Farm-In and Farm-Out Arrangements; A Practical Guide for accounting and taxation
- Published
- July 7, 2026
- 4 min read
This article is a detailed adaptation of the presentation, “Farm-In and Farm-Out Accounting,” delivered by Alfred Habaasa at the INTOSAI-WGEI Africa Extractive Industries (Africa supreme audit bodies working group on Audit of Extractives) Workshop on May 9, 2025, at the Protea Hotel in Kampala.
Extractive industries run on capital that must be committed years before it can possibly be repaid, against outcomes that are never certain: a well may be dry, a prospect may prove uneconomic, a licence may expire before its potential is ever tested. Few companies, however large, are willing or able to bear that risk alone across every acreage position they hold. The farm-in and farm-out arrangement is the industry’s oldest and most widely used answer to this problem. It allows a licence holder to bring in a partner’s capital, expertise, or both, in exchange for a share of the licence itself, without either party writing a cheque in the conventional sense. The arrangement is deceptively simple to describe and considerably harder to account for, because none of the major accounting frameworks IFRS, UK GAAP, or US GAAP set out a dedicated standard for it. This article works through what a farmout is, the commercial forms it takes, why parties enter into them, and how each of the accounting frameworks in common use across the industry actually accounts for the transaction, before closing with a real-world illustration from Tullow Oil’s farm-downs of its Ugandan licences.
1. What Is a Farm-In / Farm-Out Arrangement?
A farmout is a contractual commitment by the owner of a working interest in a petroleum licence, the farmor, to assign a portion of that interest, or a lesser interest carved out of it, to another party, the farmee, in return for the farmee undertaking, at its own cost, an agreed programme of work in the licence area. The farmor gives up equity in the licence; the farmee funds activity that the farmor would otherwise have had to fund itself, in whole or in part.
The work programme the farmee commits to typically covers one or more of three activities: the acquisition, processing and interpretation of new seismic data; the re-processing and reinterpretation of data the farmor already holds; and the drilling of one or more exploration or appraisal wells to test a prospect or evaluate a defined target or zone. In substance, the farmee is paying for its equity stake not in cash but in kind, through expenditure committed directly into the ground.
Capping the Expenditure Commitment
Farm-in agreements vary enormously in how tightly the farmee’s obligation is defined. A common formulation simply requires the farmee to drill an exploration well, an obligation that can be dangerously open-ended: drilling problems, weather, rig availability and a host of other factors can drive substantial cost overruns well beyond what either party anticipated at signing. Because of this, farmees will typically negotiate hard to cap the expenditure commitment in the agreement itself, a fixed ceiling beyond which the farmor bears any further cost, or the farmee’s earning obligation is satisfied regardless of overspend. Where a farmee can secure this cap, it converts an open-ended cost exposure into a bounded one, which matters as much to the deal’s economics as the headline interest being earned.
2. Types of Farm-Out Arrangements
Farm-outs are not a single template; the interest assigned, the scope of the earning obligation and the point at which the interest actually vests all vary by deal. The variations below are the ones most commonly encountered in practice.
1.1. Ground Floor (Heads-Up) Farm-Outs
In a ground floor or heads-up deal, the farmor assigns an interest, say 10% in exchange for the farmee bearing exactly that same 10% share of the cost of the agreed work programme. Cost-sharing and interest-sharing are proportionate; neither party is subsidising the other.
1.2. Promoted Farm-Outs
In a promoted deal, the farmor extracts a premium for agreeing to the assignment. For example, the farmor might assign a 10% working interest in return for the farmee bearing 20% of the cost of the agreed work programme, the 20% being made up of the 10% attributable to the interest being earned, plus a further 10% that represents the farmee also picking up part of the farmor’s own funding burden.
1.3. Fully Promoted Farm-Outs (Carried Interest)
At the far end of the spectrum, a farmor might assign, say, a 25% undivided interest to each of three separate farmees, with each farmee paying 33.3% of the cost of the work. The farmor ends up contributing no cash to the programme at all while retaining a 25% working interest, a position generally described as being fully carried. This structure is attractive to a farmor with a strong asset but constrained capital, since it monetises the strength of the acreage into free-carried exploration.
