THE FOLLOWING IS AN EXCERPT FROM THE PMC  FROM THE PMC-WGA REVIEW OF BELL ATLANTIC-NEW JERSEY'S ALLOCATIONS AND AFFILIATED TRANSACTIONS ACCOUNTING SYSTEM PERFORMED FOR THE NEW JERSEY BOARD OF PUBLIC UTILITIES.  

I. EXECUTIVE SUMMARY

This chapter serves both as an introduction to the operations review and as an executive level summary of the contents of the full report. This chapter presents five sections.

 

A. Introduction: serves as the descriptive of the rationale for the study, the purpose of the review, its scope, and its objectives.

B. Algorithms: provides the summary of the operations review process that was used by the PMC team.

C. Overall Assessment: is a general discussion of the applicability of the EAS and of the philosophy behind the processes used.

D. Summary of Results: provides the overall response to each objective. The detailed Results Summary will hold backup information, detailed analyses and documentation.

E. Recommendations: will be presented here with any Bell Atlantic-New Jersey comment.
 

I.A INTRODUCTION

In 1987, New Jersey Bell submitted a rate stability plan to the Board of Public Utilities (BPU). As part of that plan, caps were placed on basic residential rates. Also, services were classified as competitive and non-competitive. Further, Bell Atlantic-New Jersey provided the EAS as a method of capturing and appropriately allocating costs. Indeed, as part of the May 6, 1993, Order in Bell's alternative regulation proceeding, the Board expressed its satisfaction with the EAS. However, the Order did reflect the Board's sensitivity to concerns of interveners regarding the allocation of costs and the potential for cross-subsidization. Consequently, the Board ordered an operations review of NJ Bell's EAS Category Study for 1992.

A Request For Proposal (RFP) was issued by the Board of Public Utilities' Division of Telecommunications on January 17, 1995. The RFP requested interested consulting firms to submit a proposal to perform an operations review of the Bell Atlantic-New Jersey, Inc. Embedded Analysis System (EAS). The RFP was issued pursuant to Docket No. TX 94080347.

Interested firms submitted their proposals on or by March 13, 1995. The Board voted to award a contract to PMC Management Consultants, Inc. for the present review June 14, 1995. On September 18, 1995, the review began. This report was submitted March 4, 1996.

The review of the EAS is a complex task. The efforts of the consulting team addressed a population of approximately 10,000 input items which result in nearly 1,500 output items. The computer model that lies between the input and output has over 4,600 formulas. Any one service category may be described by as many as 1,400 individual algorithms. The individual algorithms can vary from inclusion of a single variable to 25 or more.

As part of this review, PMC has developed recommended actions designed to reduce the complexity. However, the majority of effort has been directed to addressing the RFP and the stated overall objectives, the specific objectives and applicability of the EAS to meet future issues.

Bell Atlantic - New Jersey has recognized the need to reduce complexity of the EAS System. During the course of the present study, the Company was concurrently analyzing the potential of simplifying the EAS. Presentation of findings were given during February of 1996 to PMC. A letter separate from this report, summarizes that presentation and provides comment on the analysis preformed of 1994 data outside the scope of this review.

I.A(1) Purpose of the Operations Review

The purpose of this Operations Review is:

I.A(2) Scope of Operations Review

The scope of this Operations Review must be in sufficient depth to verify that the Embedded Analysis System (EAS) can continue to monitor the cost of both competitive and non-competitive services and the other service categories of Bell's total company operation. The stakeholders who will form opinions as to the EAS' success in meeting its objectives in a going-forward basis will include the Board of Public Utilities and certain interested parties.

The Board has acknowledged and found that the EAS is the vehicle used to monitor the cost of both competitive services and the other service categories of Bell's total company operations. The EAS allocates all of Bell's investments, expenses and revenues into Group I (competitive), Group II (regulated) and other service categories. The breakdown continues with the thirty (30) broad service categories within the three primary groups.

The Board found in its hearings on Bell's Alternative Form of Regulation (Docket No. T092030358) that the EAS was a tool for monitoring Bells performance under the plan. Consequently, the scope of this Operations Review includes the study of the record to determine whether the EAS provides a proper course of action to fulfill the Board's mandate.

