Federal Communications Commission

Common Carrier Bureau

Accounting Safeguards Division

DECEMBER 22, 1998

Audit of the Continuing Property Records of the

NYNEX Telephone Operating Companies

Also Known As Bell Atlantic North

As of March 31, 1997

Audit Report of the Continuing Property Records of the

NYNEX Telephone Operating Companies (Bell Atlantic North)

Table of Contents

Page No.

I. I. Executive Summary 1

III. Purpose and Scope 6

IV. Results for Hard-wired Equipment 7

C. Verification Results 10

D. Statistical Estimates Based on Sample 11

E. Examination of Cost Support Documents 12

V. Results for Unspecified Items 13

B. Unallocated Other Costs 14

VI. NYNEX COE Inventory 15

VII. Duration and Extent of the Problem 16

VIII. Conclusions and Corrective Actions 17

IX. Recommendations 18

Appendix A: Summary of the 1994 NYNEX CPR Audit

Appendix B: NYNEX CPR Statistical Audit Plan Overview

Appendix C: Problems Encountered in the Verification Process

I. Executive Summary

1. The Audits Branch examined the accounting records of the NYNEX Telephone Operating Companies ("NYNEX or NYNEX/Bell Atlantic North") related to central office equipment ("COE") to determine whether its reported investment in COE represents property used and useful in the provision of telecommunications services. We compared descriptions of equipment in NYNEX's basic property records to its physical equipment to verify the existence of the equipment described in the records and recorded in the plant accounts. The basic property records we audited consist of the carrier's continuing property records ("CPR") and records supplemental thereto. The Commission's rules require carriers to maintain updated descriptions and locations of each of their in-service plant assets so that the equipment may be readily spot-checked for proof of physical existence. Accurate plant account balances are important because policymakers use them, among other things, to evaluate financial results, regulated/nonregulated cost allocations, jurisdictional separations allocations, depreciation rates, initial prices, low-end earnings adjustments, and productivity factors for price cap companies, inputs for forward-looking cost models for calculating universal service support, interconnection agreements, and access charges.

2. We find that NYNEX/Bell Atlantic North has not maintained its basic property records and CPR in a manner consistent with the Commission's rules. Our audit found deficiencies in NYNEX/Bell Atlantic North's CPR for COE items relating to: (1) Hard-wired Equipment, which consists of permanent equipment requiring complicated installation such as telephone switches and circuit equipment; and (2) Undetailed Investment and Unallocated Other Costs, which entail amounts of investment that are not readily associated with specific, identifiable units of equipment. We consider these deficiencies to be substantive in that the carrier's CPR contained inadequate or no asset descriptions, inaccurate quantities, missing and inaccurate location descriptions -- errors that clearly violate the requirements specified in the Commission's rules for maintaining property records. NYNEX/Bell Atlantic North's recordkeeping deficiencies raise questions about the integrity of its property records and plant investment balances recorded in its COE accounts.

3. Specifically, in our audit of a random sample of 1,224 line-items from NYNEX's CPR for Hard-wired Equipment, we found that 20.9 percent of the records that we sampled contained substantive deficiencies and did not comply with the Commission's rules. Of these deficient records, 10.3 percent described equipment that could not be found by the auditors or by company representatives ("not found" equipment). The remaining 10.6 percent could not be verified with certainty because the equipment shown to the auditors could not be matched to the record in some important respect such as location or description. Based on these findings, we estimate that NYNEX's investment related to Hard-wired Equipment is overstated by approximately $381.5 million. This estimate, however, does not take into consideration the amount of equipment in the 10.6 percent of sampled records that could not be verified definitively.

4. In addition to finding errors in NYNEX's CPR for Hard-wired Equipment, we found that a significant number of line-items in NYNEX's CPR contain the notation "Undetailed Investment" or "Unallocated Other Costs." These items had no description of either the equipment or its location, in apparent violation of the Commission's rules. We found more than 12,600 line-items representing $376.7 million in Undetailed Investment. NYNEX/Bell Atlantic North has not shown any specific physical plant or provided sufficient or convincing cost support data relating to any of the line-items for Undetailed Investment. We also found more than 34,000 line-items representing $418.9 million in Unallocated Other Costs. We are deferring final determination on the amounts associated with Unallocated Other Costs until we receive sufficient documentation from the company explaining the nature of these costs.

5. The Audits Branch provided its results to NYNEX/Bell Atlantic North and requested NYNEX/Bell Atlantic North to correct and explain any decision it believed was made in error. Further, we sent a draft audit report to NYNEX/Bell Atlantic North with a request for comment on factual errors or omissions. After reviewing NYNEX/Bell Atlantic North's responses, we made appropriate adjustments as warranted and provided a revised report to NYNEX/Bell Atlantic North for review.

