VI. The Audit

A. Background

In D.99-06-051 the Commission ordered the audit that is addressed in this proceeding. The audit addressed affiliate and non-regulated telephone relationships and transactions of Roseville Communications Company (RCC). The audit period is January 1, 1997 through June 30, 1999. The audit was included in the scope of this proceeding to the extent that it relates to the issue of whether sharing should be eliminated.

The audit was performed for ORA by Overland Consulting. ORA's overall recommendation is based on its conclusion that RTC overallocated costs to regulated operations as demonstrated by 33 audit calculations.

In the course of this proceeding, RTC made numerous objections to how the audit was conducted. However, in this proceeding we are concerned with specific audit recommendations. We analyze each recommendation individually on its merits, and base our decision on our analyses. Therefore, we need not address in this proceeding the overall performance of the audit.

B. Corporate Organization, Operations and Affiliate Relationships

RTC and its affiliates are owned by RCC. RCC is a holding company. The following is a description of the corporate organization, operations and affiliate relationships.

1. Organizational Overview

· Roseville Telephone Company (RTC) - Provides regulated local exchange and intraLATA toll services within an exchange territory encompassing Roseville, California and surrounding areas. RTC provides various non-regulated communications services, including telecommunications equipment and wiring, alarm monitoring, coin telephone and competitive local access services to business customers outside local exchange boundaries.

· Roseville Directory Company (RDC) - Sells directory advertising and arranges for printing and distribution of RTC's exchange area white and yellow page directories. RDC also publishes an independent (competing) telephone directory in the Auburn-Grass Valley area of central California (outside RTC's exchange boundary), and publishes the exchange area directory for Foresthill Telephone, a small neighboring local exchange company. RDC began operating in March, 1997.

· Roseville Long Distance (RLD) - Resells Sprint long distance service to RTC and to residential and business customers of RTC. RLD began offering service commercially in September, 1997, coincident with RTC's implementation of intraLATA pre-subscription.

· Roseville PCS and RCS Wireless - Provides wireless PCS phone services in and around Roseville, California. RCS Wireless began offering commercial wireless telephone service in July, 1999, one month after the audit period.

· Roseville Cable - A shell created to operate the Roseville, California cable TV operation that RCC attempted to acquire from Jones Cable. The acquisition did not take place. Roseville Cable is currently inactive.

· RCS Internet - This subsidiary was launched in mid 1999. RCS Internet provides internet connectivity and modem installation. The subsidiary was formed to complement digital subscriber line services, which were rolled out at approximately the same time.

2. Overview of Non-Regulated Telephone Operations

RTC is engaged in both regulated and non-regulated telephone businesses. Regulated telephone services consist of exchange telephone, exchange access and intraLATA toll services. Non-regulated telephone services consist of everything else. Key non-regulated telephone businesses include.

· Customer Premises Equipment, Networks and Wiring - RTC sells and leases telephone equipment, designs local and wide area networks, and sells and repairs inside wiring. Sales are primarily to business customers in the Roseville area.

· Alarm Monitoring - RTC monitors alarms for approximately 30,000 alarm vendors who resell the service on a retail basis.

· Coin Phone - Through a separate RTC division, RTC installs unregulated coin phones in and around its local exchange service territory.

· Competitive Local Exchange (CLEC) Service - Near the end of the audit period, RTC began selling transmission and wide area network services outside RTC's exchange boundary. In September, 1999, RTC began providing local area network service. There were no measurable revenues during the audit period.

3. Overview of Affiliate Relationships

Affiliate relationships and transactions are covered in the audit. The following list includes the most significant relationships.

1. Services and Facilities Provided By RTC to Affiliates

· RTC provides corporate executive, administrative and general services on behalf of RCC to all affiliates. Corporate administrative and general services include accounting, finance, shareholder, human resources, regulatory, information management, computer operation and maintenance, procurement, distribution and corporate communications.

· RTC provides office facilities, computers, office equipment and vehicles to all affiliates.

· RTC provides advertising, marketing, sales and various customer services to RCS Wireless and RLD. RTC provides advertising and customer services to RDC.

· RTC provides inside plant engineering, installation, provisioning and maintenance services to RCS Wireless.

· RTC provides transmission facilities, central office space and support systems and space on towers and roofs for antennas and equipment to RCS Wireless.

· RTC provides billing and collection services to RLD and RDC.

· RTC provides interconnection to RCS Wireless to enable connection to the public switched network.

2. RDC provides directory advertising sales, compilation, contract printing and contract distribution (collectively referred to as directory publishing) to RTC.

3. RLD provides long distance telephone service to RTC.

4. RCS Wireless provides PCS wireless phone service to RTC.

C. Individual Audit Calculations

4. Audit Calculation 1 - Costs Attributable to Duplicated Holding Company Responsibilities

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($141,452)	-	($138,018)	-	($140,018)

a. ORA

ORA proposes to remove an amount equal to one half of the RTC allocation of RCC chairman Robert Doyle's $330,000 salary from regulated expense.

Doyle retired as RTC's Chief Executive Officer (CEO) in 1993. ORA believes that Doyle has no involvement in the day-to-day activities of RTC or RCC. Therefore, there is no need to have two persons earning CEO salaries. ORA removed only half of Doyle's salary because he would receive retirement pay of about that much. Since regulated expenses may already have accrued an amount for Doyle's retirement expenses, ORA believes this is a conservative adjustment.

ORA states that it is not making a recommendation that Doyle should not be paid. ORA merely recommends that the costs should not be entirely allocated to ratepayers.

b. RTC

RTC opposes the reduction because it is outside the scope of the audit and Doyle's salary was found reasonable in RTC's general rate case D.96-12-074.

c. Discussion

In D.96-12-074 we addressed this issue and declined to adopt a similar recommendation by ORA. Since the situation appears to be substantially the same here, we will not adopt ORA's recommendation.

5. Audit Calculation 2 - The CEO and Chief Financial Officer (CFO) and Their Staffs Failed to Charge Their Development Efforts to Affiliates

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($97,377)	-	($112,598)	-	($145,854)

a. ORA

ORA found that during the audit period the CEO, CFO and their staffs allocated only 8 of 31,000 hours directly to affiliate and non-regulated telephone company businesses. The CEO and CFO timesheets, which were not filled by the CEO and CFO themselves, contained no information describing the activities performed. ORA found evidence of time directly spent on affiliate business development such as cable TV. ORA allocated 10% of the CEO's, CFO's and their staff's time to non-regulated businesses because it believes that at least that much could have been directly allocated.

ORA believes that it is entirely appropriate and practical to directly bill executive time when the activities performed are clearly related to specific affiliates. Examples would include time when the executive is away on affiliate related business or in meetings related to specific affiliates.

b. RTC

RTC's CFO, Michael D. Campbell, testified that he and the CEO, and consequently their staffs, spend almost all of their time directly involved with RTC operations and allocate the remainder using a three-factor formula. RTC also notes that ORA did not interview the CEO or CFO during the audit. Each affiliate has its own management team which runs its operations. In addition, the majority of the development of the Roseville Cable, Roseville PCS and RCS Wireless operations was performed in 1997 by RTC staff who directly assigned their time. Therefore, it is inappropriate to assign executive time to those development efforts for the entire audit period as ORA did.

