diff --git a/lib/ansible/inventory/yaml.py b/lib/ansible/inventory/yaml.py
index 0c2853ad944..9b950e21d64 100644
--- a/lib/ansible/inventory/yaml.py
+++ b/lib/ansible/inventory/yaml.py
@@ -106,6 +106,7 @@ class InventoryParserYaml(object):
 
             elif type(item) == dict and 'host' in item:
                 host = self._make_host(item['host'])
+
                 vars = item.get('vars', {})
                 if type(vars)==list:
                     varlist, vars = vars, {}
@@ -113,5 +114,23 @@ class InventoryParserYaml(object):
                         vars.update(subitem)
                 for (k,v) in vars.items():
                    host.set_variable(k,v)
+
+                groups = item.get('groups', {})
+                if type(groups) in [ str, unicode ]:
+                    groups = [ groups ]
+                if type(groups)==list:
+                    for subitem in groups:
+                        if subitem in self.groups:
+                            group = self.groups[subitem]
+                        else:
+                            group = Group(subitem)
+                            self.groups[group.name] = group
+                            all.add_child_group(group)
+                        group.add_host(host)
+                        grouped_hosts.append(host)
+
                 if host not in grouped_hosts:
                     ungrouped.add_host(host)
+
+        # make sure ungrouped.hosts is the complement of grouped_hosts
+        ungrouped_hosts = [host for host in ungrouped.hosts if host not in grouped_hosts]
diff --git a/test/TestInventory.py b/test/TestInventory.py
index ef551e5816a..bc1cbde0311 100644
--- a/test/TestInventory.py
+++ b/test/TestInventory.py
@@ -221,15 +221,14 @@ class TestInventory(unittest.TestCase):
     def test_yaml(self):
         inventory = self.yaml_inventory()
         hosts = inventory.list_hosts()
-        print hosts
-        expected_hosts=['jupiter', 'saturn', 'mars', 'zeus', 'hera', 'poseidon', 'thor', 'odin', 'loki']
+        expected_hosts=['garfield', 'goofy', 'hera', 'jerry', 'jupiter', 'loki', 'mars', 'mickey', 'odie', 'odin', 'poseidon', 'saturn', 'thor', 'tom', 'zeus']
         self.compare(hosts, expected_hosts)
 
     def test_yaml_all(self):
         inventory = self.yaml_inventory()
         hosts = inventory.list_hosts('all')
 
-        expected_hosts=['jupiter', 'saturn', 'mars', 'zeus', 'hera', 'poseidon', 'thor', 'odin', 'loki']
+        expected_hosts=['garfield', 'goofy', 'hera', 'jerry', 'jupiter', 'loki', 'mars', 'mickey', 'odie', 'odin', 'poseidon', 'saturn', 'thor', 'tom', 'zeus']
         self.compare(hosts, expected_hosts)
 
     def test_yaml_norse(self):
@@ -323,3 +322,29 @@ class TestInventory(unittest.TestCase):
         assert 'group_names' in vars
         assert sorted(vars['group_names']) == [ 'norse', 'ruler' ]
 
+    def test_yaml_some_animals(self):
+        inventory = self.yaml_inventory()
+        hosts = inventory.list_hosts("cat:mouse")
+        expected_hosts=['garfield', 'jerry', 'mickey', 'tom']
+        self.compare(hosts, expected_hosts)
+
+    def test_yaml_comic(self):
+        inventory = self.yaml_inventory()
+        hosts = inventory.list_hosts("comic")
+        expected_hosts=['garfield', 'odie']
+        self.compare(hosts, expected_hosts)
+
+    def test_yaml_orange(self):
+        inventory = self.yaml_inventory()
+        hosts = inventory.list_hosts("orange")
+        expected_hosts=['garfield', 'goofy']
+        self.compare(hosts, expected_hosts)
+
+    def test_yaml_garfield_vars(self):
+        inventory = self.yaml_inventory()
+        vars = inventory.get_variables('garfield')
+        assert vars == {'ears': 'pointy',
+                        'inventory_hostname': 'garfield',
+                        'group_names': ['cat', 'comic', 'orange'],
+                        'nose': 'pink'}
+ 
diff --git a/test/yaml_hosts b/test/yaml_hosts
index cf73e8d4537..adfcf5bce51 100644
--- a/test/yaml_hosts
+++ b/test/yaml_hosts
@@ -1,5 +1,7 @@
 ---
 
+# Below is the original way of defining hosts and groups.
+
 - jupiter
 - host: saturn
   vars:
@@ -37,3 +39,44 @@
 - group: multiple
   hosts:
   - saturn
+
+# Here we demonstrate that groups can be defined on a per-host basis.
+# When managing a large set of systems this format makes it easier to
+# ensure each of the systems is defined in a set of groups, compared
+# to the standard group definitions, where a host may need to be added
+# to multiple disconnected groups.
+
+- host: garfield
+  groups: [ comic, cat, orange ]
+  vars:
+  - nose: pink
+
+- host: odie
+  groups: [ comic, dog, yellow ]
+
+- host: mickey
+  groups: [ cartoon, mouse, red ]
+
+- host: goofy
+  groups: [ cartoon, dog, orange ]
+
+- host: tom
+  groups: [ cartoon, cat, gray ]
+
+- host: jerry
+  groups: [ cartoon, mouse, brown ]
+
+- group: cat
+  vars:
+  - ears: pointy
+  - nose: black
+
+- group: dog
+  vars:
+  - ears: flappy
+  - nose: black
+
+- group: mouse
+  vars:
+  - ears: round
+  - nose: black