1.4. Formation or Zone Farm-Outs
Rather than farming out an interest across an entire licence, a farmor may restrict the assignment to a defined area of the licence, or more narrowly still, to a specific geological formation or zone within it. This lets a farmor bring in a partner for a targeted objective while retaining full control and economics over the rest of the acreage.
1.5. Production-Only Farm-Outs
Common in more prospective but higher-risk areas, a production-only farm-out is structured so that an interest is earned only if the work results in a discovery. If a dry hole is drilled, or the exploration work is otherwise unsuccessful, the farmee earns nothing, notwithstanding the expenditure it has incurred. This shifts the entire risk of a negative outcome onto the farmee in exchange for the prospect of a larger reward if the work succeeds.
1.6. Seismic Option Farm-Outs
Where a prospective farmee has insufficient knowledge of the sub-surface to commit to a drilling obligation with confidence, the parties may structure what is known as a seismic option deal. The farmee first funds the acquisition and interpretation of new seismic data, and only then decides whether to exercise an option to proceed to drilling and earn its interest. This lets a cautious farmee de-risk its decision to drill in stages rather than committing to the full programme up front.
3. Commercial Rationale: Why Companies Farm Out and Farm In
1.1. Why Farm Out
A farmor typically has one or more of the following motivations. Farming out can let evaluation of an area proceed faster than the farmor could manage alone, where another company has the resources to move more quickly. The farmor may simply lack the technical expertise or proprietary data that a prospective farmee can bring to bear. It may also have insufficient confidence in a prospect, or judge that the financial risk of the property outweighs the likely reward more than another party would judge it, a difference in risk appetite or portfolio view rather than a difference in the facts. Finally, a farmor may be willing to give up an interest in a good property specifically to obtain something else it values more, such as an interest in an equally attractive property held by the farmee elsewhere.
1.2. Why Farm In
For the farmee, the calculus runs the other way. A company that has just made a significant discovery, or already has relevant infrastructure nearby, may want to farm into adjacent acreage while it holds superior subsurface information relative to other bidders. A farm-in can be a genuinely cost-effective route to acquiring new skills or information relative to an outright acquisition. The farmee may simply have greater operating experience in the play type, causing it to view a prospect as commercially viable where others do not. Some farm-ins are motivated by a desire to obtain operatorship of a venture, which carries its own strategic value regardless of the specific economics of the interest earned. Others are about establishing a footprint in a highly prospective basin to build institutional knowledge and expertise, or positioning the company favourably ahead of future licensing rounds that the host government may offer.
4. How a Farm-Out Differs from a Sale
It is tempting to treat a farm-out as simply a partial sale of a licence interest, but the two are structured around different objectives and different mechanics of consideration.
In a sale, the seller is generally seeking to recoup its investment to date, take its reward up front, and exit the area. In a farm-out, the farmor is usually seeking the opposite: greater rewards over the medium to longer term, achieved by enhancing the value of the remaining licence interest through the identification of further drillable prospects and, ideally, successive commercial discoveries. A farmor entering a farm-out therefore typically wants to retain exposure to the upside of the licence, not exit it.
The two transactions also differ in how consideration is structured. In a sale, payment of the consideration is an obligation owed to the seller, almost always discharged in cash to the seller or at its direction. In a farm-out, the farmee’s contribution is more often structured as an option or a right, for example, a “right to drill to earn”, where the only consequence of failing to perform the earning work is that the farmor is simply not obliged to make the assignment. There is no debt changing hands. The contribution is also, in the great majority of cases, made through expenditure in the ground, seismic, drilling, technical work, rather than as a payment to the farmor directly.