RTC states that ORA's adjustment should not be adopted because it is contradicted by RTC's CFO and ORA's analysis is flawed because it is attempted to assign development costs over the entire audit period.

c. Discussion

The CEO and CFO are charged with oversight of the entire corporate family. Not surprisingly, most of the operations are more directly managed by subordinate management. Therefore, we would expect that the vast majority of the CEO and CFO's time would be allocated rather than directly assigned. However, we find that RTC's direct assignment of only 8 out of 31,000 hours to affiliate and non-regulated business is not credible. We would expect that more time be devoted to specific affiliates in order to understand what each affiliate is doing and to provide some oversight of the affiliates' management. Such time could be directly assigned.

However, the issue here is whether such increased direct assignment would result in a substantially different allocation than achieved by the three-factor formula. While ORA's claim that more time should be directly allocated is reasonable, its 10% estimate is unsupported. We are not convinced that the end result would be substantially different. We will not adopt ORA's recommendation.

6. Audit Calculation 3 - The Vice President of Network Development Failed to Properly Charge His Effort in Developing RCS Wireless.

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($24,681)	-	($25,885)	-	($29,120)

a. ORA

ORA alleges that Rulon Blackburn, RCC's Vice President of Network Development, charged none of his, his secretary's or his administrative assistant's time to RCS Wireless during the audit period. However, during the period, Blackburn played a role in the development of RCS Wireless. He attended at least two related conventions and kept the RCC Board of Directors informed about development progress. ORA also states that Blackburn does not fill out or check his own timesheets.

ORA assigned 10% Blackburn's time to RCS Wireless for the audit period.

b. RTC

Blackburn testified that he spent very little time on RCS Wireless in 1997 and 1998. In 1999, a portion of his time was assigned to RCS Wireless. RTC states that ORA did not interview Blackburn during the audit. Instead, ORA relied heavily on articles in an employee newsletter and Board of Directors meeting minutes. RTC believes that this is inadequate to justify ORA's adjustment.

c. Discussion

ORA relies on articles in the employee newsletter to indicate that Blackburn did spend time on RCS Wireless. Blackburn states that he spent very little time on RCS Wireless. He does not say that he spent no time on RCS Wireless. The issue here is how much time Blackburn spent on RCS Wireless. ORA's estimate of 10% is not sufficiently supported. Therefore, we will not adopt it.

7. Audit Calculation 4 - RTC Did Not Properly Allocate Cost for the Vice President of Customer Service to RDC.

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($15,786)	-	($17,053)	-	($24,226)

a. ORA

ORA states that Jay Kinder, RCC's Vice President of Customer Service is, among other things, in charge of the directory publishing subsidiary RDC. Kinder charged no time to RDC during 1997, when RDC was initially staffed. In 1998, RTC's accountant caught the error and retroactively allocated 10% of Kinder's time to RDC in 1997. The allocation was reduced to about 2% in July, 1998. None of the costs of Kinder's administrative staff was allocated or assigned to RDC during the audit period. Since Kinder is the primary executive responsible for RDC, ORA allocated 10% of the costs of Kinder's office to RDC.

b. RTC

Kinder testified that very little of his or his administrative staff's time was spent on RDC. Kinder directly assigns time spent on RDC to RDC. Time not directly assigned is allocated using the three-factor method. RTC states that ORA's allocation of Kinder's time has no factual support and should be rejected.

c. Discussion

The issue here is how much of Mr. Kinder's office's time should have been directly charged to RDC. Kinder states that he spends very little time on RDC and directly assigns what time he does spend on RDC. We find this credible. ORA's 10% adjustment is not supported. We will not adopt it.

8. Audit Calculation 5 - Marketing Executive Costs Charged But Not Billed to Roseville Cable Development

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	$(7,036)	($7,036)	-	-	-	-

a. ORA

ORA says that 127 hours of RCC's Vice President of Marketing, Phillip Germand's time should have been billed to Roseville Cable.

b. RTC

RTC agrees with ORA on this adjustment.

c. Discussion

Since ORA and RTC agree, we will adopt the adjustment.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	($7,036)	-	-

9. Audit Calculation 6 - Accounting, Budget and Finance Efforts Attributable to Affiliate Development

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($9,614)	-	($4,716)	-	-

a. ORA

ORA alleges that RTC failed to identify and assign development efforts directly attributable to specific subsidiaries during the audit period. Based on a checklist prepared by a consultant for RTC for development of RLD, ORA estimated that 500 hours of time should have been assigned to RLD for development efforts. Notwithstanding the existence of the checklist, ORA believes that the need to set up a financial plan, develop accounting policies, coding, financial reporting, inter-company payment procedures, etc. is an obvious requirement. ORA believes that its estimate is conservative.

b. RTC

RTC says that it has a centralized accounting system which is not organized along subsidiary or divisional lines. Accounting service costs are allocated using the three-factor formula rather than directly assigned because it is impractical to directly assign time.

RTC states that its accounting employees did not incur significant time to establish accounting policies and procedures for RLD because the policies and procedures were largely based on existing policies and procedures. Additionally, RTC believes that the establishment of policies and procedures for intercompany payments benefits all affiliates, not just RTC.

RTC also points out that the checklist ORA relied on was never used and is, therefore, invalid. In addition, development work for affiliates, if any, was done in 1997 only. RTC concludes that ORA's adjustment has no factual basis and should be rejected.

c. Discussion

The accounting practices and procedures developed for RLD were essentially those that RTC had already developed. Therefore, we expect that very little time was needed. However, we believe such time should have been directly allocated. ORA's adjustment is based on a checklist that was not used. However, we agree that at least some of the tasks in the checklist would have to be accomplished. Therefore, we will adopt half of ORA's adjustment for 1997, the year in which development would have taken place.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	($4,807)	-	-

10. Audit Calculation 7 - Revenue Accounting Efforts Attributable to Non-Regulated Accounts and to Affiliates

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($15,782)	($2,960)	($10,851)	-	-

a. ORA

ORA's proposed adjustment has two components. The first is to increase the 1998 non-regulated telephone allocations of RTC's Revenue Accounting Manager's cost to 6%. In 1997, RTC retroactively adjusted the non-regulated telephone share of the manager's cost to 6.5% based on a study RTC conducted. In 1998, the manager charged only 35 hours to non-regulated telephone. RTC's overall assignment of time by the accounting section is in line with non-regulated revenue as a percentage of total revenue. Therefore, ORA used a similar figure, 6%, for 1998.

ORA's second component is the assignment of 1,000 hours of the Revenue Accounting Department's time to development of the long distance affiliate, RLD. RTC allocated no time to RLD accounting procedure development efforts. Based on the checklist referred to in Audit Calculation 6, ORA estimated that 1,000 hours should have been directly allocated to RLD in 1997 and 1998.

b. RTC

RTC agrees with ORA's adjustment of the Revenue Account Manager's time for 1998. However, RTC does not agree with the assignment of 1,000 hours to RLD. RTC argues that ORA should not have used the checklist because it was never followed. RTC also states that RTC did not incur costs to set up accounting procedures for RLD because the procedures already existed. The procedures are the same as used to set up billing and collection programs for other interexchange carriers.