In summary, the Board's mandate may be characterized as assuring that the Plan will:

The Board in its Request For Proposal pursuant to Docket No. TX94080347 specifically identifies four areas of standard performance. By evaluating the BANJ performance against these standards, the Board expects to be able to determine if its mandates can, indeed, be met. These standards of performance are:

Accountability: Does the EAS follow GAAP, FCC Part 36, Part 32, and Part 64?
 

Performance: Does the EAS allocate cost, expenses and revenues in a reasonable, consistent manner?

Auditability: Are the results in a format that is easily followed and capable of identifying cross-subsidies?

Documentation: Is the documentation accurate, relevant and complete?
 

I.A(3) Overall Objectives

The RFP provided descriptions of several overall objectives. The overall objective is to substantiate the degree to which the EAS is a tool for the evaluation of costs and the detection of cross subsidies. To make such an evaluation, it is necessary to verify and demonstrate the validity and reasonableness of the major components of the EAS. These major components are:

Algorithms: The EAS software uses stylized algebraic expressions to govern the input data. These algebraic expressions are the input and output for report algorithms. The algorithm can be up to 400 characters in length. Consequently, they may be complex and the manipulation of major series of calculations is subject to programming "short hand"; the equivalent to algebraic reduction.

To assure the reasonableness of the algorithms, the team requested a training session and the appropriate materials to assure a basic understanding of the EAS detail. Shadow runs of test data were made as were independent calculations.

Special Studies: To understand the appropriate allocation of certain common costs, special studies are undertaken to determine ratios or allocation coefficients. Sixty-six special studies were identified. The data used by Bell varies from electronically collected usage to the results of limited time and activity studies.

To assure reasonableness of the special studies, both examinations of data accumulation techniques and use of a shadow EAS type calculations were made. For example, where statistical sampling was employed, we reviewed the design of the sampling process.

Reports: Both quarterly and annual reports are issued. To assure the consistency of these reports, we relied on the results of our independent EAS type calculations and our physical review of the reports.

Differences Between EAS Quarterly and Annual Studies: To understand EAS Quarterly and Annual Reports, effort was made to understand the source data for each element of each report. PMC developed an understanding of timing differences, distribution ratios applied to accumulated amounts and details of data analysis. This requirement of the RFP was explained by recognizing the timing differences in the separate reports.

Specific Demonstration of Reasonableness: A second part of the overall objectives, the RFP correctly identified ten specific points of reasonableness. For summary purposes, the validity of the algorithms and special studies (input data) of the EAS can be demonstrated by acceptable findings in each of:

I.A(4) Specific Objectives

Additionally, the Division of Telecommunications identified special objectives. We provide each special objective within the text. For summary purposes, we provide the following categories of special objectives:

Conformance to Applicable Rules and Principles: This effort is specifically directed toward compliance with Parts 36, 32, 64 dealing with FCC rules for separations, the uniform system of accounts, and cost allocations. Where GAAP (Generally Accepted Accounting Principles) are not followed, specific reference and explanation are required. Additionally, it is necessary to determine that the actual application of sampling techniques, algorithms, and all inputs are reasonable, appropriate, and accurate.

Documentation: Adequate records of the particular results of an EAS operation are essential for several reasons. Firstly, clear documentation will remove guess work and frivolous challenges to EAS results. Secondly, the existence of complete records affords the BPU the opportunity to access and review the inputs to the EAS (a major component of this review). Thirdly, adequate documentation provides the history required for any future retrospective review.

To be assured of the completeness of the documentation, the following reviews were provided under separate covers:

Accuracy and Validity of EAS Process: The details of the overall objectives and the special objectives have to total to an overall specific objective. That overall objective is the capability to professionally state that the EAS (or as adjusted) represents an accurate and valid representation of embedded costs as per its stated objectives. Consequently, the review was designed to:

Prognosis: As an off-shoot to the detailed analysis, the team offers informed opinions as to the future of the current EAS. This analysis includes technology, software, and responsiveness to regulatory needs.

I.B SUMMARY OF PROCESS

This section provides an overview of the Operations Review Process, the EAS Process, and the efforts expended during this study.

I.B(1) Overview Of The Operations Review Process.

The process of conducting an operations review is a unique application of auditing principles. Indeed, the Comptroller General of the United States has issued specific guidelines for the conduct of such an audit. These guidelines are referred to as Standards for Performance Audits. The 1994 Revision of Government Auditing Standards, also known as the Yellow Book, contains specific chapters covering the conduct of an operations review. It is this document that governed the professional performance of this review.

