facility costs derived from separations procedures and allocates them based on relative use among the service categories. Some of this allocation takes place within the separations procedures--separations divides costs between message services (MTS and WATS) and an aggregate of private line services--the remaining allocation is done within the Interim Manual procedures. Expenses are divided among the service categories by the use of the techniques in the August Manual.

While FDC-7 divided costs among 16 service categories the Interim Manual has only four categories--MTS, WATS, an aggregate category for all private line services, and Exchange Network Facilities for Interstate Access (ENFIA). 1/

The Interim Manual has apparently mitigated the major flaws of FDC-7. By eliminating forecasting, FCC has eliminated one major trouble spot. By using separations procedures as a starting point and dividing total costs from the "top down"

1/ENFIA is discussed in chapter 8.

on the basis of relative use, FCC has also mitigated the problem of trial balancing. FCC also argues that separations based numbers are more auditable and understandable than FDC-7. By basing costing on existing separations procedures, FCC officials feel they have reduced the incentive and opportunities for manipulating the costing process. This has resulted, FCC believes, in separations procedures being more effective than FDC-7 in preventing cross-subsidy between MTS and private line services.

Regarding the contraction of service categories, FCC has argued that increases in competition in private line services have mitigated the potential for intra-private line cross-subsidy, thus removing the need for the individual private line service categories which made up the bulk of the earlier 16 categories. FCC has also noted that it is taking action in noncost approaches of resale and sharing (see p. 82), and the restructuring of private line services which will further reduce the potential for cross-subsidy. FCC has said, however, that it still expects AT&T to justify its private line tariffs using fully distributed costs but it has left the allocation techniques to AT&T.

The Interim Manual is not an appropriate cost of service methodology

Major portions of telephone plant are used jointly or interchangeably to provide interstate and intrastate service. Separations procedures were started around 1910 to allocate plant costs as well as expenses, taxes, and reserves for regulatory purposes between intrastate and interstate jurisdictions. The basis on which separations are made is the relative use of telephone plant in each of the operations. As noted below, the usage measure may be expanded by some multiple when applied to particular types of plant. This allocation occurs in a two step process. The first step is to divide the cumulative plant costs recorded in the USOA into the special plant categories used in separations. For example, the USOA has one account for all Central Office Equipment. The equipment in this account is divided into eight categories for separations purposes. The second step is to apportion the cost of the plant in each category among the operations by the application of various usage factors or by direct assignment. Usage is determined through various special studies. General guidelines for separations procedures are in the Separations Manual, which is contained in Part 67 of FCC's rules.

Separations procedures were designed to allocate costs between the interstate and intrastate jurisdictions. They were not designed to allocate costs among services. Consequently, separations uses techniques which may not produce an appropriate allocation of costs among services. For example:

--Separations uses residual costing techniques, which FCC found inappropriate in Dockets 18128 and 20814.