diff --git a/CHANGELOG b/CHANGELOG
index d177cca6f..4189d4493 100644
--- a/CHANGELOG
+++ b/CHANGELOG
@@ -1,6 +1,8 @@
 Changes between 2.0.1 and 2.0.2
 ----------------------------------------------
 
+- fix issue28 - setup_method and pytest_generate_tests work together
+
 - fix issue24 - pytest_assertrepr_compare produces an in-line
   exception on python3
 
diff --git a/_pytest/python.py b/_pytest/python.py
index c0c510670..c0e150e39 100644
--- a/_pytest/python.py
+++ b/_pytest/python.py
@@ -297,13 +297,8 @@ class Instance(PyCollectorMixin, pytest.Collector):
 class FunctionMixin(PyobjMixin):
     """ mixin for the code common to Function and Generator.
     """
-
     def setup(self):
         """ perform setup for this test function. """
-        if inspect.ismethod(self.obj):
-            name = 'setup_method'
-        else:
-            name = 'setup_function'
         if hasattr(self, '_preservedparent'):
             obj = self._preservedparent
         elif isinstance(self.parent, Instance):
@@ -311,6 +306,10 @@ class FunctionMixin(PyobjMixin):
             self.obj = self._getobj()
         else:
             obj = self.parent.obj
+        if inspect.ismethod(self.obj):
+            name = 'setup_method'
+        else:
+            name = 'setup_function'
         setup_func_or_method = getattr(obj, name, None)
         if setup_func_or_method is not None:
             setup_func_or_method(self.obj)
diff --git a/pytest.py b/pytest.py
index ebc989c11..fbd5b0d59 100644
--- a/pytest.py
+++ b/pytest.py
@@ -1,7 +1,7 @@
 """
 unit and functional testing with Python.
 """
-__version__ = '2.0.2.dev0'
+__version__ = '2.0.2.dev1'
 __all__ = ['main']
 
 from _pytest.core import main, UsageError, _preloadplugins
diff --git a/setup.py b/setup.py
index 2fd956ccd..d8e17a7a0 100644
--- a/setup.py
+++ b/setup.py
@@ -22,7 +22,7 @@ def main():
         name='pytest',
         description='py.test: simple powerful testing with Python',
         long_description = long_description,
-        version='2.0.2.dev0',
+        version='2.0.2.dev1',
         url='http://pytest.org',
         license='MIT license',
         platforms=['unix', 'linux', 'osx', 'cygwin', 'win32'],
diff --git a/testing/test_python.py b/testing/test_python.py
index 6e0639fde..31a11d71f 100644
--- a/testing/test_python.py
+++ b/testing/test_python.py
@@ -1062,6 +1062,21 @@ class TestGenfuncFunctional:
             "*2 pass*",
         ])
 
+    def test_issue28_setup_method_in_generate_tests(self, testdir):
+        p = testdir.makepyfile("""
+            def pytest_generate_tests(metafunc):
+                metafunc.addcall({'arg1': 1})
+
+            class TestClass:
+                def test_method(self, arg1):
+                    assert arg1 == self.val
+                def setup_method(self, func):
+                    self.val = 1
+            """)
+        result = testdir.runpytest(p)
+        result.stdout.fnmatch_lines([
+            "*1 pass*",
+        ])
 
 def test_conftest_funcargs_only_available_in_subdir(testdir):
     sub1 = testdir.mkpydir("sub1")