diff --git a/src/compiler/checker.ts b/src/compiler/checker.ts
index f9fd563b87..5348d2b19f 100644
--- a/src/compiler/checker.ts
+++ b/src/compiler/checker.ts
@@ -492,12 +492,16 @@ namespace ts {
                                     : false;
                             }
                             if (meaning & SymbolFlags.Value && result.flags & SymbolFlags.FunctionScopedVariable) {
-                                // function scoped variables are visible only inside function body and parameter list
-                                // technically here we might mix parameters and variables declared in function,
-                                // however this case is detected separately when checking initializers of parameters
+                                // parameters are visible only inside function body, parameter list and return type
+                                // technically for parameter list case here we might mix parameters and variables declared in function,
+                                // however it is detected separately when checking initializers of parameters
                                 // to make sure that they reference no variables declared after them.
-                                useResult = lastLocation === (<FunctionLikeDeclaration>location).type ||
-                                    lastLocation.kind === SyntaxKind.Parameter;
+                                useResult =
+                                    lastLocation.kind === SyntaxKind.Parameter ||
+                                    (
+                                        lastLocation === (<FunctionLikeDeclaration>location).type &&
+                                        result.valueDeclaration.kind === SyntaxKind.Parameter
+                                    );
                             }
                         }
 
diff --git a/tests/baselines/reference/functionVariableInReturnTypeAnnotation.errors.txt b/tests/baselines/reference/functionVariableInReturnTypeAnnotation.errors.txt
new file mode 100644
index 0000000000..93a35292b7
--- /dev/null
+++ b/tests/baselines/reference/functionVariableInReturnTypeAnnotation.errors.txt
@@ -0,0 +1,10 @@
+tests/cases/compiler/functionVariableInReturnTypeAnnotation.ts(1,24): error TS2304: Cannot find name 'b'.
+
+
+==== tests/cases/compiler/functionVariableInReturnTypeAnnotation.ts (1 errors) ====
+    function bar(): typeof b {
+                           ~
+!!! error TS2304: Cannot find name 'b'.
+        var b = 1;
+        return undefined;
+    }
\ No newline at end of file
diff --git a/tests/baselines/reference/functionVariableInReturnTypeAnnotation.js b/tests/baselines/reference/functionVariableInReturnTypeAnnotation.js
new file mode 100644
index 0000000000..191255e52c
--- /dev/null
+++ b/tests/baselines/reference/functionVariableInReturnTypeAnnotation.js
@@ -0,0 +1,11 @@
+//// [functionVariableInReturnTypeAnnotation.ts]
+function bar(): typeof b {
+    var b = 1;
+    return undefined;
+}
+
+//// [functionVariableInReturnTypeAnnotation.js]
+function bar() {
+    var b = 1;
+    return undefined;
+}
diff --git a/tests/cases/compiler/functionVariableInReturnTypeAnnotation.ts b/tests/cases/compiler/functionVariableInReturnTypeAnnotation.ts
new file mode 100644
index 0000000000..c8936034a2
--- /dev/null
+++ b/tests/cases/compiler/functionVariableInReturnTypeAnnotation.ts
@@ -0,0 +1,4 @@
+function bar(): typeof b {
+    var b = 1;
+    return undefined;
+}
\ No newline at end of file