---

---

# UNITED STATESSECURITIES AND
EXCHANGE COMMISSIONWashington, D.C. 20549

# AMENDMENT NO. 1 
TO

# FORM 20-F/A

o
          REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
          EXCHANGE ACT OF 1934

OR

x
          ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
          1934

For
the fiscal year ended December 31, 2005

OR

o
          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
          OF 1934

OR

o
          SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
          ACT OF 1934

Date of event requiring this shell company report __________

For the transition period from ___________ to _____________

Commission file number
001-14184

|B.O.S.
BETTER ONLINE SOLUTIONS LTD.(Exact name of Registrant as
               specified in its charter)
|--------------------------------------------------------------------------------------------------------

ISRAEL
(Jurisdiction of
incorporation or organization)

Beit Rabin, Teradyon
Industrial Park, Misgav, 20179, Israel
(Address of principal
executive offices)

Securities
registered or to be registered pursuant to Section 12(b) of the Act: Ordinary Shares, nominal
value NIS 4.00 per share

Securities
registered or to be registered pursuant to Section 12(g) of the Act: NONE

Securities
for which there is a reporting obligation pursuant to Section 15(d) of the Act: NONE



---

---

Indicate the number of outstanding
shares of each of the issuers classes of capital or common stock as of the close of
the period covered by the annual report: 6,589,385 Ordinary Shares, nominal value NIS
4.00 per share, as of December 31, 2005 Indicate by check mark if the registrant is a
well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o No x

If this report is an annual or
transition report, indicate by check-mark if the registrant is not required to file
reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes o No x

Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
See definition of accelerated filer and large accelerated filer in Rule 12b-2
of the Exchange Act. (Check one):

Large accelerated filer o         Accelerated filer o          Non-accelerated filer x

Indicate by check mark which
financial statement item the registrant has elected to follow:

Item 17 o Item 18 x

If this is an annual report, indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).

Yes o No x

EXPLANATORY NOTE

This Amendment no. 1 to the Annual
Report on Form 20-F for the year ended December 31, 2005, of B.O.S Better Online Solutions
Ltd. (the Registrant) includes the auditors report of Kesselman &
Kesselman, a member of PriceWaterhouseCoopers International Limited, who audited the
financial statements of Odem Electronic Technologies 1992 Ltd., a subsidiary of the
Registrant, for the fiscal year ended December 31, 2004. The Form 20-F filed by the
Registrant on June 28, 2006 included the auditors consent for the incorporation by
reference of their audit report dated March 25, 2005, in previously filed registration
statements of the Registrant and such consent mentioned that the audit report was included
in the Annual Report on Form 20-F of the Registrant for the year ended December 31, 2005,
however the audit report itself was accidentally omitted from the Annual Report. It should
be noted that the said auditors report was included in the Registrants Annual Report
for the year ended December 31, 2004. This Amendment no. 1 to the Annual Report is being
filed to include the abovementioned auditors report in the Registrants Annual Report
for the year ended December 31, 2005.



---

---

# Item 18: Financial
Statements

The audited financial statements
filed as part of this Amendment no. 1 to Form 20-F are identical to the audited financial
statements that were filed as part of the Form 20-F on June 28, 2006, except for the
addition of the auditors report of Kesselman & Kesselman, a member of
PriceWaterhouseCoopers International Limited.

# Item 19: Exhibits

The following exhibits are filed as
part of this Annual Report:

|1.1* |  | Memorandum
of Association, as amended.
|---- |  | --------------------------------------

|1.2* |  | Articles
of Association, as amended.
|---- |  | ------------------------------------

|4.1* |  | Form
of Indemnification Agreement between the Company and its officers and directors, as
amended.
|---- |  | -------------------------------------------------------------------------------------------------

