Deborah Oven, publican of the Denver City Hotel in Coolgardie, said she put the sign up on the wall of her pub after her phone was stolen on Saturday,
However, a tweet from Australia’s Race Discrimination commissioner, Dr Tim Soutphommasane revealed that the refusal of service based on ethnicity is illegal.
Social media has condemned the sign as racist and many Aboriginal customers of Denver City Hotel have been left disgusted.
“I felt like a beer so I went into the pub to buy a couple of coldies and I was turned down service and I asked why and the lady said ‘turn around there's a sign on the board’," said pub patron, Michael Adams.
"As I turned around it said no Indigenous person can be served at this hotel because of a stolen phone."
"I felt so disgusted and embarrassed as I was the only Aboriginal person in that bar and the bar had occupants as well who were staring at me."
Mr Adams is the man who took the photo of the sign that was shared almost 1000 times on Facebook overnight.
He and members of his family were asked to leave the Denver City Hotel after questioning the sign.
“I told her that's a bit racist isn’t it, and she goes no it's not, and then I told her that you can't judge every Aboriginal person just because of one individual's action and she practically just said you're all related anyway so that's why she put the sign up,” said Mr Adams.
Ms Ovens has since apologised and says the poster was only up for a few hours.
"Well that's what, I mean as soon as I realised after the gentleman had left, that nah, this is the wrong thing I shouldn't have done it. So I apologise completely to the Aboriginal community at large all across Australia if I've offended them in any way," said Ms Ovens.
When contacted by NITV News, West Australian police said the sign may not constitute an offence because it used the word ‘Indigenous’ which is non-specific.
Western Australia's hotels association has joined in the condemnation of a rural landlord who banned service to indigenous customers after her mobile phone was allegedly stolen.
"It's like someone is trapped in a time warp, in a swamp of the old Bayou of Mississippi in the 1920s," Australian Hotels Association (WA) chief executive Bradley Woods said.
"This incident highlights the fact that education around the issue of racial discrimination is still needed in 2014."