diff --git a/lib/ansible/playbook.py b/lib/ansible/playbook.py
index 278fdcf2d1..a8fe033df1 100644
--- a/lib/ansible/playbook.py
+++ b/lib/ansible/playbook.py
@@ -160,8 +160,7 @@ class PlayBook(object):
                 include_vars[k] = v
         inject_vars = play_vars.copy()
         inject_vars.update(include_vars)
-        included = utils.template_from_file(path, inject_vars, SETUP_CACHE, no_engine=True)
-        included = utils.parse_yaml(included)
+        included = utils.parse_yaml_from_file(path)
         for x in included:
             if len(include_vars):
                 x["vars"] = include_vars
diff --git a/lib/ansible/runner.py b/lib/ansible/runner.py
index 71f657af3d..7ca9eb2d37 100644
--- a/lib/ansible/runner.py
+++ b/lib/ansible/runner.py
@@ -262,14 +262,15 @@ class Runner(object):
         async_jid=None, async_module=None, async_limit=None):
         ''' runs a module that has already been transferred '''
 
-        inject = self.setup_cache.get(conn.host,{})
+        inject = self.setup_cache.get(conn.host,{}).copy()
+        host_variables = self.inventory.get_variables(conn.host)
+        inject.update(host_variables)
+        inject.update(self.module_vars)
+
         conditional = utils.double_template(self.conditional, inject, self.setup_cache)
         if not eval(conditional):
             return [ utils.smjson(dict(skipped=True)), None, 'skipped' ]
 
-        host_variables = self.inventory.get_variables(conn.host)
-        inject.update(host_variables)
-
         if self.module_name == 'setup':
             args = self._add_setup_vars(inject, args)
             args = self._add_setup_metadata(args)
diff --git a/test/TestPlayBook.py b/test/TestPlayBook.py
index c8c2eea410..72670ee4c3 100644
--- a/test/TestPlayBook.py
+++ b/test/TestPlayBook.py
@@ -172,3 +172,28 @@ class TestPlaybook(unittest.TestCase):
        print data
        assert data.find("ears") != -1, "template success"
 
+   def test_includes(self):
+        pb = os.path.join(self.test_dir, 'playbook_includes.yml')
+        actual = self._run(pb)
+
+        for i, event in enumerate(EVENTS):
+            print "EVENT %s"%(i)
+            print event
+
+            if i == 6:
+                assert 'blue' in event[1][1]['cmd']
+
+            if i == 8:
+                assert 'quack' in event[1][1]['cmd']
+
+            if i == 10:
+                assert 'RAN' in event[1][1]['cmd']
+
+            if i == 12:
+                assert 'RAN' in event[1][1]['cmd']
+
+            if i == 14:
+                assert 'red' in event[1][1]['cmd']
+
+            if i == 18 or i == 20:
+                assert 'skipped' in event[0]
diff --git a/test/common_vars.yml b/test/common_vars.yml
index d9f2a9b2db..c4c09b67f2 100644
--- a/test/common_vars.yml
+++ b/test/common_vars.yml
@@ -1,3 +1,4 @@
 ---
 duck: quack
 cow: moo
+extguard: " '$favcolor' == 'blue' "
diff --git a/test/playbook_included.yml b/test/playbook_included.yml
new file mode 100644
index 0000000000..6fb41de47e
--- /dev/null
+++ b/test/playbook_included.yml
@@ -0,0 +1,14 @@
+---
+- name: test vars
+  action: shell echo $favcolor
+
+- name: test vars_files
+  action: shell echo $duck
+
+- name: test vars condition
+  action: shell echo RAN
+  only_if: $guard
+
+- name: test vars_files condition
+  action: shell echo RAN
+  only_if: $extguard
diff --git a/test/playbook_includes.yml b/test/playbook_includes.yml
new file mode 100644
index 0000000000..b1dd36c69a
--- /dev/null
+++ b/test/playbook_includes.yml
@@ -0,0 +1,15 @@
+---
+# Test correct variable expansion in included files and only if
+- hosts: all
+  vars:
+    favcolor: "blue"
+    guard: ' "$favcolor" == "blue" '
+  vars_files:
+  - common_vars.yml
+
+  tasks:
+
+  - include: playbook_included.yml
+
+  # test overrides of variables
+  - include: playbook_included.yml favcolor=red