6. The findings of this audit highlight the significance of our previous concern about the integrity of NYNEX/Bell Atlantic North's recordkeeping. In 1994, our audit of NYNEX's CPR relating to COE revealed numerous errors and instances of insufficient information. In addition, both in 1994 and 1997, we found that NYNEX's CPR recordkeeping procedures were not being followed or were ineffective. We found that these procedures, which have been in place for many years, do not ensure that all investment recorded in the carrier's COE accounts is associated with equipment in service.

7. We recommend that NYNEX/Bell Atlantic North write off appropriate amounts from its plant account balances (as discussed in this report) to reflect our audit findings, that it engage an independent firm to conduct a complete inventory of its CPR for its COE, and that it report the results to the Commission so that we can determine whether further accounting adjustments are necessary. We further recommend that NYNEX/Bell Atlantic North engage an independent auditor to evaluate the practices, procedures, and controls NYNEX/Bell Atlantic North has in place to maintain its CPR, and to recommend improvements to ensure reliable and accurate plant account balances and records. NYNEX/Bell Atlantic North should submit the independent auditor's report to the Accounting Safeguards Division.

II. Background

8. In Part 32 of its rules, the Commission prescribes a Uniform System of Accounts ("USOA") for telecommunications carriers. The USOA includes specific details about the property records that carriers must maintain. Taken together, the data contained in the accounts and in the underlying financial and other subsidiary records must "provide the information necessary to support separations, cost of service and management reporting requirements." As a general rule, the Commission requires that financial records be kept with sufficient particularity to show fully the facts pertaining to all entries in the accounts and in a manner so as to be "readily accessible for examination" by the Commission.

A. Recordkeeping Requirements

9. The USOA provides specific requirements for recording investment in property, plant, and equipment and for maintaining certain supporting records, including the basic property records that are the subject of this audit. The basic property records consist of the CPR and all supplemental records necessary to provide the property record details required by the Commission. The CPR contains detailed descriptions as to the location, date of placement into service, and original cost of plant assets. Supplemental records include invoices, work orders, and engineering drawings that support the information in the CPR. These property records are the part of the property accounting system that preserves the identity, vintage, location, and original cost of property, as well as original and ongoing transactional data. Incumbent local exchange carriers ("LECs") must ensure that their records are auditable, subject to effective internal accounting controls, and "maintained throughout the life of the property." Further, the USOA requires that the basic property records be "equal in the aggregate to the total investment reflected in the financial property control accounts as well as the total of the cost allocations supporting the determination of cost-of-service at any particular point in time."

10. Incumbent LECs must maintain their CPR by subaccount for each accounting area of their operations. Incumbent LECs are required to provide "accurate accounting for retirements" and "data for use in connection with depreciation studies." The CPR is intended to support the regulated accounts by providing a link to the physical assets used for regulated service as well as to the underlying work orders and other documentation for related accounting entries. In addition, these records are necessary so that assets can be "readily spot-checked for proof of physical existence." By describing the plant's specific locations and providing references to invoices, work orders, and other support documents, the CPR provides a key aspect of the audit trail for the plant accounts and facilitates regulatory review of, among other things, access charges, depreciation rates, and certain jurisdictional separations and other cost allocations.

B. 1994 Audit

11. We previously audited NYNEX's CPR in 1994. We performed procedures to verify the existence of COE plant using a nonstatistical sample of items listed on NYNEX's CPR. In that audit, 16 percent of the equipment items contained in the sample could not be found. We also attempted to identify the assets associated with listings that did not contain adequate equipment descriptions. For these items, we found that NYNEX could not locate the assets and, generally, could not support its CPR values. In addition, we found that, contrary to our rules, NYNEX had not reconciled its CPR with its 1993 financial account balances.

12. The audit staff discussed these concerns with NYNEX representatives during the course of the 1994 audit. In 1994, NYNEX initiated what it called a "100 Percent Asset Verification" or inventory to correct problems in New York Telephone's CPR. As a result of this inventory, NYNEX retired $291 million of central office equipment that was recorded on the books but was not found to be in service. During the course of the present audit, NYNEX/Bell Atlantic North reported that it had nearly completed its 100 Percent Asset Verification process and that it had retired or provided additional descriptions for most of the "unspecified" items.