RTC also states that if such costs had been incurred, they would have been incurred in 1997 when development work for RLD occurred.

c. Discussion

RTC agrees with ORA's adjustment to the Revenue Account Manager's time. We will adopt it. However, we find credible RTC's claim that the accounting procedures used for RLD were already in existence. Therefore, we will not adopt the balance of ORA's recommendation.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	-	($2,960)	-

11. Audit Calculation 8 - Information Services Costs

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($36,397)	-	($101,171)	-	$132,734

a. ORA

ORA adjusts various information services cost allocations. First, ORA believes that RTC's three factor formula is heavily weighted in prior year's telephone plant purchases and is, therefore, inappropriate to allocate current year information services costs. ORA believes that the Federal Communications Commission (FCC) general allocator is more appropriate.

Second, ORA states that the end user service order and payment and collection factors are based on out of date studies, and were calculated using the wrong methodology. Additionally, the non-regulated allocation of common customer-related costs was omitted.

Third, ORA believes that RTC's general purpose computer allocator is flawed. Virtually all of the computer infrastructure is on RTC's books, much of which provides benefits to all affiliates. RTC's allocator is based on the relative levels of computer assets in each affiliate's balance sheet. This method, therefore, inappropriately overallocates these costs to RTC.

ORA's adjustment revises the allocations and corrects various mistakes and other omissions.

b. RTC

RTC states that it allocates information services costs pursuant to a study which analyzed the extent of utilization of the services by affiliates and non-regulated operations. Some costs are assigned directly, while others are allocated using the three factor formula, the end user payment and collection factor and the end user service order factor as appropriate. Remaining costs are considered common and allocated to non-regulated using the general allocator.

RTC states that ORA's adjustment should not be adopted because it would have RCS Wireless pay for part of the development of a customer information system it does not use. RTC also claims that ORA's use of revenues, much less book revenues, does not reflect the use of the information systems. Additionally, RTC states that the FCC has determined that revenues do not measure the amount of resources used by an activity.

RTC states that ORA's adjustment is inconsistent with FCC rules, is not reflective of cost causation and should be rejected.

c. Discussion

RTC's end user service order and payment collection factors are based on out of date studies. RTC's allocations overallocate computer asset costs to RTC because the computer infrastructure is on RTC's books. Therefore, some adjustment is appropriate. However, ORA's allocation based on revenues is also flawed. Therefore, we will adopt half of ORA's adjustments.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	($18,198)	($50,586)	$66,367

12. Audit Calculation 9 - Valuation Project Costs Attributable to RCS Wireless

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	-	-	($19,125)	-	-

a. ORA

ORA believes that the cost of a valuation study performed to justify transferring RTC's interest in RCS Wireless to RCC at book value was incorrectly charged to RTC. ORA states that the cost should not be charged to RTC because it would not have occurred if RTC had not chosen to get into the non-regulated wireless business, and ratepayers should be indifferent to the existence of non-regulated affiliates.

b. RTC

RTC asserts that since the Commission required the valuation study to determine the fair market value of RTC's interest in RCS Wireless, the costs should be charged entirely to RTC. However, RTC decided to allocate about one-third to RCS Wireless given the nature of the regulatory requirement for the valuation.

c. Discussion

RCC decided to acquire RTC's interest in RCS Wireless. RCC was required to follow the Commission's transfer pricing rules which in turn necessitated the determination of the fair market value of RTC's interest. Although the study was performed to satisfy a Commission requirement, it was the result of RCC's decision to acquire RTC's interest. Therefore, RTC's ratepayers should not have to pay for the study. The costs should not have been charged to RTC. We will adopt ORA's adjustment.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	-	($19,125)	-

13. Audit Calculation 10 - Regulatory Costs Charged But Not Billed to Roseville Cable Development

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	($5,966)	($5,966)	-	-	-	-

a. ORA

ORA identified 190 hours charged to Roseville Cable during 1997 that were not charged or billed to below-the-line accounts.

b. RTC

RTC agrees that those charges should have been recorded to Roseville Cable.

c. Discussion

Since the parties agree, we will adopt the adjustment.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	($5,966)	-	-

14. Audit Calculation 11 - Human Resource Costs Attributable to Affiliate Development

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($5,273)	-	($10,253)	-	($10,252)

a. ORA

ORA states that during the audit period, RTC failed to identify and assign 675 human resources hours for development and initial staffing. These costs should have been directly assigned to RDC and RCS Wireless. ORA did not find a problem with RTC's common cost treatment of routine human resource activities related to maintaining staffing at existing subsidiaries.

b. RTC

RTC claims that its allocation of human resource expense is reasonable. RTC's human resource functions are centralized. Individual affiliates do not have separate human resource organizations. RTC allocates human resource costs among affiliates based on a head count factor. RTC believes that it is impractical to identify blocks of human resource time spent on RTC or other individual affiliates. RTC also states that RTC staffed the majority of RDC `s sales force by hiring employees of the contractor that had previously worked on RTC's telephone directory. Therefore, the recruiting costs for these personnel were less than might otherwise have been the case.

RTC also alleges that ORA's allocation double counts the allocation of expenses to RDC and RCS Wireless. The double counting takes place because ORA directly assigned costs to RDC and RCS Wireless without removing those same costs from the common cost pool.

c. Discussion

We do not find credible RTC's contention that it is impractical to directly assign any human resource costs. However, we agree with RTC's contention that staffing of RDC should have required less than might have otherwise been expected since the majority of the sales force came from the previous contractor. It also appears that some double counting may have occurred in ORA's adjustment. Therefore, we will adopt ¼ of ORA's adjustments.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	($1,318)	($2,563)	($2,563)

15. Woman, Minority and Disabled Veteran (WMDV) Program Purchasing Costs

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($11,640)	-	($4,615)	-	($4,092)

a. ORA

ORA claims that RTC directly assigned two-thirds of the cost of administering the WMDV purchasing program to regulated accounts. ORA states that these costs should have been recorded in common purchasing accounts and allocated to RTC and all affiliates. The WMDV program serves both RTC and its affiliates and, therefore, should be paid for by RTC and the affiliates.

b. RTC

RTC states that the WMDV program is administered solely to meet the Commission's requirements for RTC. It is not administered for any unregulated affiliate. Therefore, RTC believes that these costs should be directly assigned to RTC. However, RTC recognizes that unregulated affiliates may derive some benefit such as expansion of the vendor pool. Therefore, RTC directly assigned two-thirds of the costs to regulated operations and one-third to the common cost pool to be allocated to non-regulated operations and affiliates using the three factor formula.

c. Discussion

We agree that the WMDV program was created to satisfy Commission requirements. We also agree that non-regulated operations and affiliates derive some benefit. Therefore, given that the WMDV program was created due to a regulatory requirement, we do not believe RTC's allocation is unreasonable. We will not adopt the ORA recommendation.

