diff --git a/docsite/rst/api.rst b/docsite/rst/api.rst
index a901c86b727..e6449866965 100644
--- a/docsite/rst/api.rst
+++ b/docsite/rst/api.rst
@@ -100,16 +100,35 @@ It's possible to write an external inventory script in any language.  If you are
 Script Conventions
 ``````````````````
 
-When the external node script is called with the single argument '--list', the script must return a JSON hash/dictionary of all the groups to be managed, with a list of each host/IP as the value for each hash/dictionary element, like so::
+When the external node script is called with the single argument '--list', the script must return a JSON hash/dictionary of all the groups to be managed.
+Each group's value should be either a hash/dictionary containing a list of each host/IP, potential child groups, and potential group variables, or
+simply a list of host/IP addresses, like so::
 
     {
-        'databases'  : [ 'host1.example.com', 'host2.example.com' ],
-        'webservers' : [ 'host2.example.com', 'host3.example.com' ],
-        'atlanta'    : [ 'host1.example.com', 'host4.example.com', 'host5.example.com' ] 
+        'databases'   : {
+            'hosts'   : [ 'host1.example.com', 'host2.example.com' ],
+            'vars'    : {
+                'a'   : true
+            }
+        },
+        'webservers'  : [ 'host2.example.com', 'host3.example.com' ],
+        'atlanta'     : {
+            'hosts'   : [ 'host1.example.com', 'host4.example.com', 'host5.example.com' ],
+            'vars'    : {
+                'b'   : false
+            },
+            'children': [ 'marietta', '5points' ],
+        },
+        'marietta'    : [ 'host6.example.com' ],
+        '5points'     : [ 'host7.example.com' ]
     }
 
+.. versionadded: 1.0
+
+Before version 1.0, each group could only have a list of hostnames/IP addresses, like the webservers, marietta, and 5points groups above.
+
 When called with the arguments '--host <hostname>' (where <hostname> is a host from above), the script must return either an empty JSON
-hash/dictionary, or a list of key/value variables to make available to templates or playbooks.  Returning variables is optional,
+hash/dictionary, or a hash/dictionary of variables to make available to templates and playbooks.  Returning variables is optional,
 if the script does not wish to do this, returning an empty hash/dictionary is the way to go::
 
     {
diff --git a/lib/ansible/inventory/__init__.py b/lib/ansible/inventory/__init__.py
index 12bf0ffac3b..6e1a356e9fc 100644
--- a/lib/ansible/inventory/__init__.py
+++ b/lib/ansible/inventory/__init__.py
@@ -278,6 +278,7 @@ class Inventory(object):
             if updated is not None:
                 vars.update(updated)
 
+        vars.update(host.get_variables())
         if self._is_script:
             cmd = [self.host_list,"--host",hostname]
             try:
@@ -287,14 +288,7 @@ class Inventory(object):
             (out, err) = sp.communicate()
             results = utils.parse_json(out)
 
-            # FIXME: this is a bit redundant with host.py and should share code
-            results['inventory_hostname'] = hostname
-            results['inventory_hostname_short'] = hostname.split('.')[0]
-            groups = [ g.name for g in host.get_groups() if g.name != 'all' ]
-            results['group_names'] = sorted(groups)
             vars.update(results)
-        else:
-            vars.update(host.get_variables())
         return vars
 
     def add_group(self, group):
diff --git a/lib/ansible/inventory/script.py b/lib/ansible/inventory/script.py
index 77666580ce5..b665d4322dc 100644
--- a/lib/ansible/inventory/script.py
+++ b/lib/ansible/inventory/script.py
@@ -45,15 +45,25 @@ class InventoryScript(object):
         all=Group('all')
         groups = dict(all=all)
         group = None
-        for (group_name, hosts) in self.raw.items():
+        for (group_name, data) in self.raw.items():
             group = groups[group_name] = Group(group_name)
             host = None
-            for hostname in hosts:
-                if not hostname in all_hosts:
-                    all_hosts[hostname] = Host(hostname)
-                host = all_hosts[hostname]
-                group.add_host(host)
-                # FIXME: hack shouldn't be needed
-                all.add_host(host)
+            if not isinstance(data, dict):
+                data = {'hosts': data}
+            if 'hosts' in data:
+                for hostname in data['hosts']:
+                    if not hostname in all_hosts:
+                        all_hosts[hostname] = Host(hostname)
+                    host = all_hosts[hostname]
+                    group.add_host(host)
+            if 'vars' in data:
+                for k, v in data['vars'].iteritems():
+                    group.set_variable(k, v)
             all.add_child_group(group)
+        # Separate loop to ensure all groups are defined
+        for (group_name, data) in self.raw.items():
+            if isinstance(data, dict) and 'children' in data:
+                for child_name in data['children']:
+                    if child_name in groups:
+                        groups[group_name].add_child_group(groups[child_name])
         return groups