III. Purpose and Scope

13. The purpose of our current audit was to determine whether NYNEX is in compliance with the Commission's requirements regarding basic property records and continuing property records, as set forth in sections 32.2000(e) and (f) of the Commission's rules, and to determine whether NYNEX's plant accounts accurately reflect the cost of assets used and useful in the provision of telecommunications services.

14. We reviewed the CPR for all of NYNEX's COE as of March 31, 1997. As of that date, NYNEX had approximately $12.7 billion of investment in COE. We classified COE into three categories for purposes of this audit: (1) Hard-wired Equipment; (2) Plug-in Equipment; and (3) Unspecified Items. The Hard-wired Equipment category contains permanent equipment requiring complicated installation such as telephone switches and circuit equipment. The Plug-in Equipment contains modular items designed to be installed readily by simply plugging them in where needed and thus are more easily moved from place to place. The category described as Unspecified Items includes significant amounts of investment that are not readily associated with specific, identifiable units of equipment. The Unspecified Items consisted of four groups: Undetailed Investment, Unallocated Other Costs, Plug-in Other Costs, and Right-to-use Fees. The following table summarizes NYNEX's total COE investment.

Table 1

15. This audit report focuses primarily on the Hard-wired Equipment category and two groups in the Unspecified Items category: Undetailed Investment and Unallocated Other Costs. We did not focus our efforts on the Plug-in Equipment category or on the other groups in the Unspecified Items category (i.e., Right-to-use Fees, or Plug-in Other Costs), because of the nature of these items and the manner in which NYNEX maintains its CPR for them. For example, Plug-in Equipment consists of units that are very portable and their locations are not individually identified in NYNEX's CPR. Consequently, an audit based upon the physical inspection of such items requires a different approach than was used for Hard-wired Equipment.

IV. Results for Hard-wired Equipment

16. During the week of May 12 through May 16, 1997, NYNEX presented, at our request, an overview of the company's system for maintaining its basic property records and CPR. NYNEX also described its audit procedures and reconciliations that it performs periodically to ensure the accuracy of those records. Following NYNEX's presentation, we began our detailed examination of the records described in this report. NYNEX's CPR for its COE consists of a total of 465,600 records. Of this total, 419,000 records related to Hard-wired Equipment.

17. Generally, our audit of NYNEX's Hard-wired Equipment records consisted of a statistical sampling of equipment items (1,224 records randomly selected) from NYNEX's CPR. We travelled to each location specified in the sampled CPR, and determined, through a physical inspection, whether the equipment was installed and whether the CPR description, location, and quantity were accurate and complete. We also requested cost support documentation to determine whether the costs stated in NYNEX's CPR were recorded accurately and in accordance with the Commission's rules. These efforts and results are discussed in the following paragraphs.

A. Verification Process

18. In order to verify the existence of equipment listed on the CPR, we selected 34 different central office locations. Prior to visiting the selected offices, we notified NYNEX and requested the assistance of technical staff familiar with the COE in these offices. Generally, three or more company employees accompanied us during the verification process. Upon arrival at the central office location each morning, the selected sample was presented to NYNEX's technical staff. With NYNEX's technical staff, we then jointly attempted to locate the sampled equipment. When the equipment was not found in the location specified in the CPR or when the CPR did not contain a specific equipment location, we provided company personnel an opportunity to locate the equipment elsewhere within the office. In the course of this process, we were often taken to other locations in the office and shown items on different frames than those listed in the CPR. Items were considered not found only when the sampled equipment could not be located anywhere in the central office.

B. Records Examined

19. A sample of 1,224 records was randomly selected for audit from Hard-wired Equipment items listed on NYNEX's CPR for its COE. The 1,224 line-items consisted of 36 randomly-selected items from each of the 34 selected central office locations we visited. With assistance from NYNEX personnel as described above, we attempted to verify the existence of the property recorded in the 1,224 line-items. We encountered numerous problems in our attempts to verify the sample. These problems were sometimes the result of deficiencies in the records, such as a lack of specificity as to location, description, or quantity, and sometimes the result of discrepancies between the record and the equipment we were shown. Of the 1,224 line-items, 256 line-items (20.9 percent of the sampled items) were found to be seriously deficient in that we were shown no equipment, were shown equipment of less quantity than the records indicated, or were shown equipment that we could not verify with certainty due to discrepancies between the record and the equipment shown. Although less serious, we also encountered problems with some of the other 968 line-items that we marked as found. In some instances there were misleading or inconsistent floor indications in these records. In other instances, descriptions of the items were incomplete. The problems encountered in the verification process are discussed in greater detail in Appendix C.