|4.2 |  | Share
Purchase Agreement, dated as of February 23, 2003, and Option Agreement and Registration
Rights Agreement, dated as of March 30, 2003, by and between Catalyst Investments L.P.
and the Registrant (incorporated by reference to the Companys Annual Report on Form
20-F filed on June 17, 2004).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 |  | Services
Agreement, dated as of April 15, 2003, between Cukierman & Co. Investment House Ltd.,
BOScom Ltd. and the Registrant (incorporated by reference to the Companys Annual
Report on Form 20-F filed on June 17, 2004).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.4 |  | M&A
Addendum to the Service Agreement, as of August 22, 2004, between Cukierman &Co.
Investment House Ltd., BOScom Ltd. and the Registrant (incorporated by reference to the
Companys Annual Report on Form 20-F filed on June 27, 2005).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.5 |  | Management
Agreement between Signum Ltd., Adiv Baruch and the Registrant, dated as of January 1,
2004 (incorporated by reference to the Companys Annual Report on Form 20-F filed on
June 17, 2004).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.6 |  | Securities
Purchase Agreement and Master Security Agreement and Registration Rights Agreement, dated
as of June 10, 2004, by and between Laurus Master Fund Ltd. and the Registrant
(incorporated by reference to the Companys Annual Report on Form 20-F filed on June
17, 2004), and Amendment no. 1 to the Securities Purchase Agreement dated as of November
16, 2004 (incorporated by reference to the Companys Registration Statement on Form
F-3 no. 333-117529).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.7* |  | Securities
Purchase Agreement and Master Security Agreement, dated as of September 29, 2005, by and
between Laurus Master Fund Ltd. and the Registrant (the Secured Convertible Term Note,
Ordinary Shares Purchase Warrant and Registration Rights Agreement are incorporated by
reference to the Companys Registration Statement on Form F-3 no. 333-130048).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.8 |  | Distribution
 Agreement,  dated as of January 15, 2003,  by and between  BOScom Ltd. and BOSaNOVA
         Inc.  (incorporated  by reference to the Company's  Annual Report on Form 20-F/A
filed on January          6, 2005).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.9 |  | Asset
Purchase  Agreement,  dated as of September 29, 2004, by and between  Quasar
 Communication          Systems  Ltd.  and the  Registrant  (incorporated  by  reference
 to the  Company's  Registration          Statement on Form F-3 no. 333-117529).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.10 |  | Share
 Purchase  Agreement,  dated as of November 2, 2004,  by and between Jacob and Sara
Neuhof,          Odem  Electronic  Technologies  1992 Ltd. and the  Registrant
 (incorporated  by reference to the          Company's Registration Statement on Form F-3
no. 333-117529).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



---

---

|4.11* |  | Agreement,
dated as of September 29, 2005, by and between Jacob and Sara Neuhof and the Registrant,
for the purchase of the shares of Odem Electronic Technologies 1992 Ltd. held by the
Jacob and Sara Neuhof.
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.12 |  | Share
 Purchase  Agreement,  dated as of  November  2, 2004,  by and between  Telsys  Ltd.,
 Odem          Electronic  Technologies  1992  Ltd.  and  the  Registrant  (incorporated
 by  reference  to  the          Company's Registration Statement on Form F-3 no.
333-117529).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.13* |  | Share
Purchase Agreement, dated as of October 31, 2005, by and between Telsys Ltd. and the
Registrant.
|----- |  | ------------------------------------------------------------------------------------------------------

|4.14 |  | Share
Purchase Agreement, dated as of May 24, 2005, by and between certain investors and the
Registrant (incorporated by reference to the Companys Annual Report on Form 20-F
filed on June 27, 2005).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.15* |  | Asset
Purchase Agreement and Amendments no. 1 and 2 to Agreement, dated as of July 18, 2005,
August 31, 2005 and September 25, 2005, respectively, by and between BOSCom, Consist
Technologies Ltd. and Consist International Inc., and Escrow Agreement and Amendment no.
1 to Escrow Agreement between the parties, dated as of July 18, 2005 and August 31, 2005,
respectively.
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.16* |  | Asset
 Purchase  Agreement,  Amendment  no.  1 to  the  Agreement  and  Amendment  no.  2 to
 the          Agreement,  dated as of October 26, 2005, November 2, 2005, and December
31, 2005,  respectively,          by and between  Qualmax,  Inc.,  BOScom  Ltd.  and the
 Registrant;  Loan  Agreement  dated as of          December  31,  2005,  by and  between
 Qualmax  Ltd.  and  the  Registrant;  Registration  Rights          Agreement,  dated as
of December 31, 2005, by and between  Qualmax Inc. and the  Registrant;  and
         Form of warrant dated as of December 31, 2005, issued by Qualmax Inc. to the
Registrant.
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.17 |  | The
 Registrant's  Israeli 2003 Share  Option Plan  (incorporated  by reference to the
 Company's          Registration Statement on Form S-8 No. 333-11650).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|8.1 |  | List
of subsidiaries (incorporated by reference to Item 4C of this Annual Report on Form 20-F).
|--- |  | -----------------------------------------------------------------------------------------------

|10.1 |  | Consent
of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global.
|---- |  | --------------------------------------------------------------------------

|10.2 |  | Consent
of Kesselman & Kesselman, a member of PriceWaterhouseCoopers International Limited.
|---- |  | -------------------------------------------------------------------------------------------

|12.1 |  | Certification
by Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities
Exchange Act of 1934.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------

|12.2 |  | Certification
by Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities
Exchange Act of 1934.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------

|13.1 |  | Certification
by Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) or Rule
15d-14(b) of the Securities Exchange Act of 1934.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------

* previously filed



---

---

# Signatures

The Registrant hereby certifies that
it meets all of the requirements for filing on Form 20-F and that it has duly caused and
authorized the undersigned to sign this Amendment no. 1 to its annual report on its
behalf.

