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Review of BT's Cost Attribution Methodologies

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Review of BT's Cost Attribution Methodologies Review of BT’s cost attribution methodologies Consultation Publication date: 12 June 2015 Closing Date for Responses: 7 August 2015 About this document This document sets out our proposals for changes to the way that BT attributes its costs to services. BT is subject to regulatory financial reporting obligations. These have been imposed by Ofcom where BT has been found to have Significant Market Power in a relevant market. These include obligations relating to accounting separation and cost accounting and include requirements to produce and publish annual Regulatory Financial Statements and to maintain and publish certain accounting documents setting out how BT prepares those statements. In May 2014, we decided that BT’s Regulatory Financial Statements should comply with a new set of guiding principles, which we called the Regulatory Accounting Principles. We explained that we would establish Regulatory Accounting Guidelines which will contain high level guidelines and accounting rules. We explained that we would review BT’s existing attribution rules against the new Regulatory Accounting Principles and that we would consult on the findings from this review alongside the Business Connectivity Market Review consultation, with the intention that any proposed changes to the attribution rules would be reflected in any consequent price control. This document sets out the initial findings from that review and invites stakeholders’ views on if and how BT’s existing attribution rules need to change. Contents Section Page 1 Summary 1 2 Introduction 5 3 BT’s cost attribution system 9 4 Scope and approach 13 5 Cost attribution in 2013/14 18 6 Issues considered in this review 26 7 Correction of errors 33 8 Attribution by pay and return on assets 52 9 Review of other attribution methodologies 73 10 Review of supporting evidence 106 11 Review of documentation 119 12 Future developments 129 13 Implementation of proposed changes 138 Annex Page 1 Responding to this consultation 143 2 Ofcom’s consultation principles 145 3 Consultation response cover sheet 146 4 Consultation questions 148 5 Estimate of market level impact 150 Section 1 1 Summary Overview 1.1 British Telecommunications plc (“BT”) is subject to regulatory financial reporting obligations. These have been imposed by Ofcom where BT has been found to have Significant Market Power in a relevant market. These include obligations relating to accounting separation and cost accounting and include requirements to produce and publish annual regulatory financial statements (the Regulatory Financial Statements) and to maintain and publish certain accounting documents setting out how BT prepares those statements. 1.2 In May 2014, we introduced a new set of Regulatory Accounting Principles1. These provide a set of guiding principles to be followed in BT’s Regulatory Financial Statements. We explained that we will also establish Regulatory Accounting Guidelines which will contain high level guidelines and accounting rules.2 1.3 We explained that we would review BT’s existing attribution rules against the new Regulatory Accounting Principles. We explained that we would consult on the findings from this review alongside the Business Connectivity Market Review (BCMR), with the intention that any proposed changes to the attribution rules would, subject to consultation, be reflected in the market review and any consequent price control. 1.4 This document sets out the initial findings from that review and proposes how BT’s attribution rules should change to comply with the new Regulatory Accounting Principles going forward. 1.5 These proposals may have implications for future charge controls that we might set as an outcome of our market reviews, including the BCMR, and subsequently the Fixed Access Market Review, to the extent that the proposed changes are reflected in the cost data used to inform these decisions. 1.6 Separately, we are consulting on our proposals for new charge controls on leased lines services (the 2015 Leased Lines Charge Control, or “LLCC” Consultation), as part of the BCMR. The proposals for the leased lines charge controls rely on the analysis described in this document in relation to a number of proposed adjustments to BT’s costs. 1 The Regulatory Accounting Principles are, in order of priority: Completeness; Accuracy; Objectivity; Consistency with regulatory decisions; Causality; Compliance with statutory accounting standards; and Consistency of the Regulatory Financial Statements as a whole and from one period to another. 2 The 2014 Statement followed a call for inputs of November 2011, a consultation in September 2012 (the “2012 Consultation”) and a further consultation in December 2013 (the “2013 Consultation”). 2http://stakeholders.ofcom.org.uk/telecoms/ga-scheme/specific-conditions-entitlement/market- power/fixed-access-market-reviews-2014/statement/ 1 Summary of our review 1.7 Due to the complex nature of BT’s cost attribution systems, it is not always straightforward to identify and understand the cost categories and attribution rules that have most impact on the reported costs of regulated services. 