20. Upon completion of the physical inspection for the Hard-wired Equipment sampled from the CPR, we provided NYNEX/Bell Atlantic North with the verification results and requested explanations or corrections to our findings that the equipment could not be found. We reviewed NYNEX/Bell Atlantic North's explanatory material and adjusted our original results when we were convinced by the explanation and supporting documentation that the missing plant was actually in service. On July 20, 1998, we provided NYNEX/Bell Atlantic North with a draft audit report and requested that it provide comment on any factual errors or omissions contained in the draft audit report. On August 19, 1998, NYNEX/Bell Atlantic North submitted its response to the draft audit report. We reviewed NYNEX/Bell Atlantic North's response and made appropriate adjustments as warranted.

C. Verification Results

21. The following table summarizes the results of our sample:

Table 2

Assets Found: We found all of the equipment in this category. For 932 of these line-items, equipment was found that matched description and location information in the CPR. For the remaining 36 line-items in this category, the CPR did not indicate a specific location in the building, but we were satisfied that the equipment observed was the equipment described in the record.

Assets Partially Found: We found some of the equipment in this category but the quantity found was less than the quantity specified in the record. For each record, we prorated the cost of the equipment between the equipment found and the equipment not found based on the relative quantity of each group.

No Assets Found: Neither we nor the company personnel could find the equipment in this category.

Unverifiable Assets: We were shown equipment but were unable to determine with certainty that it was the equipment described in the CPR because of either deficiencies in the CPR or discrepancies between the CPR and equipment shown. This category included equipment that could not be matched with the CPR as to location, description, or identification number because of incomplete or missing information.

D. Statistical Estimates Based on Sample

22. Because of the challenges presented in this audit, i.e., over 419,000 records relating to Hard-wired Equipment located in over a thousand central offices in six states, we selected a random sampling plan to estimate the total cost associated with amounts of Hard-wired Equipment not found. This enabled us to maximize the precision of our audit results within our resource constraints. Our sampling plan is described in detail in Appendix B.

23. Generally, our random sampling plan consisted of the following steps: (1) for each sampled office we computed the cost of not found Hard-wired Equipment per sampled line-item; (2) for each stratum we computed the average cost of not found Hard-wired Equipment by weighting the average cost of not found items for each office with the relative number of records in the office; (3) for each stratum we calculated the total cost of not found items by multiplying the average cost of not found items by the number of records in the stratum; and (4) for each stratum we determined NYNEX's total cost of not found items by summing the cost of the not found items. Based on our sample findings, we project that 20.2 percent of NYNEX/Bell Atlantic North's entire CPR for its COE Hard-wired Equipment, or 84,600 line-items, contain substantive errors or omissions and do not comply with our recordkeeping requirements. From this analysis, we estimate that $381.5 million of the cost recorded in NYNEX/Bell Atlantic North's COE accounts represents not found Hard-wired Equipment.

24. The USOA requires that the CPR include the original cost of all property record units. Further, the rules require that "[a]ll drawings, computations, and other detailed records which support quantities and costs or estimated costs shall be retained as part of or in support of the continuing property record." To confirm that NYNEX/Bell Atlantic North's practices, procedures, and controls are effective in ensuring that accurate costs and quantities are recorded in the CPR, we requested the supporting invoices, work orders, and other construction documentation for the material and in-place costs.

25. By letters dated June 9, 1997 and October 8, 1997, we requested cost documentation for 1,224 audited sample line-items to be provided by July 10, 1997 and November 8, 1997, respectively. NYNEX/Bell Atlantic North responded that it would be unable to provide this cost documentation by the dates requested. On December 5, 1997, we submitted a cost support request based on a sample of 50 randomly selected Hard-wired Equipment COE line-items. We requested data for this sample so that we could determine whether cost support for all the data specified in the June 9, 1997 and October 8, 1997 requests would be necessary. On January 9, 1998, NYNEX/Bell Atlantic North responded that it would provide the information by June 30, 1998. To date, NYNEX/Bell Atlantic North has not yet provided cost documentation for all of these 50 Hard-wired line-items.

26. In summary, we have requested data from NYNEX/Bell Atlantic North to verify the original costs of the property record units listed on its CPR. NYNEX/Bell Atlantic North, however, has not provided sufficient documentation for us to make a determination that these costs were recorded accurately. We, therefore, have decided to suspend judgment temporarily on the accuracy of the original costs recorded on NYNEX/Bell Atlantic North's CPR. For the purposes of this report, we assume the original costs recorded on its CPR are correct. At a later date, we will investigate these costs and determine their validity. After we receive and analyze the cost support, we intend to issue a separate report on the matter of cost support.

