It has been suggested that plant and equipment could be replaced more quickly if depreciation rates for income tax and accounting purposes were substantially increased. As a result, business operations would receive the benefit of more modern and more efficient plant facilities. Discuss the merits of this proposition.

Depreciation is the accounting practice of assigning the cost of tangible assets to expenses in a systematic and sensible manner to the periods in which the asset is expected to be used.

The undepreciated cost of the old asset is not a consideration to consider when deciding whether or not to replace it. As a result, the amount of depreciation reported should have no bearing on the decision to replace plant assets. The relative efficiency of new equipment compared to existing equipment, the cost of new facilities, the availability of cash for the new asset, and other considerations all play a role in the selection.

Although the asset was still in use, the fact that it had been fully depreciated via the application of any accelerated depreciation technique should not normally prompt management to replace it. It is unreasonable for management to replace an asset simply because all or a significant portion of the cost had been carried off for tax and accounting purposes.

If depreciation rates were greater, it's possible that a company would be better equipped to replace assets since a bigger percentage of the asset's cost would have been charged to expenditure in the early years of its usage, resulting in a lower amount of income tax paid during that time. The greater depreciation charge may be sustained for tax purposes by selling the old item, which may result in a capital gain and acquiring a new asset. However, if the asset was traded in, the new asset would have a lower basis due to the larger depreciation.

It's worth noting that higher depreciation rates may drive growth rather than just replacement. Management may be enticed to expand because they believe that in the first few years when they are relatively certain that the additional facilities will be profitable, they will be able to depreciate a significant percentage of the cost for tax purposes. Similarly, because a replacement necessitates additional capital expenditures, the tax treatment may have an impact.

There may also be a propensity in the economy as a whole for the accounting and tax treatment of the cost of plant assets to affect the retirement of existing plant assets because of the encouragement to grow or establish new firms.