The actual process was conducted in a sequence of logical steps. First, the EAS system was reviewed with PMC team members. Electronic and paper copies of the EAS inputs, algorithms and outputs were analyzed. Further data requests were submitted. Interviews were conducted to clarify analyses and preliminary findings. Verification of study results was accomplished in monthly report submissions, intra-team comparisons and BANJ responses to specific data requests. Task reports (or documents-in-process), closely following the RFP objectives for factual verification were presented to BPU Staff and BANJ EAS personnel.

After review of task reports, a draft report was completed in compliance with the RFP. A three-party meeting was held to establish the agreement for the final report. The final report is in two parts:

I.B(2) The EAS System

The Embedded Analysis System is the name applied to a set of algorithms that represent algebraic relationships among revenues, investments and expenses. The impact on various service categories is calculated by application of the EAS.

Service categories are described as competitive (Group I), regulated (Group II) or other. Costs, as accounted, are not split into service categories. Consequently, the EAS is used to assign costs to the service categories. The EAS methodologies are of importance to the BPU. The BPU is concerned with the allocation of costs to the Group II service categories.

Input to the EAS is obtained from existing corporate financial, accounting, administrative and separations accounting sources. Consequently, historic records are used based on a calendar year that has been closed to the books of the Company. The EAS develops revenue/cost relationships for the total operations of the Company.

Revenues: Revenues are reported by USOA Report No. 2 and Report No. 2A. Report No.2 requires four broad categories of revenue be divided into Intrastate and Interstate revenues. These categories are:

Report No. 2A subdivides these four revenue classifications into the sources of revenues (i.e. service categories). Consequently, direct assignment is possible.

Investment: The sources of investment assignments include changes in telephone plant account as reported in USOA Report No. 6A, certain entries in USOA Report No. 5 which covers current and non-current assets. Sub account detail is developed by use of the Part 36 Separations process and the Company's accounting system.

The assignment of investment subcategories is more complex than that for revenues. Assignment to the service categories is by the use of algorithms. These algebraic relationships may be based on:

Expenses and Other: Operating expenses and taxes are taken from various Company reports. Assignment to the service categories is on a cost-causative basis. Where direct assignment can be made, it is applied. However, many expenses are not tracked by category. Consequently, assignments are made based on proxies. Such proxy approaches include:

I.B(3) The EAS Process

For the purposes of this study, it is important to acknowledge the process that uses the EAS model. As a stand alone system, the EAS does follow its design criteria to demonstrate allocations to each service category. The process surrounding the system includes the analysts and their tools. It is the analysts' job to assure that inputs are correct and that outputs are interpreted.

The EAS Process includes the BANJ analysts who maintain the EAS System, verify data inputs, and reviews EAS System results. The EAS Process, also, includes the BPU analysts who trend EAS System outputs for possible situations of cross subsidies among services in Group I and Group II.

I.C OVERALL ASSESSMENT

To provide an overall assessment, it is best to consider the standards of performance expressed in Docket TX 94080347.

I.C(1) Accountability

All tests and/or analyses show that:

I.C(2) Performance

The EAS allocates cost, expenses and revenues in a consistent and generally reasonable manner. There are exceptions of three specific allocations, accounting for a nonmaterial amount of $7 million. Also 25 accounts, amounting to $75 million, vary from FCC Part 36 accounts. While a deviation, Bell Atlantic - New Jersey allocations for these 25 accounts are reasonable.

I.C(3) Audit Ability

The EAS produces reports that are useful and understandable to competent analysts. The EAS is a tool to be used in the process to identify examples of cross-subsidization. The EAS does provide information that a trained analyst would use to flag changes in EAS categories and services. The trained analyst would then collaborate with Bell Atlantic-New Jersey to determine the details of any noted changes.

I.C(4) Documentation

Documentation of the EAS is extensive and complete with few exceptions. The system was developed in 1984 to run on IBM-XT class personal computer. The original computer code is not documented although this caused no problem during the study. Documentation for certain special studies was not complete.