V. Results for Unspecified Items

27. NYNEX/Bell Atlantic North's CPR for its COE consists of a total of 465,600 records. Of this total, we found a large number of NYNEX's CPR records contained neither equipment descriptions nor location descriptions. In its CPR, NYNEX/Bell Atlantic North refers to many of these items as Undetailed Investment (12,600 records) or Unallocated Other Costs (34,000 records). Because there were no equipment or location descriptions in these records, we were unable to locate physically the assets relating to these records.

A. Undetailed Investment

28. We identified approximately 12,600 records representing $376.7 million of Undetailed Investment. NYNEX/Bell Atlantic North stated that these records represent costs associated with assets that for some reason it did not identify in its CPR. The only specific explanation that NYNEX/Bell Atlantic North offered for these records is that they represent a portion of the investment installed prior to the implementation of its mechanized CPR in 1973.

29. Because of the lack of specificity in these records, we adopted a number of steps in our audit procedure to determine what type of equipment was represented by the Undetailed Investment and whether the investment amounts contained in NYNEX/Bell Atlantic North's CPR were legitimate. First, we requested that NYNEX/Bell Atlantic North representatives identify the equipment associated with all of the Undetailed Investment at three of the sampled central office locations. For these central offices, the company was unable to locate any of the Undetailed Investment entries during our on-site visits. In addition, in letters dated September 9, and October 8, 1997, we requested, among other things, that NYNEX/Bell Atlantic North provide the cost support for the 450 Undetailed Investment entries listed in all of the sampled 34 central offices. NYNEX/Bell Atlantic North failed to provide any of the requested cost support documentation. On December 5, 1997, we again wrote NYNEX/Bell Atlantic North requesting the cost support for a sample of 25 line-items of the Undetailed Investment. In a letter dated January 9, 1998, NYNEX/Bell Atlantic North stated that it would not be able to provide the cost support for the Undetailed Investment until June 30, 1998.

30. We examined the cost support provided by NYNEX/Bell Atlantic North in its June 30, 1998 submission and did not find that NYNEX/Bell Atlantic North provided sufficient and convincing support for the Undetailed Investment or otherwise provided a sufficient indication of what items of plant investment support the entries in the CPR for Undetailed Investment. In summary, NYNEX/Bell Atlantic North failed to substantiate the physical existence of equipment associated with the Undetailed Investment line-items or provide sufficient and convincing cost support for the related investment amounts shown in the CPR, as required by Part 32 of the Commission's rules. We gave NYNEX/Bell Atlantic North numerous opportunities either to show us the equipment associated with an Undetailed Investment entry or to provide sufficient and convincing documentation supporting it. In each instance, NYNEX/Bell Atlantic North failed to satisfy our request and the requirements of Part 32. In conclusion, we find, based on our audit work, that the existence of the plant related to Undetailed Investment cannot be substantiated, and the costs related to the Undetailed Investment should be removed from NYNEX/Bell Atlantic North's CPR and its plant accounts.

B. Unallocated Other Costs

31. NYNEX/Bell Atlantic North's CPR contains another type of entry with no equipment or location description, called "Unallocated Other Costs." We found more than 34,000 such entries representing $418.9 million in investment. According to NYNEX/Bell Atlantic North, Unallocated Other Costs represent Hard-wired related costs that are not properly includable as in-place costs because they are "in excess of those reasonably includable in the item in-place cost." We have requested information from NYNEX/Bell Atlantic North to verify the validity of these entries. After reviewing NYNEX/Bell Atlantic North's cost documentation, we intend to issue a further report on the matter of Unallocated Other Costs.

VI. NYNEX/Bell Atlantic North's COE Inventory

32. After our 1994 audit, NYNEX/Bell Atlantic North conducted a complete COE inventory for the New York Telephone Company. As a result of this inventory, in 1995, NYNEX/Bell Atlantic North found deficiencies and retired $137 million in Hard-wired and plug-in central office equipment. Likewise, in 1996 NYNEX/Bell Atlantic North found further deficiencies in its COE inventory and retired $154 million in Hard-wired and plug-in equipment. Both the $137 million and $154 million retirements were made using standard retirement entries, i.e., removing the cost of the asset from the asset account and charging the same amount to the accumulated depreciation account. The effect of these retirement entries was to leave the net book value of these assets unchanged. We believe, however, that the deficiencies found by NYNEX/Bell Atlantic North in 1995 and 1996, reflect the same type of accounting and recordkeeping errors that we found in our current audit. Therefore, we believe that the errors identified in NYNEX/Bell Atlantic North's inventory should be resolved in the same manner that we recommend to resolve the discrepancies identified in this audit, i.e., through plant write-offs.

