Opinion ID: 1926458
Heading Depth: 1
Heading Rank: 9

Heading: research and development costs

Text: The Commission contends that the district court erred in requiring the expensing of research and fundamental development costs paid by South Central Bell to AT&T pursuant to the License Contract Agreement. It argues that, because these funds are expended to benefit future ratepayers, they should be capitalized and recouped in the future through amortization. On the other hand, South Central Bell argues that research and development costs should be expensed in that they represent payment for services rendered for the benefit of current ratepayers, sound accounting principles dictate such treatment, and South Central Bell has consistently expensed such costs in the past which method of accounting has been accepted by the Commission in prior rate proceedings. On July 1, 1968, South Central Bell and AT&T entered into a License Contract Agreement in which AT&T granted certain rights and agreed to furnish certain services to South Central Bell. Other operating companies of the Bell System have similar contracts with AT&T. Basically, the rights and services furnished by AT&T to the companies under this agreement are (1) the right to use telephones and telephonic devices, methods and systems which are covered by patents owned or controlled by AT&T, (2) the right to receive advice and assistance in the conduct of telephone operations, (3) financial advice and assistance, and (4) the right to share in the results of research and development of the art and science of telephony. In consideration for AT&T's performance of these services, each operating company agreed to pay annually 2½% of the company's gross earnings computed in conformity with the Uniform System of Accounts prescribed by the Federal Communications Commission. On the same date as the contract (July 1, 1968), a letter was addressed to South Central Bell by AT&T in which AT&T agreed to accept until further notice as payment for its services under the contract 1% of the total gross earnings. Thereafter, on June 3, 1974, a similar letter was addressed to South Central Bell by AT&T informing South Central Bell that effective October 1, 1974 and continuing thereafter until further notice AT&T would require an amount equal to South Central Bell's allocated share of the total costs associated with providing services under the contract, but not to exceed the rate of 2½ of gross earnings. There is evidence in the record that, pursuant to this agreement, South Central Bell pays about 5% of the total license service costs with the share of its Louisiana operation comprising about one-fifth of that amount. The task of research and fundamental development is performed by Bell Telephone Laboratories, which is owned equally by AT&T and Western Electric Company (a wholly-owned subsidiary of AT&T). According to Mr. W. R. Meredith, Jr., general revenue supervisor for South Central Bell, experience has demonstrated that it is more efficient and economical to perform work involving common needs and problems of the Bell companies on a centralized basis conducted by the Bell Labs. Mr. James H. Brenneman, manager of license and regulatory matters of AT&T, testified that research and development is not product-oriented; rather, its primary purpose is to develop innovative techniques resulting in more efficient operations of the Bell System companies. In other words, the efforts of Bell Labs are geared to assisting the operating companies in solving their day-to-day problems. He further indicated that, when the efforts of Bell Labs reach a point that they can be identified with a specific product, the funding of the product by AT&T ceases and thereupon is assumed by Western Electric. Brenneman also testified that, according to accepted accounting principles and a formal opinion by the Financial Accounting Standards Board, costs attributable to research and fundamental development are expensed rather than capitalized. Although the Commission expressed reservations about any assessment under the License Contract in excess of 1% of revenues, it did not disallow the amount of the license service costs but rather elected to adjust only the costs attributable to research and fundamental development by requiring that they be capitalized and amortized over a future period. This ruling was contrary to expert testimony in the record that accepted accounting principles would treat such costs as an expense item. After reviewing the Commission's order, the district court found no reasonable basis to support the Commission's decision to capitalize these costs and thus concluded that the Commission had abused its discretion in disallowing the expensing of these costs. The court ordered the Commission to make the necessary adjustments to conform with its ruling. Based upon the evidence in the record, I believe that the costs of research and fundamental development are properly treated for rate-making purposes as an operating expense. There is no implication that the License Contract Agreement was entered in bad faith. Nor is there any dispute that the services rendered by AT&T under the contract were beneficial to South Central Bell and more than justified the payments made by the company to AT&T. The costs are clearly expended to enable South Central Bell to provide its current ratepayers with efficient and economic telephone service and are expensed and allocated to the operating companies in the year in which they are incurred. Moreover, the expensing of these costs conforms with generally accepted accounting principles as enunciated by the Financial Accounting Standards Board. Furthermore, in two recent utility decisions, research and development costs were found to be a proper and appropriate expense item for rate-making purposes. Re The Chesapeake & Potomac Telephone Co., ___ P.U.R.4th___ (Order No. 62319, Public Service Commission of Maryland, May 5, 1977); Re Ohio Bell Telephone Co., 15 P.U. R.4th 344 (Ohio Pub.Util.Comm.1976). Accordingly, I find that the district court did not err in ordering that the costs attributable to research and fundamental development be treated as an operating expense.