I.C(5) Conclusion

The major question to which an answer must be provided has been framed by the Staff as "Does the EAS do the job?" Let us define "the job" as the EAS performing as a "non-structural safeguard to ensure that the costs of New Jersey Bell are properly allocated and to ensure that cross subsidization does not occur." (Docket No. T092030358) The EAS System does, indeed, ensure that costs are properly allocated. The EAS Process provides that if cross subsidies occur, they can be identified.

In the Order at Docket No. T092030358, the Board stated that it wanted assurance "that the EAS detects cross-subsidization between competitive and non-competitive services, and between regulated and unregulated services on a going forward basis." As summarized below and detailed throughout the report, the EAS process can provide the required assurances.

PMC does not find the results of this study to be earth shattering. A study of the level of detail, as in the present study, will be likely to find errors in input data, lapses in documentation and areas of professional difference. Overall, PMC found that the EAS is technically a reasonable representation of the Board's reporting requirements and that it performs as it was designed to do.

The EAS has been described by PMC as a tool to enable a qualified analyst to initiate an investigation when cross-subsidization is expected. While the EAS system does not measure cross subsidies, the process surrounding the use of the EAS is designed to prevent cross subsidization. Further, the Telecommunications Division has resident analysts who are part of the EAS process and can challenge common allocations.

The EAS is a stand-alone reporting system that was developed (and has further evolved) to produce information that satisfies regulatory data requirements. Bell Atlantic-New Jersey has no internal use for EAS reports. The EAS reports can not be used directly to provide pricing parameters for the individual services they address. However, over time, a trend line of profitability for a service indicates a profitable service.

The EAS may well be best described by analogy to the IQ test and Intelligence Quotient. Many people accept the definition of an IQ test as a test that measures the Intelligence Quotient. The definition of Intelligence Quotient is the number resulting from what the IQ test measures. While clearly a circular definition, few will argue against the fact that broad use of the IQ test has been useful to researchers and others.

The EAS is similar in that the results or outputs of the EAS are what the EAS measures. Consistent application of the accountability and performance criteria permit the period to period comparison of EAS outputs. As an analyst notes material changes, access can be made to the EAS files in collaboration with Bell Atlantic-New Jersey. If material changes are caused by cross subsidies, then such cross subsidies will be quantified.

I.D SUMMARY OF RESULTS

This section provides the overall response to each objective.

OO.A1 VERIFY AND DEMONSTRATE THE VALIDITY AND REASONABLENESS OF ALL ALGORITHMS USED TO SEPARATE AND /OR ALLOCATE REVENUES, INVESTMENTS AND EXPENSES.

Tests for verification included manual calculation of detailed algorithms and the mechanical validation of over 7000 algorithms selected from the 1992 and 1993 EAS models. The results demonstrated the validity and reasonableness of algorithms used to separate and /or allocate revenues, investments and expenses. Specifically, of the 160 manually validated algorithms, all were found to be correct. Of the 7000 algorithms mechanically validated, all successfully passed tests of accuracy.

OO.A2 VERIFY AND DEMONSTRATE THE VALIDITY AND REASONABLENESS OF ALL SPECIAL STUDIES NEEDED TO DEVELOP ADDITIONAL INPUT INFORMATION NOT NORMALLY AVAILABLE FROM STANDARD REPORTS.

All special studies were reviewed for reasonableness in their respective need and for validity of their methodology. For this review, Bell Atlantic-New Jersey had prepared a Standards Manual For Special Studies. Interviews were conducted with analysts responsible for each special study. All special studies served valid and reasonable purposes. Streamlining has potential to maintain a contemporaneous design. Specific efforts must continue to bring compliance with the Standards Manual.

OO.A3 VERIFY AND DEMONSTRATE THE VALIDITY AND REASONABLENESS OF ALL REPORTS ISSUED BY THE EAS ON EITHER AN ANNUAL OR A QUARTERLY BASIS.

All reports issued by the EAS were reviewed. Guidelines for accounting and allocations were reviewed according to existing and independent authorities. Variances in reports were satisfactorily explained and verified. The EAS Process results in the generation of reasonable and valid reports.

OO.A4 VERIFY AND DEMONSTRATE THE VALIDITY AND REASONABLENESS OF ANY DIFFERENCES IN METHODS BETWEEN ANNUAL EAS STUDIES AND QUARTERLY EAS REPORTS.