VII. Duration and Extent of the Problem

33. We have found numerous substantive deficiencies in NYNEX/Bell Atlantic North's CPR. We first became aware of the nature and scope of this problem during our 1994 audit of NYNEX/Bell Atlantic North's CPR. That audit, and NYNEX/Bell Atlantic North's own inventory, demonstrated that the problems were so pronounced and prevalent as to make it highly unlikely that the errors had developed in a relatively short period of time.

34. Our current audit findings make it even clearer that NYNEX/Bell Atlantic North's CPR problems are longstanding. Based on our current audit we estimate, as detailed in Appendix B, that over 130,000 records, or nearly 30 percent of the records within the scope of this audit, are inaccurate or deficient in some important respect. It is unlikely that such a large number of errors in NYNEX/Bell Atlantic North's CPR occurred over a short span of years. It is much more likely that NYNEX/Bell Atlantic North has been recording a substantial percentage of its entries inaccurately for many years. For example, in a typical year, NYNEX/Bell Atlantic North generates approximately 40,000 new CPR line-items. If NYNEX/Bell Atlantic North would have recorded all new entries incorrectly in recent years, it would have taken more than three years to create 130,000 inaccurate records. This would require, however, that every recent entry was inaccurate, and we do not believe that is the case. On the other hand, if we assume a more likely error rate, e.g., 20 percent a year, NYNEX/Bell Atlantic North would have recorded approximately 8,000 of its new line-items each year incorrectly. It would take NYNEX/Bell Atlantic North about 16 years to generate a total of 130,000 incorrect records (130,000 divided by 8,000). Based upon our understanding of NYNEX/Bell Atlantic North's procedures and their limitations, this would appear to be the more likely case.

35. Nor do we believe the CPR problem has accelerated in recent years. In fact, the company's procedures have changed very little over the past 20 years. Recording items as Undetailed Investment, in particular, has been a problem for many years. Of the 12,600 Undetailed Investment records, representing $376.7 million of plant investment, over 6,500 line-items representing $236.9 million, are pre-1990 vintage entries.

VIII. Conclusions and Corrective Actions

36. We conclude that NYNEX/Bell Atlantic North has not maintained its basic property records and its CPR in a manner consistent with the Commission's rules. We base this conclusion on the findings of our statistical sampling of Hard-wired Equipment and actual records of Undetailed Investment and Unallocated Other Costs that show a high percentage of records with substantive deficiencies, such as inadequate or no asset descriptions, inaccurate quantities, missing and inaccurate location descriptions, and the high percentage of assets that could not be found by either our auditors or NYNEX/Bell Atlantic North's technical staff. We also base this conclusion on NYNEX/Bell Atlantic North's inability to provide supporting cost information and other data to substantiate the existence of a large number of entries in its CPR.

37. We believe the problems revealed in this audit are longstanding and unlikely to self-correct. This is indicated by the fact that similar problems were found in our 1994 audit of NYNEX/Bell Atlantic North's records. Since that audit, NYNEX/Bell Atlantic North conducted an extensive inventory for New York Telephone Company's COE and took corrective action. Despite these efforts, the current audit demonstrates that substantive problems in NYNEX/Bell Atlantic North's plant records persist.

38. The inability of the company to demonstrate the existence of such a high percentage of the equipment contained in its records raises significant questions about the valuation of NYNEX/Bell Atlantic North's plant accounts. At its worst, failure to provide sufficient and convincing documentation for the acquisition of the assets in question and for their placement into regulated accounts raises doubts whether policymakers can rely on these records.

39. We believe corrective action concerning the accounting treatment of the overstated amounts is necessary to address the deficiencies found in our audit. We believe that the amounts associated with Hard-wired Equipment that was not found ($381.5 million) and Undetailed Investment that could not be substantiated ($376.7 million) should be written-off NYNEX/Bell Atlantic North's plant accounts. We also believe the retirements NYNEX/Bell Atlantic North made in 1995 and 1996 to correct the $291 million of missing plant reflect the same type of accounting and recordkeeping deficiencies that were found in this audit, and these amounts also should be written-off NYNEX/Bell Atlantic North's plant accounts.