16. Audit Calculation 13 - Purchasing Costs Attributable to Affiliates

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	-	-	($67,297)	-	($69,254)

a. ORA

ORA alleges that during 1998 and 1999, RTC treated common purchasing costs as residual costs which were unattributable to specific cost objectives. Therefore, RTC allocated these costs based on its three factor formula. ORA believes that these costs should be attributed to affiliates based on measures of purchasing activity. ORA allocated purchasing costs for RCS Wireless based on the value of RCS Wireless purchases during the audit period.

ORA states that RCS Wireless was allocated 1% of the purchasing costs during a period when 30% of the capital expenditures were for RCS Wireless. ORA believes that while the value of purchases is not the best allocator, it is more consistent with the underlying nature of purchasing services than RTC's three factor allocation.

b. RTC

RTC believes that allocating purchasing costs based on the relative capital expenditures is not reasonable because it is not consistent with the nature of the purchasing services provided to RCS Wireless. RTC's purchasing department does not evaluate supplier's products, select suppliers, negotiate prices or set standards for RCS Wireless. RCS Wireless performs these functions. RTC's primary role is merely to process RCS Wireless's purchase orders.

RTC says that ORA's adjustment is inappropriate because the vast majority of RCS Wireless purchases did not occur until the last quarter of 1998. Additionally, $11 million of the $11.5 million in capital expenditures by RCS Wireless in 1998 was for the single purchase of a central office switch in November, 1998.

c. Discussion

We find that RTC has provided a reasonable explanation of why its small allocation of purchasing costs to RCS Wireless was appropriate even though its relative amount of purchases was high. We will not adopt ORA's adjustments.

17. Audit Calculation 14 - Common Office Equipment Maintenance Costs

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($1,991)	-	($7,303)	-	($14,890)

a. ORA

ORA found that, during the audit period, RTC failed to allocate office equipment maintenance to affiliates. ORA believes that these are residual costs which should be allocated using the general allocator as required by FCC rules.

b. RTC

RTC does not object to the premise that office equipment maintenance costs should be treated as common costs. However, RTC believes that since these costs are indirectly attributable to affiliate operations, the general allocator is not appropriate. Rather, RTC's three factor formula should be used. Use of the common allocator is not consistent with FCC rules because the costs are indirectly attributable. RTC believes that no adjustment is necessary.

c. Discussion

RTC and ORA agree that office equipment maintenance cost are common costs. We are not convinced, however, that they are not indirectly attributable. Therefore, we will not adopt ORA's adjustments.

18. Audit Calculation 15 - Common Telephone Museum Administration Costs

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	($966)	($2,675)	-	-	-	-

a. ORA

ORA determined that the Museum Administrator charged approximately 900 hours to a regulated product management subaccount in 1997. ORA believes that the Museum Administrator's function benefits the corporation as a whole. Therefore, ORA allocated these costs using the FCC general allocator.

b. RTC

RTC agrees that the Museum Administrator should charge his time to a common account. The time was properly charged in 1998 and 1999. RTC agrees that the 1997 time was not properly charged, but disagrees with ORA's calculation. RTC believes that the general allocator should be used because the museum displays are RTC or telephone related. However, RTC believes that ORA's general allocator is inflated by counting goods and services that are resold.

c. Discussion

RTC and ORA agree that the museum administrator's time in 1997 should have been charged to a common account. The disagreement is in the calculation of the allocator.

As discussed under Audit Calculation 32, we believe ORA's calculation of the general allocator is correct. We will adopt ORA's adjustment.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	($2,675)	-	-

19. Audit Calculation 16 - Product Development Section Efforts Attributable to Non-Regulated Telephone Activities

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($16,622)	-	($16,727)	-	($16,242)

a. ORA

ORA found that Product Development Section employees directly assigned nearly all of their efforts. ORA analyzed, among other things, the time charged during specific periods when news articles featured articles describing marketing work on non-regulated services. Therefore, ORA determined that the amount of time RTC's Product Development Section employees charged to non-regulated services was too low. ORA believes that the amount of time charged to non-regulated services should have been proportional to the relative regulated and non-regulated revenue.

b. RTC

RTC points out that FCC rules state that costs should be directly assigned where possible. This is what RTC did. In addition, RTC states that the FCC has found that revenues are disfavored as an allocator.

c. Discussion

We agree that direct assignment of expenses is preferable to an allocation when direct assignment is possible. We are not convinced that ORA's allocation is more reflective of actual cost causation than RTC's recorded direct assignment. Therefore, we will not adopt ORA's adjustments.

20. Audit Calculation 17 - Product Development Section Management and Administration Costs Attributable to RLD

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($10,938)	-	($12,895)	-	($13,942)

a. ORA

ORA found that RTC's Product Development Section's managers and their administrative assistants charged virtually none of their time to non-regulated activities. ORA believes that, with the exception of the Long Distance Product Manager whose efforts are entirely attributable to non-regulated operations, 50% of the Development Section's operations benefited both RTC and RLD. Therefore, ORA recommends that those costs should be treated as common costs and allocated as such.

b. RTC

RTC states that for 1997 through August 1998, RLD did not report to the Marketing and Product Development Manager, therefore, no time recorded by the Marketing and Product Development Management or its administrative staff should be assigned to RLD. Additionally, there is no common administrative staff shared by RTC and RLD.

c. Discussion

RTC has offered a reasonable explanation as to how these costs were assigned. The explanation was provided by RTC's Marketing and Product Development Manager. We find RTC's explanation more credible than ORA's estimate. Therefore, we will not adopt ORA's adjustments.

21. Audit Calculation 18 - Sales Section Efforts Attributable to Development of RLD

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	($241)	($4,581)	-	-	-	-

a. ORA

Based on a checklist prepared by an RTC consultant, ORA determined that 200 hours should have been assigned to RLD for sales and marketing development efforts. ORA asserts that even though the checklist was not actually used to develop RLD, the tasks included in the checklist would have been performed. Given that RTC charged only 10 hours to RLD during the development period, ORA believes that its adjustment is reasonable.

b. RTC

RTC states that the checklist was not used and the activities were never performed. RTC, however admits that 10.5 hours were incorrectly not billed to RLD by RTC for development work during 1997. These costs should be reallocated to non-regulated activities.

c. Discussion

ORA relied on a checklist that was not used. In addition, RTC says that the functions on the checklist were never performed. Therefore, we are not convinced that ORA's adjustment is reasonable and will not adopt it. We will, however, adopt the 10.5 hours adjustment for 1997 proposed by RTC.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	($241)	-	-

22. Audit Calculation 19 - Alarm Monitoring, Sales Misallocated to Regulated Expense

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	($43,695)	($43,695)	($47,037)	($47,037)	($21,242)	($21,242)

a. ORA

ORA discovered that RTC allocated approximately 20% of the labor costs and certain non-labor costs from the Alarm Monitoring Sales Section to regulated accounts.

b. RTC

RTC agrees that it did not charge the Alarm Monitoring Sales Section's time properly.

c. Discussion

Since the parties agree, we will adopt ORA's adjustments.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	($43,695)	($47,037)	($21,242)

23. Audit Calculation 20 - Customer Services Support Costs

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	($5,968)	($104,760)	($11,443)	($135,891)	-	($176,600)

a. ORA

ORA states that customer service support activities, which support common regulated and non-regulated customer service functions, are themselves common. ORA reassigned customer service support costs that RTC had treated as "regulated only" to common subaccounts. ORA then allocated these costs based on the relative amount of regulated and non-regulated revenue managed by the customer service functions.

b. RTC

RTC states that the Customer Service Support Section does not support affiliate operations. It supports RTC's regulated and non-regulated operations. The time is charged directly to regulated or non-regulated operations or common costs depending on the work performed.