The methodologies used by the annual EAS Report and quarterly reports were reviewed regarding inputs and outputs. Direct comparisons between quarter and annual reports are not possible due to timing differences. The timing differences are reasonable and provide the most timely data available on the report schedule.

OO.B1 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL DOCUMENTATION AND KEY PROCEDURES AND CONTROLS INCLUDING COMPARISON OF COMPANY PROCEDURES WITH APPLICABLE RULES AND REGULATIONS.

The review and determination of the reasonableness of the formal process include document review, procedures review, and testing of controls. Comparisons to Parts 32, 36, and 64 were made. EAS documentation, key procedures and controls were found to be in compliance with applicable rules and regulations.

OO.B2 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL INPUT CONTROLS AND TESTS FOR HISTORICAL AND/OR STATISTICAL DATA.

Manual and electronic reviews were performed of approximately 5000 input items. Source references were verified. Verification tests were applied. Accuracy rates were over 99.9% before verification procedures. Input controls and tests are reasonable.

OO.B3 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL DOCUMENTATION OF THE DATA COLLECTION PROCESS INCLUDING SPECIAL STUDIES, ALGORITHM DEVELOPMENT AND STATISTICAL DATA DEVELOPMENT PROCEDURES.

Review of documentation and interviews were used to determine the reasonableness of documentation of the data collection process. Data taken from Company reports was completely documented. The data collection process used to prepare special studies was not completely documented.

OO.B4 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL PROCEDURES, SYSTEMS, AND DOCUMENTATION SUPPORTING ALGORITHM CHANGES IN EAS.

The review of algorithmic changes included the comparison of over 9000 algorithms for 1992 and 1993. Categories of changes were established. Information was obtained concerning each reviewed change. The work papers were consistently useful but provided a difficult audit trail.

OO.B5 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL INPUT DATA, SPECIFICALLY TESTING STATISTICAL DATA, GENERAL LEDGER INFORMATION, AND SPECIAL STUDIES.

All input sources were reviewed for validity, completeness and applicability. Reasonableness was provided by compliance with Federal Communications Commission rules and regulations. General ledger, separations, and special study inputs to the EAS were found to be reasonable.

OO.B6 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL SPECIAL STUDIES TO DETERMINE THAT STUDIES ARE PERFORMED IN ACCORDANCE WITH VALID COST ALLOCATION PROCEDURES.

All special studies were reviewed with respect to their respective cost allocation methodology and the Parts 64 and 36 rules. With the exclusion of nine special studies that lacked sufficient documentation, all special studies were in accordance with valid cost allocation methods.

OO.B7 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL FLUCTUATION ANALYSES OF SPECIAL STUDY RESULTS.

An analysis of the differences in special studies from 1992 to 1993 was conducted. For each studied variance, the fluctuation resulted from a change in underlying usage related to cost or booked general ledger activity. All fluctuations were considered reasonable.

OO.B8 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF COST ALLOCATION SYSTEMS FOR PROCESSING INFORMATION IN ACCORDANCE WITH VALID COST ALLOCATION PROCEDURES.

Title 47 of the Code of Federal Regulations (FCC Parts 32, 36, and 64) must be adhered to in the recording and allocation of financial and operational activities. Part 32 is complied with in the accounting of cost allocations. However, twenty eight allocations were noted for explanation of non compliance. Part 36 compliance is audited periodically by independent auditors. Part 64 compliance is audited by independent auditors.

OO.B9 REVIEW, ANALYZE, AND DETERMINE THE MATHEMATICAL ACCURACY OF ALGORITHMS.

The mathematical accuracy of algorithms was reviewed by the performance of manual calculations. An approximately 5% sample of the 3500 substantial algorithms showed 100% accurate calculation.

OO.B10 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF OUTPUTS GENERATED FROM THE COST ALLOCATION SYSTEM.

A detailed review of EAS Report 22 and the Quarterly Surveillance Reports shows general reasonableness of outputs from the cost allocation system. However, three issues arise: in the allocation of common costs and investments in the Quarterly Surveillance Reports; failure by the BPU to specify the methodology to determine return on equity; and the absence of rate of return information in the Annual Study.

SO.A1 DETERMINE THAT STUDY METHODS CONFORM TO THE FCC RULES (PART 36 "SEPARATIONS", PART 64 "COST ALLOCATIONS", PART 32 "UNIFORM SYSTEM OF ACCOUNTS").

