diff --git a/langfuse/_client/client.py b/langfuse/_client/client.py
index af06e69ef..087172a04 100644
--- a/langfuse/_client/client.py
+++ b/langfuse/_client/client.py
@@ -1030,6 +1030,9 @@ def start_as_current_observation(
 
         The created observation will be the child of the current span in the context.
 
+        An asyncio.CancelledError escaping the context marks the observation as ERROR
+        with the cancellation message and is re-raised to preserve task cancellation.
+
         Args:
             trace_context: Optional context for connecting to an existing trace
             name: Name of the observation (e.g., function or operation name)
@@ -1389,7 +1392,16 @@ def _start_as_current_otel_span_with_processed_media(
                     )
                 # For span-like types (span, agent, tool, chain, retriever, evaluator, guardrail), no generation properties needed
 
-                yield span_class(**common_args)  # type: ignore[arg-type]
+                observation = span_class(**common_args)  # type: ignore[arg-type]
+                try:
+                    yield observation
+                except asyncio.CancelledError as error:
+                    if otel_span.is_recording():
+                        observation.update(
+                            level="ERROR",
+                            status_message=str(error) or type(error).__name__,
+                        )
+                    raise
 
             finally:
                 if baggage_token is not None:
diff --git a/tests/unit/test_otel.py b/tests/unit/test_otel.py
index 46a085a71..b0cfdba44 100644
--- a/tests/unit/test_otel.py
+++ b/tests/unit/test_otel.py
@@ -1,9 +1,11 @@
+import asyncio
 import json
 from datetime import datetime
 from hashlib import sha256
 from typing import List, Sequence
 
 import pytest
+from opentelemetry import context as context_api
 from opentelemetry import trace as trace_api
 from opentelemetry.sdk.resources import Resource
 from opentelemetry.sdk.trace import ReadableSpan, TracerProvider
@@ -2787,6 +2789,100 @@ def test_blocked_scope_drop_logs_scope_name(
         )
 
 
+@pytest.mark.asyncio
+@pytest.mark.parametrize("as_type", ["span", "generation"])
+@pytest.mark.parametrize("cancellation", ["empty", "message", "timeout"])
+async def test_observation_context_records_cancellation(
+    langfuse_memory_client, get_span, as_type, cancellation
+):
+    client = langfuse_memory_client
+    ready = asyncio.Event()
+    restored_context = None
+
+    async def work():
+        nonlocal restored_context
+        try:
+            with client.start_as_current_observation(
+                name="cancelled-observation", as_type=as_type
+            ):
+                ready.set()
+                await asyncio.Event().wait()
+        finally:
+            restored_context = context_api.get_current()
+
+    with client.start_as_current_observation(name="parent") as parent:
+        parent_context = context_api.get_current()
+        task = asyncio.create_task(work())
+        await asyncio.wait_for(ready.wait(), timeout=5)
+
+        if cancellation == "timeout":
+            with pytest.raises(asyncio.TimeoutError):
+                await asyncio.wait_for(task, timeout=0)
+        else:
+            message = "service shutting down" if cancellation == "message" else None
+            task.cancel(message)
+            with pytest.raises(asyncio.CancelledError) as exc_info:
+                await task
+            assert str(exc_info.value) == (message or "")
+
+        assert task.cancelled()
+        assert restored_context is parent_context
+        assert trace_api.get_current_span().get_span_context().span_id == int(
+            parent.id, 16
+        )
+
+    client.flush()
+    span = get_span("cancelled-observation")
+    expected_message = (
+        "service shutting down" if cancellation == "message" else "CancelledError"
+    )
+    assert span.attributes.get(LangfuseOtelSpanAttributes.OBSERVATION_LEVEL) == "ERROR"
+    assert (
+        span.attributes[LangfuseOtelSpanAttributes.OBSERVATION_STATUS_MESSAGE]
+        == expected_message
+    )
+    assert span.status.status_code == trace_api.StatusCode.ERROR
+    assert span.status.description == expected_message
+    assert span.end_time is not None
+    assert span.parent.span_id == int(parent.id, 16)
+    assert get_span("parent").status.status_code == trace_api.StatusCode.UNSET
+
+
+@pytest.mark.parametrize("as_type", ["span", "generation"])
+def test_observation_cancellation_preserves_manual_end(
+    langfuse_memory_client, get_span, memory_exporter, as_type
+):
+    client = langfuse_memory_client
+    cancellation = asyncio.CancelledError("cancelled child")
+    with client.start_as_current_observation(name="parent") as parent:
+        parent_context = context_api.get_current()
+        with pytest.raises(asyncio.CancelledError) as exc_info:
+            with client.start_as_current_observation(
+                name="manual-end-child",
+                as_type=as_type,
+                trace_context={
+                    "trace_id": parent.trace_id,
+                    "parent_span_id": parent.id,
+                },
+                end_on_exit=False,
+            ) as child:
+                raise cancellation
+
+        assert exc_info.value is cancellation
+        assert context_api.get_current() is parent_context
+        assert child._otel_span.is_recording()
+        client.flush()
+        assert memory_exporter.get_finished_spans() == []
+        child.end()
+
+    client.flush()
+    span = get_span("manual-end-child")
+    assert span.attributes.get(LangfuseOtelSpanAttributes.OBSERVATION_LEVEL) == "ERROR"
+    assert span.status.description == "cancelled child"
+    assert span.parent.span_id == int(parent.id, 16)
+    assert len(memory_exporter.get_finished_spans()) == 2
+
+
 class TestConcurrencyAndAsync(TestOTelBase):
     """Tests for asynchronous and concurrent span operations."""