RTC discovered that the section supervisor's time was incorrectly charged to a regulated account. It should have been charged to a common account for 1997 and 1998. Additionally, in 1999 the section was reorganized and given additional responsibilities. Accordingly, the section's time reporting for administrative functions are now recorded as common costs and allocated to non-regulated activities using the customer services manager allocation factor.

RTC states that ORA's use of an allocator based on revenues is inappropriate. RTC states that its adjustments for 1997 and 1998 should be adopted.

c. Discussion

ORA has not provided convincing evidence that RTC failed to properly allocate these costs with one exception. RTC and ORA agree that the section supervisor's time should not have been allocated exclusively to regulated operations. Additionally, we do not find ORA's use of revenues to be more appropriate than RTC's method. Therefore, we will only adopt the adjustments for the supervisor's time as calculated by RTC.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	($5,968)	($11,443)	-

24. Audit Calculation 21 - Customer Service Collection Costs

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($145,528)	($331)	($124,153)	($155)	($143,454)

a. ORA

ORA found that RTC allocated almost all of the RTC collection representatives time to regulated accounts. During the audit period, 21,000 hours were assigned to regulated activities, 221 hours to non-regulated coin phone collection and 11 hours to all remaining categories of non-regulated services. ORA reassigned the time as common and allocated it between regulated and non-regulated services based on the amount of regulated vs. non-regulated revenues.

ORA states that RTC's allocation factor is based on the number of regulated and non-regulated lines printed on bills. ORA believes that relative revenues are more reflective of collection costs than the relative number of lines on bills.

b. RTC

RTC claims that the FCC's rules provide that costs are not to be allocated when direct assignment or indirect allocation is possible. Additionally, relative revenues are disfavored as an allocator. RTC states that many of the unregulated services are not supported by RTC's Customer Services Collection Section or are services provided to businesses that require significantly less collection time. Also, RTC states that adjusting ORA's methodology to eliminate non-regulated revenues that do not involve collection activities produces a non-regulated allocation very close to the amount RTC used. RTC made a correction to its accounting by moving its Collections Supervisor and one of his employee's time from a regulated account code to a common account code for 1998 and 1999.

c. Discussion

We believe that, as stated by RTC, some non-regulated activities would require little or no collection effort. Since RTC's recalculation of ORA's adjustment excluding such non-regulated revenues is very close to RTC's allocation, we will not adopt ORA's adjustment. We will, however, adopt RTC's correction adjustments.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	-	($331)	($155)

25. Audit Calculation 22 - Alarm Monitoring Costs Attributable to the Non-Regulated Vendor Alarm Business

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	($159,278)	($159,278)	($127,828)	($127,828)	($180,822)	($180,822)

a. ORA

ORA found that RTC had improperly recorded and allocated certain alarm monitoring costs.

b. RTC

RTC agrees with ORA's adjustment and states that it has taken steps to correct the errors.

c. Discussion

The parties agree on the adjustments. Therefore, we will adopt them.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	($159,278)	($127,828)	$180,822)

26. Audit Calculation 23 - Employee Health Insurance Attributable to RDC

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	($46,610)	($46,610)	-	-	-	-

a. ORA

ORA determined that certain health insurance costs were paid by RTC on behalf of RDC. RTC caught the mistake in 1998 but did not record an adjustment for 1997. ORA's adjustment makes the correction for 1997.

b. RTC

RTC agrees that the change should have been made for 1997.

c. Discussion

Both parties agree that the adjustment should be made. We will adopt it.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	($46,610)	-	-

27. Audit Calculation 24 - Corporate Advertising Charged to Regulated Accounts

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	-	-	-	($1,918)	($29,558)

a. ORA

In 1999, RCC took out a full page ad on the back cover of the RTC directory. The ad features the names and logos of various subsidiaries and non-regulated businesses. The entire cost of the ad was charged to regulated accounts. ORA points out that the Commission does not permit any of the cost of corporate image advertising to be allocated to regulated operations. However, for conservatism, ORA's adjustment allocates 1/5 of the cost to RTC's regulated operations because the ad listed five RCC subsidiaries of which RTC is one. As an alternative, ORA recommends that none of the costs be allocated to RTC.

b. RTC

RTC does not object to the treatment of this cost as common. However, RTC believes that ORA's allocation based on the number of subsidiaries is inappropriate because it does not reflect the benefits received by each affiliate. RTC believes that its three factor formula is more reflective of the benefits received.

c. Discussion

The Commission does not allow recovery from ratepayers of institutional or goodwill advertising (D.83162 (1974), 77 CPUC 117, 154-5. D.96-12-074, mimeo p. 135-6). The advertising that is at issue here had the logos of RTC and four other affiliates on it. Therefore, we conclude that it was institutional and/or goodwill advertising. As a result we will not allow any of it.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	-	-	($36,948)

28. Audit Calculation 25 - Development Costs Billable to RLD

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	($79,287)	-	-	-	-

a. ORA

ORA states that during 1997, RTC employees charged approximately 2,567 hours to RLD. However, RTC did not bill RLD for 1,500 of those hours. ORA's adjustment reflects the billing of the additional 1,500 hours for RLD.

ORA states that RTC pays more than the market price for the long distance service it buys from RLD. The difference between what RTC pays RLD and what RLD pays Sprint for the use of Sprint's long distance network goes to the benefit of RCC's shareholders. Therefore, RTC is not the primary beneficiary of RLD's development or operations.

b. RTC

RTC allocates new product and service feasibility analyses, which occur prior to product development and implementation, to each subsidiary based on RTC's three factor formula, and to RTC's non-regulated division based on the general allocator.

RTC believes this is reasonable because:

· it addresses costs related to products or services that ultimately are not implemented,

· all subsidiaries benefit because existing support costs are spread to more subsidiaries,

· existing subsidiaries benefit from resulting economies of scale, and

· new products directly benefit the provision of regulated services.

In this case RTC states that the formation of RLD benefited RTC by using RTC's access and billing and collection services.

c. Discussion

The 1,500 hours that ORA assigns to RLD were for the development of RLD. RLD was created and is in operation. While RTC may benefit from RLD's operations, all costs directly related to RLD should have been charged to RLD. We will adopt ORA's adjustment.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	($79,287)	-	-

29. Audit Calculation 26 - Network Engineering Costs Attributable to RCS Wireless

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	-	-	($49,033)	-	($49,154)

a. ORA

ORA states that inside plant engineering of the RCS Wireless network was performed by RTC. During the audit period, ORA found that RCS Wireless accounted for 20% of the Central Office plant added by RCC. However, RTC inside plant engineering employees charged less than 2% of their time to RCS Wireless. ORA estimates that at least 5% of their time should have been charged to RCS Wireless.

b. RTC

RTC states that the major plant expense for RCS Wireless was for installation of a central office switch. The engineering and installation work for the switch was done by a contractor and paid for by RCS Wireless. RTC's involvement was minimal and was directly assigned to RCS Wireless.

c. Discussion

RTC has demonstrated that the major plant addition by RCS Wireless did not significantly involve RTC's inside plant engineering employees. The costs were paid for or directly allocated to RTC. Therefore, we are not convinced that ORA's adjustments are reasonable and will not adopt them.