EAS outputs for 1993 were tested for agreement in total with corresponding input files. Variances were reviewed for materiality. Study methods were found to conform with Parts 32, 36 and 64.

SO.A2 DETERMINE THAT STUDY METHODS CONFORM TO GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) AND IF NOT, WHY NOT.

To ensure that the integrity of GAAP has been maintained through the EAS process, output reports for 1993 were summarized and traced to corresponding accounting system inputs. Statement of Financial Accounting Standards number 71 (SFAS-71) was found to affect financial accounting and not regulatory reporting. Regulatory reporting was found to be in compliance with GAAP.

SO.A3 DETERMINE THAT ALL STUDY INPUTS ARE BOOKED IN THE CORRECT ACCOUNTS.

Three separate analyses were conducted. A matrix of EAS account distributions was developed based on Level II (1993) documentation. An analysis of the internal accounting documentation was conducted. Finally, comparison was made to the FCC Automated Regulatory Management Information System (ARMIS) reports to ensure consistency with external reporting requirements. All three tests proved positive booking to correct accounts.

SO.A4 DETERMINE THAT ALL ALGORITHMS USED WITHIN THE EAS ARE ACTUALLY USED AS DESCRIBED IN THE DOCUMENTATION.

A one percent random sample of the 1992/ 1993 set of EAS algorithms was selected and verified by use of the Level I Documentation. All sampled algorithms were recalculated and tested and were used as described in the documentation.

SO.A5 DETERMINE THAT ANY SAMPLING TECHNIQUES USED ARE STATISTICALLY VALID.

All special studies were reviewed to identify those that used sampling methodologies. Interviews were conducted with the respective analysts. Work papers were reviewed. Sampling techniques ranged from 100% samples to statistically determined sample sizes. All sampling methodologies were valid statistical applications.

SO.B INCLUDE RELEVANT LISTINGS AND DOCUMENTATION WITH EAS.

In addition to providing the required documentation under separate cover, PMC analyzed each of the 9,255 lines of code between 1992 and 1993. All substantive changes to algorithms reflected appropriately supported rationale.

SO.C EVALUATE THE ACCURACY AND VALIDITY OF THE EAS PROCESS AS A WHOLE.

Tests of input data, the EAS System, special studies, and allocation methodologies were conducted. A full review of all efforts in this study was prepared. After evaluation, the EAS Process was found to be accurate and valid.

SO.D PERFORM AN ANALYSIS OF HOW WELL THE EAS WILL CONTINUE TO ACCOMPLISH ITS MISSION OVER THE NEXT FIVE TO TEN YEARS GIVEN THE CHANGING NETWORK AND EMERGENCE OF NEW TECHNOLOGIES.

The EAS System has the capacity to accommodate approximately two more times the current volume of categories and outputs. Consequently, the EAS System should be able to adopt future changes due to network and technological improvements.

I.E SUMMARY OF RECOMMENDATIONS

This section summarizes recommendations. The parenthetical references are to the proceeding findings and conclusions.

OO.A1 VERIFY AND DEMONSTRATE THE VALIDITY AND REASONABLENESS OF ALL ALGORITHMS USED TO SEPARATE AND /OR ALLOCATE REVENUES, INVESTMENTS AND EXPENSES.

OO.A1.R1 BANJ Should Locate The Original Source Documentation For The EAS. (OO.A1.F2 & OO.A1.F6)

Company Comment:

BANJ agrees that conceptually that, for an operations review of this nature, having the original source documentation for the Embedded Analysis System as it was developed by BELLCORE could initially have been viewed as desirable. Yet, because the algorithms used in New Jersey have been changed in accordance with state regulatory reporting requirements established by the New Jersey Board of Public Utilities, BANJ sees no practical value in uncovering the now outdated BELLCORE source documentation. Although a significant amount of time has already been spent to locate the documentation during the course of the Review, BANJ will attempt to locate it. However, it should be noted that no benefit to either the corporation or the board would result from uncovering the documentation and, as PMC points out, they were able to successfully conduct the review without it.

OO.A2 VERIFY AND DEMONSTRATE THE VALIDITY AND REASONABLENESS OF ALL SPECIAL STUDIES NEEDED TO DEVELOP ADDITIONAL INPUT INFORMATION NOT NORMALLY AVAILABLE FROM STANDARD REPORTS.