40. In addition, we believe further corrective action involving a complete inventory and audit of NYNEX/Bell Atlantic North's CPR, practices, procedures, and controls are necessary to bring NYNEX/Bell Atlantic North into compliance with the Commission's rules. A carrier's CPR consists of a large number of individual line-items, each of which represents one or more specific items of equipment. The only way to ensure a CPR line-item is correct is to examine the corresponding equipment items. The only way to validate all of the line-items in a CPR is to conduct an inventory of the entire CPR. The current audit findings demonstrate that NYNEX/Bell Atlantic North's CPR for its COE contain substantive and numerous deficiencies. Because its CPR contains thousands of records that are apparently not associated with plant used and useful in the provision of telecommunications service, we conclude that the only practical way to resolve all of these deficiencies is for NYNEX/Bell Atlantic North to engage an independent firm to perform an inventory of its entire COE and provide the results to the Commission. In addition, NYNEX/Bell Atlantic North should engage an independent firm to review its practices, procedures, and controls for maintaining its CPR and to make recommendations for improving these systems so that NYNEX/Bell Atlantic North's CPR and plant balances can be maintained in compliance with the Commission's rules.

41. Finally, we identified an additional $418.9 million of Unallocated Other Costs investment for which the carrier apparently has not kept sufficient records. These records contain no asset descriptions and no specific locations. We have serious concerns about the proper accounting treatment of much of this cost, including whether these line-items should remain on the carrier's CPR and plant account balances. We are still considering this issue, however, and will make a decision upon further review of the carrier's documentation for this type of investment.

IX. Recommendations

42. We recommend the following actions:

43. NYNEX/Bell Atlantic North should write off $758.2 million from its central office equipment to remove the estimated cost of its missing Hard-wired Equipment ($381.5 million) and Undetailed Investment ($376.7 million) from its central office equipment accounts.

44. NYNEX/Bell Atlantic North should reverse the retirement entries it made in 1995 and 1996 related to its COE inventory, and correct its books by writing-off the $291 million from its central office equipment plant accounts.

45. In order to correct its CPR, NYNEX/Bell Atlantic North should be required to engage an independent firm to perform an inventory of its entire COE and provide the results to the Commission. We recommend that the Commission analyze the results of this inventory and direct NYNEX/Bell Atlantic North to make all entries necessary to correct further its CPR and account balances.

46. In order to improve the likelihood that its CPR will be maintained correctly in the future, NYNEX/Bell Atlantic North should be required to engage an independent auditor to review its practices, procedures, and controls for maintaining CPR and to make recommendations for improving these systems so that NYNEX/Bell Atlantic North's CPR and plant balances can be maintained in compliance with the Commission's rules. Based on the audit, NYNEX/Bell Atlantic North should develop and submit to the Commission for approval a plan of corrective action for maintenance of its CPR. At a minimum, the scope of the independent audit should include a review of: (1) the existing internal controls related to prevention, detection, and correction of errors on a timely basis; (2) existing automated systems that serve to eliminate or reduce the potential for errors and that provide an appropriate audit trail for verification of the CPR; and (3) the controls and processes necessary to comply with the Commission's rules pertaining to the CPR.

Appendix A

Summary of the 1994 NYNEX CPR Audit

In 1994, the Commission audit staff conducted an audit of NYNEX's continuing property records ("CPR") for its central office equipment ("COE"). This equipment was broken into three categories for the audit: hard-wired equipment; plug-in equipment; and unspecified items.

Hard-Wired Inventory

We examined a sample of 56 judgmentally-selected central office items, from five central offices in New York City. We attempted to sample items from different COE accounts, different manufacturers, and different installation dates. We excluded from our sample plug-ins, unspecified items, and any non-COE maintained in NYNEX's CPR system. After making our selections, we physically inventoried all of the selected items with the assistance of NYNEX technical personnel. We also gave NYNEX an opportunity, after we finished our on-site inventory, to provide any documentation to prove the existence of items that we were not able to find. In the end, we were unable to locate nine items, or 16 percent of our sample. We found that equipment not manufactured by AT&T was particularly difficult to locate. This was so because NYNEX's CPR was designed by AT&T at a time when almost all of NYNEX's equipment was AT&T-manufactured.

Plug-Ins

We found that the CPR for NYNEX's plug-in investment did not allow the tracking of the location of individual plug-in equipment items. Plug-ins are portable items that are frequently moved within and between central offices. Auditing plug-ins was therefore very difficult because of the limits of NYNEX's CPR system. We concluded that the accuracy of its CPR may not be determinable without a complete inventory of all plug-ins at each accounting location (building).

Reconciliation of CPR and Financial Records

The Commission's rules require that carriers reconcile their CPRs with their financial accounting records. If the CPR and financial accounting figures are not equal, a carrier must reconcile the differences. We found, however, that NYNEX had not been reconciling substantial differences between its CPR and financial records. In 1993, NYNEX's records reflected a difference of $233 million between the amount recorded on its CPR and the

Appendix A

amount recorded on its financial accounting records. NYNEX did not reconcile the difference. Furthermore, upon request, it did not provide information to demonstrate whether it had reconciled its balances in any year from 1988 through 1992.

