diff --git a/hgext/largefiles/overrides.py b/hgext/largefiles/overrides.py
--- a/hgext/largefiles/overrides.py
+++ b/hgext/largefiles/overrides.py
@@ -265,13 +265,10 @@ def override_update(orig, ui, repo, *pat
 # The overridden function filters the unknown files by removing any
 # largefiles. This makes the merge proceed and we can then handle this
 # case further in the overridden manifestmerge function below.
-def override_checkunknown(origfn, wctx, mctx, folding):
-    origunknown = wctx.unknown()
-    wctx._unknown = filter(lambda f: lfutil.standin(f) not in wctx, origunknown)
-    try:
-        return origfn(wctx, mctx, folding)
-    finally:
-        wctx._unknown = origunknown
+def override_checkunknownfile(origfn, repo, wctx, mctx, f):
+    if lfutil.standin(f) in wctx:
+        return False
+    return origfn(repo, wctx, mctx, f)
 
 # The manifest merge handles conflicts on the manifest level. We want
 # to handle changes in largefile-ness of files at this level too.
diff --git a/hgext/largefiles/uisetup.py b/hgext/largefiles/uisetup.py
--- a/hgext/largefiles/uisetup.py
+++ b/hgext/largefiles/uisetup.py
@@ -64,8 +64,8 @@ def uisetup(ui):
                                    overrides.override_update)
     entry = extensions.wrapcommand(commands.table, 'pull',
                                    overrides.override_pull)
-    entry = extensions.wrapfunction(merge, '_checkunknown',
-                                    overrides.override_checkunknown)
+    entry = extensions.wrapfunction(merge, '_checkunknownfile',
+                                    overrides.override_checkunknownfile)
     entry = extensions.wrapfunction(merge, 'manifestmerge',
                                     overrides.override_manifestmerge)
     entry = extensions.wrapfunction(filemerge, 'filemerge',
diff --git a/mercurial/merge.py b/mercurial/merge.py
--- a/mercurial/merge.py
+++ b/mercurial/merge.py
@@ -81,22 +81,19 @@ class mergestate(object):
             self.mark(dfile, 'r')
         return r
 
-def _checkunknown(wctx, mctx, folding):
+def _checkunknownfile(repo, wctx, mctx, f):
+    return (not repo.dirstate._ignore(f)
+        and os.path.exists(repo.wjoin(f))
+        and mctx[f].cmp(wctx[f]))
+
+def _checkunknown(repo, wctx, mctx):
     "check for collisions between unknown files and files in mctx"
-    if folding:
-        foldf = util.normcase
-    else:
-        foldf = lambda fn: fn
-    folded = {}
-    for fn in mctx:
-        folded[foldf(fn)] = fn
 
     error = False
-    for fn in wctx.unknown():
-        f = foldf(fn)
-        if f in folded and mctx[folded[f]].cmp(wctx[f]):
+    for f in mctx:
+        if f not in wctx and _checkunknownfile(repo, wctx, mctx, f):
             error = True
-            wctx._repo.ui.warn(_("%s: untracked file differs\n") % fn)
+            wctx._repo.ui.warn(_("%s: untracked file differs\n") % f)
     if error:
         raise util.Abort(_("untracked files in working directory differ "
                            "from files in requested revision"))
@@ -565,7 +562,7 @@ def update(repo, node, branchmerge, forc
         wc.status(unknown=True) # prime cache
         folding = not util.checkcase(repo.path)
         if not force:
-            _checkunknown(wc, p2, folding)
+            _checkunknown(repo, wc, p2)
         if folding:
             _checkcollision(p2, branchmerge and p1)
         action += _forgetremoved(wc, p2, branchmerge)