OO.A2.R1 The Standards Manual Requirements For Special Study Documentation And Provision For An Audit Trail Should Be Enforced. (OO.A2.F2 & OO.A2.F4)

Company Comment:

BANJ agrees and will do so. It warrants emphasis, however, that this recommendation does not reflect negativity on the special studies now being produced. PMC acknowledges that BANJ's current analysts are experienced and qualified, and that the special studies that they are responsible for preparing are satisfactory.

OO.A2.R2 Supervisory Review Of Special Study Results Should Be Required Prior To Input Into The EAS Study. (OO.A2.F5.)

Company Comment:

BANJ agrees and will require that all special studies have the approval of the analyst's manager on a going forward basis. The requirement will be added to the EAS Standards Manual. In addition, BANJ is in the process of incorporating some special studies directly into EAS algorithms. This will provide additional assurance that the studies, as they do now, produce quality results.

OO.A2.R3 The EAS Process Needs To Be Upgraded To Match The Company's Current Activities, Regulatory Requirements, And Streamlined To Eliminate Unnecessary Data Handling. (OO.A2.F6 and OO.A2.F7)

Company Comment:

The Board has determine that EAS meets all of its regulatory requirements. However, BANJ agrees that streamlining the System would be beneficial and is in the process of doing just that by consolidating and refining algorithms and data inputs as PMC recommends.

OO.A3 VERIFY AND DEMONSTRATE THE VALIDITY AND REASONABLENESS OF ALL REPORTS ISSUED BY THE EAS ON EITHER AN ANNUAL OR A QUARTERLY BASIS.

None.

OO.A4 VERIFY AND DEMONSTRATE THE VALIDITY AND REASONABLENESS OF ANY DIFFERENCES IN METHODS BETWEEN ANNUAL EAS STUDIES AND QUARTERLY EAS REPORTS.

OO.A4.R1 To Enable The Assessment Of The Results Of BANJ's Quarterly EAS Process, Annual Surveillance Reports Should Be Developed To Coincide With The Results From Annual EAS Studies. (OO.A4.F1 and OO.A4.F2).

Company Comment:

BANJ agrees with PMC that this recommendation in no way affects the quarterly financial monitoring reports required by BANJ's Board approved Plan for Alternative Regulation. Therefore PMC, and the Board staff have agreed that, in order to have all quarterly surveillance reports based on the same Annual EAS Study, the report for the first quarter will be submitted coincident with the submission of the Study (i.e. approximately one month later than what is now required).

OO.B1 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL DOCUMENTATION AND KEY PROCEDURES AND CONTROLS INCLUDING COMPARISON OF COMPANY PROCEDURES WITH APPLICABLE RULES AND REGULATIONS.

None.

OO.B2 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL INPUT CONTROLS AND TESTS FOR HISTORICAL AND/OR STATISTICAL DATA.

None.

OO.B3 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL DOCUMENTATION OF THE DATA COLLECTION PROCESS INCLUDING SPECIAL STUDIES, ALGORITHM DEVELOPMENT AND STATISTICAL DATA DEVELOPMENT PROCEDURES.

None.

OO.B4 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL PROCEDURES, SYSTEMS, AND DOCUMENTATION SUPPORTING ALGORITHM CHANGES IN EAS.

OO.B4.R1 The EAS Group Should Collect The Information On The Algorithmic Changes In One Centrally Available Official Document. (OO.B4.F2 and OO.B4.F3)

Company Comment:

Documentation currently exists in the form of working papers for all algorithm changes made vs. the prior year's Study.

At PMC's suggestion, BANJ agrees to file a copy of these work papers in one centrally available document segregated into 1) cosmetic changes; 2) non-substantive changes; and, 3) substantive changes

OO.B5 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL INPUT DATA, SPECIFICALLY TESTING STATISTICAL DATA, GENERAL LEDGER INFORMATION, AND SPECIAL STUDIES.

None.

OO.B6 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL SPECIAL STUDIES TO DETERMINE THAT STUDIES ARE PERFORMED IN ACCORDANCE WITH VALID COST ALLOCATION PROCEDURES.

OO.B6.R1 Complete All Supporting Documentation For All Special Studies. (OO.B6.F3, OO.B6.F4, OO.B6.F5)

Company Comment:

BANJ agrees and will comply on a going forward basis.

