To provide for long-term financing in the event that the remarketing agents are unable to sell the redeemed bonds within a specified period, the government issuing demand bonds generally enters into an agreement with a financial institution to convert the bonds to an installment loan that is repayable over a specified period. This type of arrangement is known as a take out agreement and may be part of the letter of credit or may be a separate agreement.

The question as to the accounting for demand bonds centers around whether a demand bond that matures in ten years but may be redeemed by the bondholder at any time with thirty days’ notice is a long-term liability or a short-term liability. The accounting for demand bonds was established by GASB Interpretation
No. 1, “Demand Bonds Issued by State and Local Governments” (GASBI 1). It addresses the accounting for demand bonds that have demand provisions that are exercisable at the balance sheet date or within one year from the date of the balance sheet. Interpretation No. 1 requires that these bonds be reported as a liability of the fund (usually the capital projects fund) unless all of the following conditions are met:

• The government bond issuer has entered into a financing (takeout) agreement to convert the bonds into some other form of long-term obligation. (Also, this takeout agreement must be with an unrelated third party.)
• The takeout agreement does not expire within one year from the date of the government’s balance sheet.
• The takeout agreement is not cancelable by the lender or the prospective lender during that year, and obligations incurred under the takeout agreement are not callable during the year.
• The other party to the takeout agreement is expected to be financially capable of honoring the takeout agreement.

So what does all this mean in English? If a government has a fairly ironclad ability to avoid paying demand bonds out of current financial resources by using a takeout agreement, the liability does not have to be recorded in the governmental fund and would appear only on the government-wide statement of net assets
since it would be considered a long-term liability. However, if there is no takeout agreement, or if the takeout agreement has some loopholes, the assumption is that current financial resources may have to be used to pay the demand bonds, and the liability for the demand bonds would be recorded as a liability on the balance sheet of the governmental fund as well as on the government-wide statement of net assets.

Taken From : Governmental Accounting Made Easy

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