30. Audit Calculation 27 - Central Office Facilities Attributable to RCS Wireless

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Revenues	-	-	-	$20,052	-	$147,316

a. ORA

ORA determined that RCS Wireless occupied central office space at RTC's Citrus Heights central office from October, 1998 until the end of the audit period. RCS Wireless was not charged for the space it occupied. ORA's adjustment includes the revenue that RTC should have received from RCS Wireless for use of the space. The amount is based on the $167,000 RTC claims it charged to RCS Wireless at the close of 1999.

b. RTC

RTC states that it was unable to determine the correct market price to charge RCS Wireless until it completed an agreement with a third party for use of such space. RTC states that before it closed its books for 1999, it recorded an adjustment of $167,000 for the period of November 1998 through December 1999 based on RTC's proposed collocation prices. RTC will true-up those charges based on the charges that will be set for collocation in a pending arbitration proceeding with Covad Communications (Application 00-01-012).

c. Discussion

We find that ORA is correct that RCS Wireless was not charged for collocation during the audit period. RTC booked collocation revenues of $167,368 in late 1999, after the audit period. Our calculation of the audit results is based on 1999 recorded data except for Audit Calculation 32. Therefore, we will adopt a revenue adjustment of $20,052 for 1998 and subtract this amount from 1999.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Revenues	-	$20,052	$20,052

31. Audit Calculation 28 - Office Space Costs Attributable to RCS Wireless and RDC

Proposed Adjustments:
1997			1998			1999
Adjustment to	RTC	ORA	RTC	ORA		RTC	ORA
Revenues	$58,012	$58,012	$63,286	$63,286	$137,608		$137,608

a. ORA

ORA determined that RTC charged RCS Wireless and RDC a market rate of $1.35 per square foot for leased office space. The Commission's transfer pricing rules require the use of the higher of the fully distributed costs or market costs. RTC's fully distributed costs were $2.75 per square foot. RTC should have charged the higher cost as reflected in ORA's adjustment.

b. RTC

RTC agrees that ORA's calculation of office space costs is correct.

c. Discussion

Since both parties agree, we will adopt ORA's adjustments.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Revenues	$58,012	$63,286	$137, 608

32. Audit Calculation 29 - Tower License and Roof Space Attributable to RCS Wireless

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Revenues	-	-	-	$15,064	-	$60,258

a. ORA

ORA found that in September, 1998, RTC entered into five-year lease agreements with RCS Wireless to provide space on its antennas and roofs at a specific rate. Within eight months, RTC had entered into contracts to provide similar space to other non-affiliated providers at rates averaging 38% to 56% more. ORA's adjustment assumes that RCS Wireless should have been charged the same as non-affiliated providers.

b. RTC

RTC states that the September 1998 price charged to RCS Wireless was based on the lease prices negotiated with an unaffiliated third party. RTC signed a lease with a third party that provided for the same rate over the lifetime of the lease as was charged to RCS Wireless. In addition, the price was comparable with prices RCS Wireless negotiated with unaffiliated third parties. As market prices have risen, RTC has increased its prices for more recent leases.

c. Discussion

If RTC negotiated a lease price that met our requirements at the time, subsequent unforeseen developments do not make the lease unreasonable. ORA has not stated that the initial negotiated price was unreasonable at the time. We will not adopt ORA's adjustments.

33. Audit Calculation 30 - Indirect Facilities Overheads Attributable to Non-Regulated and Affiliate Operations

Proposed Adjustments:
1997			1998					1999
Adjustment to	RTC	ORA	RTC			ORA		RTC		ORA
Expenses	($184,071)	($663,480)		($304,389)		($899,507)		($422,928)		($1,188,646)
Rate Base	$2,921,652	$2,921,652			$2,846,933		$2,846,933		$2,792,994	$2,792,994

a. ORA

ORA found that during the audit period, RTC allocated facilities costs to non-regulated RTC operations using a "land and building" allocator based or an outdated building usage study. ORA computed a facilities loading factor of 37.02% to be applied to employee labor dollars to correct RTC's allocation.

ORA states that its calculation matches current activities performed for affiliates and non-regulated operations with current facilities costs. Additionally, ORA's calculation includes all capital and expense costs associated with facilities. ORA states that RTC did not allocate any land and building costs to affiliates.

ORA believes that although RTC's calculation somewhat refines ORA's calculation, it is not accurate. Therefore, ORA believes that a factor between RTC's 22.6% factor and its 37.02% factor should be used.

ORA notes that in RTC's calculation of its expense adjustment, it not only used a lower factor, but it also applied the factor only to the much smaller pool of labor hours included in its other proposed adjustments.

b. RTC

RTC agrees that its usage study is outdated. However, it does not agree with ORA's 37.02% factor, RTC states that ORA's calculation is wrong because:

· it assumes all employees use space equally,

· RTC's outside plant employees have building and plant space dedicated to their use,

· some land and space are used exclusively by RTC,

· RCS Wireless leases space from an unaffiliated party,

· some building investments were excluded by ORA,

· ORA excluded contract labor used by RTC, and

· the FCC requires that space be allocated based on how it is actually used.

RTC states that it has not finished updating its study. Therefore, RTC agrees to use its revised calculation of ORA's factor for this proceeding (22.61%). RTC's revised calculation corrects errors it found in ORA's calculation.

c. Discussion

It appears that ORA's factor of 37.02% is imperfect. RTC's allocation factor has not been shown to be correct. Therefore, as recommended by ORA, we will use a factor in between the two. Since neither calculation has been shown to be better than the other we will split the difference. We will use a factor of 29.8%. Since there is no disagreement on the rate base adjustments, we will adopt them.

Adopted Adjustments: (Does not include expense effect of adopted factor.)
Adjustment to	1997	1998	1999
Rate Base	$2,921,652	$2,846,933	$2,792,994

34. Audit Calculation 31 - Residual Costs Attributable to Affiliates

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	($18,126)	$123,958	($65,534)	($834,113)	-	($1,887,952)

a. ORA

ORA determined that RTC allocated residual general and administrative costs using a three factor formula. ORA states that RTC's three factor formula is flawed because:

· it assigns costs based on assets recorded in prior years,

· it classifies common assets as belonging to RTC,

· it classifies employees with administrative and general functions as RTC employees,

· the three factor formula is applied to the same pool of costs to which the FCC general allocator is applied for allocating to non-regulated telephone activities.

· use of the three factor formula and the general allocator to allocate the same pool of costs is prohibited by the FCC.

· the FCC rejected use of the three factor formula for allocating residual costs.