1.8 The purpose of this review is to improve our understanding of BT’s cost attribution system, identify the key attribution methodologies and their impact on the reported costs of regulated services and determine whether those methodologies are appropriate. 1.9 We engaged consultants (Cartesian) to inform our review. We asked Cartesian to provide a report to: • Provide an overview of BT’s cost attribution system; • Help us and other stakeholders to identify the cost categories and attribution rules that account for a significant proportion of the costs allocated to regulated services; • Explain how those costs are attributed in BT’s cost attribution system; and • Consider whether the attribution bases are consistent with the Regulatory Accounting Principles. 1.10 We have published Cartesian’s report alongside this consultation and we refer to that report extensively throughout this document. The proposals set out in this consultation were informed by Cartesian’s findings but the final assessment of whether the methodologies are appropriate and the decision whether to propose changes to those methods are ours. Our findings 1.11 Cartesian said that it was “satisfied that BT’s cost attribution system is free from bias.”3 However, Cartesian did find “areas of weakness that BT could improve on.”4 In particular Cartesian “identified a large number of concerns with the methodologies used to apportion costs”, although it noted that “the majority of these concerns do not have a material impact on cost attribution.”5 1.12 Informed by Cartesian’s review of BT’s cost attribution system we have identified issues in four categories: • Errors. We have identified mathematical or input errors in spreadsheets and supporting calculations as well as allocation errors where costs have been allocated incorrectly (for example where costs have been allocated to a service that is not delivered using those costs). Where we have identified errors, we set out how they will be corrected by BT. As explained in Section 7, we estimate that the effect of correcting these errors could be to move costs (on a fully allocated cost basis) of around £36m away from regulated markets. 3 Cartesian, Cost Attribution Review, Executive Summary 4 Cartesian, Cost Attribution Review, Executive Summary 5 Cartesian, Cost Attribution Review, Executive Summary 2 • Inappropriate attribution methodologies. We have identified some attribution methodologies (including methodologies relating to BT’s General Overheads) that we consider are inappropriate because we do not consider that they appropriately reflect the activities that cause the costs to be incurred. Where we consider that current rules are not appropriate, we propose what we consider to be appropriate cost attribution methodologies. As explained in Section 8, the impact of changing the current attribution rules will depend on the rules that take their place, but we estimate that the effect of moving to our proposed bases for the attribution of General Overheads could be to reattribute costs of around £226m away from regulated markets. We have also identified some other attribution methodologies that we consider need further investigation. As set out in Section 9, we seek stakeholders’ views on these other methodologies and may return to these in a second consultation if we consider that the current rules are not appropriate, but at this stage we have not attempted to quantify the possible impact of any potential changes to the current rules. • Deficient supporting evidence. In some areas, we have considered that BT may not be using the most objective and accurate source of data. It has also become apparent that some supporting data and calculations (such as Excel spreadsheets) that generate apportionments to be input into the cost attribution system are difficult to review and potentially not fit for purpose. In Section 10, we set out the steps we expect BT to take in respect of its evidence sources. In some of those cases we have suggested an alternative source of data which could offer a better, more objective source of evidence. Additionally, where we consider there may be scope for BT to update its supporting calculations, we expect BT to take the necessary steps to address these concerns. In the event that BT has not adequately addressed our concerns, we will consider whether more prescriptive action may be appropriate. There are also some cases where we have not been able to identify a better alternative. We will therefore engage with BT to gain a better understanding of the available sources of information. • Inadequate documentation. We have identified aspects of the documentation published by BT to explain how the cost attribution system works that are unclear and not sufficiently transparent. We also consider that some of the explanatory documentation appears inaccurate or inconsistent. In Section 11, we highlight our concerns and explain that we expect BT to take the necessary steps to address these in the 2014/15 Regulatory Financial Statements.
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