OO.B7 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF ALL FLUCTUATION ANALYSES OF SPECIAL STUDY RESULTS.

None.

OO.B8 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF COST ALLOCATION SYSTEMS FOR PROCESSING INFORMATION IN ACCORDANCE WITH VALID COST ALLOCATION PROCEDURES.

OO.B8.R1 Review The EAS Treatment Of The Non Operating Plant Account And The Non Operating Federal Income Tax Account Distributions. (OO.B8.F5).

Company Comment:

BANJ is required by the Plan for Alternative Regulation to close the BANJ books of accounts. For this reason, these accounts must be included in the EAS Base Study. However, PMC correctly points out that these accounts would be excluded from a traditional regulatory Cost of Service Analysis and in fact they are excluded in the Intrastate numbers provided in the EAS Separated Study and the EAS Quarterly Reports.

OO.B8.R2 Review Allocation Methodology Specifically for The Twenty-Eight (28) Noted Accounts. (OO.B8.F6).

Company Comment:

BANJ has reviewed the twenty-eight accounts in question and found that twenty of these are directly assigned to the EAS service category "Common". PMC's analysis is based on FCC Part 36 allocations which do not have a category for "Common". As the Board recognizes in its Order regarding BANJ's Plan for Alternative Regulation: "...expenses and investments assigned to the Common category are allocated to other service categories using a 'cost-on-cost' methodology. This method allocates common costs to the various services proportionately to the costs already assigned to the service categories." This method is applied to both the EAS Separated Study and the EAS Quarterly Reports.

Of the remaining accounts, the methodology employed has been previously reviewed and approved by the Board staff.

OO.B9 REVIEW, ANALYZE, AND DETERMINE THE MATHEMATICAL ACCURACY OF ALGORITHMS.

OO.B9.R1 For Future Audits and Reviews, A Step-By-Step Procedure That Could Be Followed In Logical Sequence Would Be Helpful, Especially When Verifying The Long, Complex Algorithms. (OO.B9.F1).

Company Comment:

BANJ could produce a step-by-step procedure; however, any future audit or review which followed procedures recommended by BANJ would cause the results of the audit or review to be suspect if they were to be scrutinized as part of any future litigation or proceeding.

OO.B10 REVIEW, ANALYZE, AND DETERMINE THE REASONABLENESS OF OUTPUTS GENERATED FROM THE COST ALLOCATION SYSTEM.

OO.B10.R1 The Quarterly Surveillance Report Reflecting The Fully Distributed Cost Methodology Should Be Designated As The Applicable Version Under The Plan For Alternative Regulation.

Company Comment:

It is understood that the Fully Distributed Cost (FDC) methodology is used to gauge the company's financial performance for its rate-regulated services under the Plan for Alternative Regulation. For example, in assessing the thresholds for formula-based rate adjustments, the Board focuses upon the FDC-based results. Nevertheless, the Plan continues the requirement established by the Board in the Rate Stability Plan proceedings that the quarterly reports also include results based upon Embedded and Direct Cost methodologies.

OO.B10.R2 Annual Surveillance Reports Based Upon The Output From The Annual EAS Study Should Be Developed And Submitted To The BPU With The Annual EAS Study.

Company Comment:

See response to 00.A4.R1.

SO.A1 DETERMINE THAT STUDY METHODS CONFORM TO THE FCC RULES (PART 36 "SEPARATIONS", PART 64 "COST ALLOCATIONS", PART 32 "UNIFORM SYSTEM OF ACCOUNTS").

None.

SO.A2 DETERMINE THAT STUDY METHODS CONFORM TO GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) AND IF NOT, WHY NOT.

None.

SO.A3 DETERMINE THAT ALL STUDY INPUTS ARE BOOKED IN THE CORRECT ACCOUNTS.

None.

SO.A4 DETERMINE THAT ALL ALGORITHMS USED WITHIN THE EAS ARE ACTUALLY USED AS DESCRIBED IN THE DOCUMENTATION.

None.

SO.A5 DETERMINE THAT ANY SAMPLING TECHNIQUES USED ARE STATISTICALLY VALID.

SO.A5.R1 Complete The SLUS Study In 1996.

Company Comment:

BANJ agrees and will comply.