ORA states that residual general and administrative costs should be allocated to affiliates the same way they are allocated to non-regulated operations using the general allocator.

b. RTC

RTC states that use of its three factor formula for allocation to affiliates is appropriate because it is based on cost causation. Since there is a direct link between resource utilization and the size and nature of operations, the three factor formula is appropriate. The three factor formula is based on gross plant, total expenses and employee headcount. RTC states that since ORA's allocator is not based on available cost-causative indicators, it is inconsistent with FCC requirements. RTC states that its use of the general allocator for allocation of the same pool of costs to non-regulated operations is also appropriate because no cost-causative relationship exists for non-regulated operations. This is because while the affiliates are free standing with respect to RTC, RTC's non-regulated operations are not.

c. Discussion

We will adopt ORA's proposed adjustment. We find that RTC's three-factor formula does not reflect cost causation and leads to an under-allocation of common general and administrative expenses to unregulated affiliates. ORA's use of the general allocator based on expenses is the better of the two approaches in the record.

We begin our analysis by noting that the parties agree that we should apply Part 64 rules. RTC is correct that those rules establish a hierarchy of approaches to allocating costs. Part 64 favors allocation based, whenever possible, upon direct analysis of the origin of the costs and, as a second choice, based upon "an indirect, cost causative linkage" to another cost category (or categories). If neither of these options are feasible, Part 64 directs the use of a "general allocator computed by using the ratio of all expenses directly assigned or attributed to regulated and nonregulated activities." (47 CFR Section 64.901(b)(3).) RTC claims that its three-factor formula comports with the second-choice use of an indirect, cost causative allocator. ORA disagrees that RTC's formula reflects cost causation and concludes that the general allocator must be used.

The fact that RTC claims that its three-factor formula is based on cost causation does not make it so. The issue here is whether the factors identified by RTC would fairly approximate the extent to which common general and administrative costs are caused by RTC, on the one hand, or RTC's regulated affiliates, on the other hand. RTC's three factors are gross plant (i.e., a comparison of the assets of RTC with those of its affiliates); expenses (i.e., a comparison of the expenses of RTC with those of its affiliates) and employee headcount (i.e., a comparison of the number of employees of RTC with those of its affiliates).

We are persuaded by ORA that RTC's three-factor formula does not reflect cost causation and instead over-allocates costs to RTC. ORA correctly points out that the three-factor formula over emphasizes asset accumulations, both through the gross plant factor and through depreciation expense reflected in the expense factor. As a mature company, RTC has accumulated considerable assets over a long period of time. In contrast, in a dynamic and fast changing period in the telecommunications industry, most of RTC's affiliates - including RDC, RLD, Roseville PCS and RCS Wireless, and RCS Internet -- were just coming into existence during the audit period. Even though these affiliates obviously required the expenditure of general and administrative costs, they have had little time to accumulate assets. Consequently, the use of accumulated assets as a significant factor in allocating common costs - as reflected in the gross plant factor and the depreciation component of the expense factor - does not provide a reasonable approximation of the extent to which affiliates caused common costs to be incurred.

ORA makes the point quite well:

"In 1997, Roseville performed financial forecasting and budgeting for a significant new affiliate - RCS Wireless. The amount of budgeting and forecasting effort in 1997 may have been indirectly related to RCS Wireless' future size, but it was definitely not related to RCS Wireless' past size (RCS Wireless had no past size). However, for the budgeting and forecasting effort conducted by RTC, RCS Wireless gets no allocation from the asset component of Roseville's three-factor formula, because RCS Wireless has yet to buy the assets being budgeted. RCS Wireless also gets no allocation from the headcount or operating expense components of the formula, because it has yet to hire the employees being forecasted. Using Roseville's backward-looking three factor formula, another subsidiary (guess which one) must have `caused' the 1997 financial forecasting and budgeting effort conducted for RCS Wireless. The budgeting and forecasting costs in this example were `caused' by current period activities, not by past-period asset acquisitions. The FCC's general allocator produces a rational allocation of residual cost because it is based on a composite of costs incurred in conducting current period activities. While the general allocator is not perfect (indeed, the forecasting effort described above demonstrates why it is important to identify and directly assign efforts associated with an affiliate), it is certainly better than an allocator loaded with decades of prior period regulated asset accumulations." (ORA Opening Brief at 70, emphasis in original).

The reasoning of the FCC's Order on Reconsideration in which it modified the Part 64 rules applied here buttresses our conclusion that RTC's three-factor formula over-emphasizes past activities as an estimator of current cost causation. There, in determining how to calculate the general allocator, the FCC rejected AT&T''s proposal to use expense data from the prior year. The FCC found:

"AT&T's proposal, to use prior year's data updated quarterly, would appear to produce skewed results in an environment in which nonregulated services offered through the network are expected to grow dramatically. Use of last year's data would consistently understate non-regulated usage."³

Even though the FCC wrote those words in 1987, they are more relevant today, when services provided by unregulated affiliates have proliferated and grown exponentially. In this environment, use of an allocator - such as RTC's three-factor formula -- that emphasizes past asset accumulation would "consistently understate" usage by unregulated affiliates.

Because RTC's three-factor formula is inappropriate, we adopt ORA's audit adjustment using the general allocator authorized by Part 64.

Adopted Adjustments:
Adjustment to	1997	1998	1999
Expenses	$123,958	($834,113)	($1,887,952)

35. Audit Calculation 32 - Residual Costs Attributable to Non-Regulated Operations

	Proposed Adjustments:
	1997			1998		1999
Adjustment to		RTC	ORA	RTC	ORA	RTC	ORA
	Expenses	($65,954)	($1,040,131)	($71,783)	($773,786)	($32,195)	($822,620)

a. ORA

ORA states that residual costs are costs for which neither direct nor indirect measures of cost allocations can be found. The FCC requires that these costs be allocated using a general allocator computed by using the ratio of all expenses directly assigned or attributed to regulated and to non-regulated activities.

ORA found that in calculating its general allocator, RTC excluded from directly assigned or attributed expenses a number of non-regulated expenses. RTC excluded all direct non-regulated expenses except alarm monitoring expenses. RTC also excluded indirect non-regulated product management, sales and advertising expenses.

ORA agrees with RTC that it is appropriate to remove the costs of goods sold as required by the FCC. However, the FCC defines the cost of goods sold as the cost of goods held in inventory for resale. ORA states that the costs RTC excluded are not items purchased for resale, and, therefore, should not have been excluded.

The Costs RTC excluded include:

· customer telecommunications consulting and engineering services provided by RTC employees,

· installation and maintenance labor and labor loadings related to equipment and wiring sales, equipment leases and warrantees,

· costs of installation, maintenance and collection from RTC's coin phones,

· depreciation on leased equipment, and

· indirect costs of product management, sales and advertising expense.

ORA recommends that its proposal, adjusted to remove "material cost of sales," "OEL Maintenance Material" and "T&M Material," be adopted.

b. RTC

RTC claims that it removed from the calculation of the general allocator only the costs of goods sold.

c. Discussion

The issue here is what is meant by the "costs of goods held in inventory for resale." We do not see how such costs as consulting, engineering, labor loadings, etc. can reasonably fit that definition. These may be related costs, but they are not the costs of the goods themselves. We do not adopt ORA's specific proposed adjustments because they depend on other adjustments we did not adopt. We will, however, adopt ORA's method for calculating the general allocator.