5. The Accounting Challenge: A Gap in the Standards
Despite how common farm-in and farm-out arrangements are across the extractive industries, none of IFRS, UK GAAP or US GAAP contains a standard drafted specifically to address them. The IASB’s own staff have acknowledged this. A September 2021 IASB staff paper reviewing matters raised during post-implementation outreach on IFRS Standards noted that stakeholders particularly preparers and national standard-setters had identified certain arrangements as unique and not specifically addressed by any IFRS Standard. Farm-in and farm-out arrangements were named explicitly, alongside streaming arrangements common in the mining sector, as examples of this gap. (IASB Staff Paper, Post-implementation Review of IFRS 6, September 2021)
In practice, this gap is filled by analogy: preparers apply the general recognition and measurement principles of whichever accounting framework they use, together with long-standing industry practice, national SORPs, and where none of those settle the point, the accounting policy the entity already applies to exploration and evaluation costs generally (successful efforts or full cost). The result is a reasonably consistent set of conventions industry-wide, but one built on practice and analogy rather than a single authoritative rule.
6. Accounting Treatment under IFRS
The Scope of IFRS 6
IFRS 6, Exploration for and Evaluation of Mineral Resources, is the only IFRS Standard that speaks directly to this phase of the value chain, and even its scope is narrow. Paragraphs 3 to 5 confine it to exploration and evaluation (E&E) expenditure specifically: an entity applies the Standard to E&E expenditure that it incurs, and the Standard does not address other aspects of accounting by entities engaged in exploration and evaluation. It explicitly excludes expenditure incurred before the entity has obtained the legal right to explore a specific area, and expenditure incurred after the technical feasibility and commercial viability of extracting a mineral resource have been demonstrated, at which point the project moves out of IFRS 6’s scope entirely and into the ordinary IFRS framework for property, plant and equipment or intangible assets.
A farm-in / farm-out arrangement sits awkwardly across this scope. It results in the farmee recognising E&E assets, squarely inside IFRS 6, while potentially triggering a partial disposal of an E&E asset by the farmor, a question IFRS 6 does not answer directly. In the absence of specific guidance, practice under IFRS has settled on treating the farmor’s side of the transaction as a partial disposal recognised through the carrying amount of the retained asset rather than through profit or loss in the way an ordinary asset sale would be. The farmor does not recognise the expenditure the farmee will fund on the farmor’s behalf, and any proceeds it receives from the farmee are first applied to reduce the carrying amount of the farmor’s existing capitalised E&E asset; only proceeds in excess of that carrying amount are recognised as a gain. An entity holding, say, CU500 of capitalised E&E costs that receives CU1,000 from an incoming farmee would credit CU500 against the asset and recognise the remaining CU500 as income, rather than recognising a CU1,000 disposal gain against a written-off asset. (CU -Currency Units as commonly used in IFRS illustrations)
This convention is not mandated by the text of IFRS 6 itself; it reflects an approach many entities carried over from national practice that predates IFRS 6 and that the Standard neither disturbed nor codified. It is precisely this kind of practice-led answer, applied consistently but without a clear textual anchor, that prompted the IASB’s stakeholders to flag farm-outs as unaddressed.
7. Accounting Treatment under UK GAAP: The Oil Industry Accounting Committee SORP
In the United Kingdom, the Statement of Recommended Practice on Accounting for Oil and Gas Exploration, Development, Production and Decommissioning Activities, issued by the Oil Industry Accounting Committee (OIAC), sets out the most detailed and long-standing guidance available on farm-out accounting, predating IFRS 6 by many years and still widely referenced across the industry even outside the UK.
The Farmor’s Position
The recommended practice is that the farmor should not record in its financial statements any expenditure made on its behalf by the farmee, the farmee’s spending under the work programme never touches the farmor’s books. Any capitalised costs the farmor had previously incurred in respect of the whole interest are re-designated as relating only to the partial interest the farmor retains after the assignment.
Where the farmee reimburses costs the farmor had already incurred, the SORP treats this as a credit to the accounts that were originally debited with those costs, rather than as revenue. Any cash received in excess of the related unamortised past costs is treated by a successful-efforts company as a gain on disposal of an interest in the field. A full-cost company, by contrast, may credit reimbursements in excess of incurred costs to a single pool of capitalised costs where that pool spans several licence blocks, spreading the effect of the farm-out across the cost pool rather than recognising it as an isolated gain.