Unspecified Items

We found that NYNEX had listed assets in its CPR that could not readily be spot checked because the CPR did not provide adequate information to allow its identification. In addition, some of these unspecified items were so old that they likely were no longer in service.

100 Percent Asset Verification Effort

In 1994, NYNEX began field work for "100 Percent Asset Verification Effort" for the New York Telephone Company. According to NYNEX, the goal was to correct equipment location information in the hard-wired COE CPR and to reduce listings for the unspecified items. NYNEX stated that, as part of this effort, it was making retirement entries for the assets not found in the course of its inventory. At the same time it was putting onto its books the equipment items found that were not already shown on its CPR.

APPENDIX B

NYNEX CPR Statistical Audit Plan Overview

Objectives:

The objectives of the audit were: to determine the extent to which NYNEX's continuing property records ("CPR") reflect the assets it uses in the provision of telecommunications services; to substantiate the investment recorded in NYNEX's plant accounts; and, in general, to determine the extent to which NYNEX is in compliance with the Commission's property record requirements.

Population:

The "population" is the entire group of individual units about which statistical inferences are to be drawn based on a sample of individual units chosen randomly from the group. In the CPR audit, the population is all of the line-items representing NYNEX's hard-wired central office equipment ("COE") in its CPR. Each line-item in this population represents one or more items of hard-wired COE.

Sampling Units:

We divided the population into sampling units. These units cover the entire population and do not overlap. The sampling units in the CPR audit are the individual CPR records, i.e., the line-items in the CPR for hard-wired COE.

Data to be Collected:

The plan was to verify the accuracy of each line-item in the sample by making an on- site inspection of the hard-wired COE described in the individual records. The auditors, first, verified the physical existence of the unit of COE. The auditors then verified the accuracy of the information contained in the record regarding the description, quantity, and location of the COE item.

Degree of Precision Desired:

A primary goal was to determine the percentage of NYNEX's CPR records that comply with our rules, i.e., the percentage of records that correctly reflect the existence, quantity, description, location, and cost of the COE equipment. We used random sampling techniques in order to achieve a precise estimate based on mathematical principles and statistical reasoning that would provide a valid conclusion about NYNEX's CPR records. We selected a sample size so that, with a 90 percent confidence level, our percentage estimate would be within 2.5 percent of the actual percentage of records that are in compliance with our rules.

Sample Design:

We considered two basic sampling designs: simple random sampling and random two-stage stratified sampling. Simple random sampling requires that the sample be selected by a random process so that each member of the population has an equal probability of being included in the sample. Simple random sampling has the advantage of simplicity. Once a listing of the population is assembled, no other information is necessary to select the sample. Furthermore, the calculations necessary to derive the statistical inferences are relatively simple.

In random two-stage stratified sampling, each unit of the population is assigned to one of several groups and each group is assigned to one stratum. Then, groups are selected randomly from each stratum and population units are selected randomly from each selected group. In this application, the CPR line-items are the basic units of the population and the central offices are the groups that are stratified by size of office, i.e., how many line-items there are in each central office. This sampling design requires prior knowledge of the population characteristics so that each member of the population can be assigned to one and only one stratum.

Random two-stage stratified sampling has a number of advantages. First, it can be used to ensure representation of groups that are important for policy reasons to be included in the sampling process. Second, in cases where the population is clustered in different locations, it allows concentration of the sampling in those areas that contain most of the population, thus reducing the travel and labor costs. Finally, it can be used to increase the precision of the sample estimators, i.e., reduce their variability.

Because of these advantages, we selected a random two-stage stratified sampling plan. We stratified the equipment by central office size, as indicated by number of records per office. Our decision was based on the following factors. The hard-wired COE equipment listed in the CPR is located in central offices of various sizes located throughout the NYNEX region that encompasses six states. The majority of the equipment is concentrated in the larger central offices in large metropolitan areas such as New York and Boston. To verify the accuracy of the line-items included in a sample, our auditors travelled to the various central offices and actually observed the physical pieces of equipment listed in the CPR. By employing a random two-stage stratified sampling plan using strata based on office size, we could ensure that all office sizes are represented in the sampling process. In addition, by stratifying, we could ensure that small, remote central offices would not be over-represented which could increase the cost of the audit without a corresponding improvement in precision.

Sample Size:

We used the following formula to determine the sample size, n, necessary to reach our precision goal.

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