36. Audit Calculation 33 - Regulated Directory Revenue Shifted to RLD

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Revenues	-	-	-	$286,222	-	$327,516

a. ORA

ORA's calculation returns ½ of the regulated revenue that RTC ceded to RDC when RDC began publishing RTC's telephone directory. ORA claims that RTC's decision to have RTC publish its directory was not based on an adequate study of the costs involved. ORA believes that, as a result, RTC's revenues would be greater if the previous directory publisher had been kept. ORA recommends that its calculation of the lost revenues or an amount equal to the 5% reduction in regulated directory revenue ceded by RTC to RDC be adopted.

b. RTC

RTC says that its intention in switching publishers was to increase net revenues associated with directory publication. As a result of the change, RTC received greater directory revenues from RDC than it would have from with its previous publisher. RTC further states that had RTC not made the change, its revenues would have decreased.

RTC states that its decision to switch publishers was a management decision. This decision is beyond the scope of the audit and not related to cost allocations.

c. Discussion

ORA's proposal is based upon ORA's disagreement with a management decision to change publishers. ORA has not demonstrated that the decision was deliberately intended to reduce RTC's revenues. Therefore, we will not adopt ORA's adjustments.

D. Calculation of NRF Results of Operations and Earnings

This section addresses how overall NRF results of operations and earnings should be calculated to determine sharable earnings for 1997, 1998 and 1999. In addition to the 33 audit calculations, ORA takes issue with RTC's reclassification of regulated directory revenues, RTC's expensing of software development costs, and RTC's income tax expense adjustments.

In addition to opposition to the specific adjustments proposed by ORA, RTC objects to consideration of the audit results in this proceeding at all. RTC states that the proposed adjustments are not a proper issue under the Commission's ordered audit scope. RTC also states that its sharable earnings advice letters for 1997 and 1998 were filed and not protested. They should not be reopened now.

37. Regulated Directory Revenues

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Revenues	($2,930,811)	-	($2,705,613)	-	($3,317,400)	-

a. ORA

ORA states that pursuant to RTC's publishing agreement with RDC, RTC is entitled to a percentage of the revenue from RTC's directory. RDC's share is to cover all of RDC's costs including sales and marketing.

ORA alleges that RTC removed from regulated directory earnings, revenues from advertiser's in RTC's directory who are located outside of RTC's service territory. ORA represents that RTC removed these revenues prior to applying the allocation of revenues between RTC and RDC. This is the primary reason that RTC's composite intrastate separation of miscellaneous revenue for 1997, 1998 and 1999 is substantially lower than what was adopted in the 1996 GRC.

ORA states that all NRF companies are required to reflect directory advertising revenues above-the-line for calculating sharable earnings (D.89-10-031, D.96-12-074). ORA also points out that the Commission has never permitted RTC to reclassify exchange area directory revenues as non-regulated revenues to be excluded from the sharing calculation.

ORA also points out that it agrees with RTC that revenue from publishing directories other than RTC's are properly assigned to RDC.

b. RTC

RTC states that it is appropriate to exclude revenues and expenses from advertisements in RTC's directory by businesses located outside of RTC's service territory. RTC says that such revenues and expenses are non-regulated. RTC states that it is necessary to remove this revenue in order to compensate RDC for the related costs.

c. Discussion

RTC and ORA agree that the RTC directory revenues should be included in the sharing calculation. The issue is whether revenues and expenses due to advertisers who are located outside of RTC's territory should be excluded. Our policy has been to include all directory revenues and expenses in the calculation. Additionally, the directory publishing agreement between RTC and RDC covers RDC's expenses. Therefore, we do not adopt RTC's adjustment.

38. Expensing of Software Development Costs

Proposed Adjustments:
1997			1998		1999
Adjustment to	RTC	ORA	RTC	ORA	RTC	ORA
Expenses	-	-	-	-	$5,316,223	-

a. ORA

ORA states that for 1999 RTC increased regulated operating costs by $5,316,223 to cover the expense for software development. ORA opposes this adjustment because it does not match the costs with the periods over which the software will be used. ORA points out that, as required by the American Institute of Certified Public Accountants Statement of Position (SOP) 98-1, RTC capitalized the costs it incurred in 1999 to develop its "Genesys" customer software system in its books. However, RTC expenses the total cost in 1999 in its sharing calculation. ORA states that RTC has not provided in its exhibits or workpapers any explanation or justification for this adjustment.

b. RTC

RTC states that it expensed the software development costs in 1999 because the Commission has not adopted SOP 98-1 for ratemaking purposes. RTC states that there are other instances where the Commission has requirements for ratemaking purposes that are different from what is required for financial statements.

c. Discussion

It is not necessary that we specifically adopt SOP 98-1. The "Genesys" software will be used well beyond 1999 and RTC capitalized its development costs. There is no reason that RTC should expense the entire costs in 1999 in its sharing calculation. Therefore, we do not adopt RTC's adjustment.

39. Income Tax Expense

a. ORA

ORA states that RTC uses in its sharing calculations an effective income tax rate that is much higher than the combined California and federal tax rates. RTC's combined rate is 47.28% compared to a combined statutory state and federal tax rate of 40.75%. ORA further points out that RTC's books for 1999 show an effective tax rate of 40.2%. ORA represents that RTC has not justified the allowance for funds used during construction (AFUDC), interest expense and deferred item adjustments to its tax calculations that, among other things, cause the higher effective tax rate. Therefore, ORA recommends that the combined statutory rate be used.

b. RTC

RTC believes its calculation is correct. It states that it has utilized adjustments consistent with the California ratemaking rules established for RTC in D.96-12-074. RTC also states that ORA is incorrect because it did not use the correct state tax rate adopted in 1997.

c. Discussion

The income tax calculation should follow the same methodology used to develop the startup NRF revenue requirement in D.96-12-074. RTC's explanation that ratemaking adjustments could cause the effective tax rate to be higher than the effective tax rate are plausible. Therefore, we will adopt RTC's methodology to calculate the income tax expense.

E. Adopted Audit Results - Sharable Earnings

Our calculation of sharable earnings based on our adopted audit results is as follows:

F. ORA's Request for Another Audit

1. ORA

ORA recommends that the Commission order another audit in connection with RTC `s next NRF review. The audit would examine whether RTC's cost allocations are correct.

2. RTC

RTC opposes this recommendation. It states that the Commission established a procedure in Ordering Paragraph 16 of D.96-07-059 that ORA should follow if it believes an audit is necessary.

3. Discussion

The audit performed by ORA in this proceeding found instances where RTC had not properly accounted for its affiliated transactions. By this order, we require RTC to make the necessary corrections. We expect RTC to comply.

The Commission recently issued Order Instituting Investigation (I.) 01-04-026, in which it authorized ORA to perform an audit of RTC in connection with an investigation of RTC's intrastate revenue requirement. In light of that impending audit, we decline to mandate another audit at this time. However, in light of the findings of the audit reviewed in this decision, we expect that it will be necessary to review affiliate and non-regulated telephone relationships and transactions of RCC in connection with the next review of Roseville's NRF. In addition, we note that ORA may, at any time, exercise its broad discovery rights under the Public Utilities Code in order to fulfill its duties of representing the interests of ratepayers.