The Farmee’s Position
The farmee accounts for the costs it incurs as a result of the farm-in, including any payment made to the farmor, in the ordinary way. The initial expenditure is capitalised, and, for a company applying the successful efforts method, is written off to expense if the drilling activity establishes that the well is dry.
8. Accounting Treatment under US GAAP
Under US GAAP, the accounting for extractive activities in oil and gas sits in ASC 932, and farmout transactions are addressed through the lens of the entity’s chosen policy, successful efforts or full cost applied to both parties to the deal.
The Farmor’s Perspective
The farmor derecognises the carrying amount of the working interest transferred to the farmee. Where the fair value of the consideration received differs from the carrying amount of the interest relinquished, the farmor recognises a gain or loss on the transaction. Any interest the farmor retains, typically a reduced working interest, continues to be accounted for under the farmor’s existing accounting policy for exploration and production costs, whether that is successful efforts or full cost.
The Farmee’s Perspective
The farmee recognises an asset representing the working interest it has acquired. The initial measurement of that asset typically comprises any cash paid to the farmor plus the costs the farmee incurs in fulfilling its obligations under the farm-in agreement, drilling costs, seismic costs, and the like capitalised in accordance with whichever method, successful efforts or full cost, the farmee applies to its own exploration and production activity.
A Common Thread Across Frameworks
Read literally, US GAAP’s language of recognising a gain or loss on the farmor’s side looks quite different from the UK SORP’s approach of crediting proceeds against the carrying amount of the retained asset. In practice, the two conventions converge more than the wording suggests: for what the industry treats as a normal farmout where the farmee earns an interest by funding work on the licence rather than paying cash to the farmor outright, neither framework typically produces a gain unless the value the farmor receives exceeds the costs it has already capitalised on the whole interest. Where that excess does arise, both frameworks recognise it, just through slightly different bookkeeping: as a credit against a cost pool under the SORP, or as a gain on a partial disposal under US GAAP. The substantive question a preparer has to answer under either framework is the same one: does the value received by the farmor exceed the costs being given up, and if so, by how much?
9. Farm-Outs in the Nature of a Loan
Some farm-in arrangements are structured, in substance, as a loan from the farmee to the farmor rather than as a conventional earning of interest. The farmee funds historical and future expenditure on the licence, with that funding repayable out of the farmor’s share of future production. This kind of arrangement is typically unsecured, and tends to appear where proven recoverable reserves already exist, the farmor may only begin receiving its share of production once the farmee has recovered its payback from the field, at which point the farmor’s production entitlement reverts to its full working interest.
The accounting treatment turns entirely on the wording and substance of the agreement. Where the arrangement is clearly a loan and is secured on the farmor’s assets, the farmor accounts for the proceeds received from the farmee as a loan, a liability, not a disposal. Where instead the arrangement provides that the loan is only repayable out of future production, the appropriate treatment depends on how certain it is that the loan can in fact be repaid from that production. If the value of estimated proven recoverable reserves is adequate to cover the farmee’s contribution, the transaction can be accounted for as a loan. If it has not yet been proven that recoverable reserves will cover the farmee’s contribution, the contribution is instead accounted for as a credit to the farmor’s expenditure accounts; if exploration and drilling subsequently succeed and production commences, that credit is reversed and a liability to the farmee is recognised in its place.
10. Disclosure
The UK SORP recommends that the farmor disclose sufficient information to give users of the financial statements an indication of the full consideration it has received, in cases where the farm-in requires the farmee to bear costs that would otherwise have fallen on the interest the farmor retains. The farmor is expected to disclose the aggregate amount of such expenditure for the accounting period. No equivalent additional disclosure is recommended for the farmee, since expenditure it incurs on its licence interests will already be disclosed through its normal reporting. Beyond the financial statements themselves, disclosure of material farm-out transactions is generally required for listed entities under securities and exchange rules, and is otherwise voluntary but encouraged under both IFRS and US GAAP.
11. Tax Considerations
The detailed tax treatment of farmouts varies significantly by jurisdiction and is beyond the scope of an accounting explainer, but it cannot be ignored in practice. Each party to a farmout will be seeking to maximise its own tax position, and this frequently produces competing preferences over how the transaction is structured, for instance, whether consideration flows as cash, as carried costs, or as an option to earn. Most farm-in and farm-out arrangements in the extractive industries require government or regulatory approval, and tax exposure, particularly capital gains tax on the interest being assigned, can become a major hurdle in getting a transaction over the line, as the Uganda case below illustrates
12. Case in Point: Tullow Oil's Farm-Downs in Uganda
Uganda’s Albertine Graben provides one of the better-documented illustrations of farm-out mechanics, and of how quickly tax considerations can complicate an otherwise straightforward commercial deal.
Tullow Oil built up its position in Uganda’s exploration licences through the 2000s, culminating in a major farm-down agreed in 2010: Tullow agreed to assign a combined 66.6666% of its Ugandan licence interests to CNOOC Limited and Total (now TotalEnergies) for a total cash consideration of $2.9 billion, with operatorship split between the three companies, Total taking Exploration Area 1, Tullow retaining Exploration Area 2, and CNOOC operating the Kanywataba licence and the Kingfisher production licence.
The transaction, however, did not complete until 21 February 2012, a delay of roughly two years driven substantially by a dispute with the Uganda Revenue Authority (URA) over capital gains tax on the assigned interests. The URA initially assessed a liability of $473 million. Tullow contested the assessment through Uganda’s Tax Appeals Tribunal and, later, international arbitration, while making a part-payment of $142 million in 2012 to allow the transaction to proceed. The dispute was not finally resolved until June 2015, when Tullow and the URA settled on a total liability of $250 million. The episode is a vivid demonstration of the point made above, tax exposure on the assignment of an interest is frequently the single hardest issue to resolve in an otherwise agreed farm-out, and can hold up completion for years even after the commercial terms are settled.
Tullow’s Ugandan story continued beyond that farm-down. In April 2020, Tullow agreed to sell its entire remaining stake in the Lake Albert Development Project, the whole of its residual Ugandan interest, to Total for $575 million, a transaction completed later that year. Where the 2010–2012 transaction was a classic farm-down retaining a working interest and operatorship, the 2020 sale was a full exit: Tullow gave up its remaining upside in Uganda entirely in exchange for cash, illustrating the distinction between a farm-out (retained, longer-term upside) and a sale (upfront value, clean exit).
13. Conclusion
Farm-in and farm-out arrangements let extractive companies share the cost and the risk of exploration without either party writing a conventional cheque, and the commercial forms these deals take, heads-up, promoted, fully carried, formation-specific, production-only, or seismic-option, reflect a genuine diversity of negotiating positions and risk appetites. The accounting, by contrast, has had to develop without a dedicated standard under any of the major frameworks. IFRS 6 addresses only the E&E phase and is silent on farmouts specifically; the UK’s OIAC SORP offers the most detailed treatment, built around crediting proceeds against the farmor’s retained cost base; and US GAAP frames the same transaction in the language of derecognition and gain or loss. Despite the differences in mechanics, all three converge on the same underlying question a preparer must answer: what value has genuinely changed hands, relative to the cost being given up, and how should that be reflected in the accounts of both the farmor and the farmee. Understanding that question, and the practice that has grown up around answering it is the essential starting point for auditing or reporting on any extractive company active in farm-in and farm-out transactions.
About Alfred Habaasa
Alfred assists companies in resolving complex cross-border commercial disputes, international tax structuring, and developing robust Transfer Pricing defense portfolios within the East African Community. For specialized consulting, reach out to our advisory teams at REDMOND TAX & ADVISORY for Uganda Taxes and TAX IQ Africa for International Tax and Transfer Pricing
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