|B.O.S. Better Online Solutions Ltd.                                                |                                                                             
|---------------------------------------------------------------------------------- | ----------------------------------------------------------------------------
|By: /s/ Adiv Baruch
Adiv BaruchPresident and Chief Executive Officer | By: /s/ Nehemia Kaufman
Nehemia KaufmanChief Financial Officer

Date: September 7, 2006



---

---

# B.O.S. BETTER ONLINE
SOLUTIONS LTD.

# AND ITS SUBSIDIARIES

# CONSOLIDATED FINANCIAL
STATEMENTS

# AS OF DECEMBER 31, 2005

# U.S. DOLLARS IN
THOUSANDS

# INDEX

|                                                                 | Page       
|---------------------------------------------------------------- | -----------
|                                                                 |            
|Report of Independent Auditors Registered Public Accounting Firm | F-2        
|                                                                
|Consolidated Balance Sheets                                      | F-3 - F-4  
|                                                                
|Consolidated Statements of Operations                            | F-5        
|                                                                
|Statements of Changes in Shareholders' Equity                    | F-6 - F-7  
|                                                                
|Consolidated Statements of Cash Flows                            | F-8 - F-10 
|                                                                
|Notes to Consolidated Financial Statements                       | F-11 - F-47



---

---

| |   |                                                                  |   |                                           
| | - | ---------------------------------------------------------------- | - | ------------------------------------------
| | n | Kost Forer Gabbay & Kasierer3 Aminadav St.Tel-Aviv 67067, Israel | n | Phone: 972-3-6232525Fax:     972-3-5622555

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

# To the Shareholders of

# B.O.S. BETTER ONLINE
SOLUTIONS LTD.

We
have audited the accompanying consolidated balance sheets of B.O.S Better Online Solutions
Ltd. (the Company) and subsidiaries as of December 31, 2005 and 2004, and the
related consolidated statements of operations, changes in shareholders equity and
cash flows for each of the three years in the period ended December 31, 2005. These
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on our audits.
We did not audit the December 31, 2004 financial statements of Odem Electronic
Technologies 1992 Ltd (Odem) a subsidiary, whose statements reflect total
assets constituting 30.6% as of December 31, 2004, and total revenues for the period from
November 18, 2004 (date of acquisition of Odem) to December 31, 2004 constituting 23.5% of
the related consolidated total revenues. Those statements were audited by other auditors
whose reports have been furnished to us, and our opinion, insofar as it relates to amounts
included for Odem, is based solely on the reports of the other auditors. Those auditors
expressed an unqualified opinion on those statements in their report dated March 25, 2005.

We
conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. We were not engaged to perform an audit of the Companys
internal control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Companys internal control over financial reporting. Accordingly
we express no such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management and evaluating the
overall financial statement presentation. We believe that our audits and the report of the
other auditors provide a reasonable basis for our opinion.

In
our opinion, based on our audits and the report of other auditors, the consolidated
financial statements referred to above present fairly, in all material respects, the
consolidated financial position of the Company and its subsidiaries at December 31,
2005 and 2004, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 2005, in conformity with
U.S. generally accepted accounting principles.

|                 |                                 
|---------------- | --------------------------------
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER    
|March 27, 2006   | A Member of Ernst & Young Global

F - 2

---

---

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of

# ODEM ELECTRONIC
TECHNOLOGIES 1992 LTD.

We have audited the consolidated balance
sheets of Odem Electronic Technologies 1992 Ltd. (the Company) and its
subsidiaries as of December 31, 2003 and 2004 and the related consolidated statements
of operations, changes in shareholders equity and cash flows for each of the years
ended on those dates. These financial statements are the responsibility of the
Companys Board of Directors and management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance
with auditing standards generally accepted in Israel and the standards of the Public
Company Accounting Oversight Board (United States), including those prescribed by the
Israeli Auditors (Mode of Performance) Regulations, 1973. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant estimates
made by the Companys Board of Directors and management, as well as evaluating the
overall financial statement presentation. We believe that our audit provide a reasonable
basis for our opinion.

In our opinion, the consolidated
financial statements referred to above, present fairly, in all material respects, the
consolidated financial position of the Company and its subsidiaries as of
December 31, 2003 and 2004 and the consolidated results of operations, changes in
shareholders equity and cash flows for each of the years ended on those dates, in
conformity with accounting principles generally accepted in the United States of America.

|Jerusalem, Israel 
    March 25, 2005 | Kesselman & Kesselman
Certified Public Accountants (Israel)
A member of PricewaterhouseCoopers International Limited
|------------------------------------- | --------------------------------------------------------------------------------------------------------------------



---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
|-----------------------------------
|AND ITS SUBSIDIARIES               
|CONSOLIDATED BALANCE SHEETS        
|                                   
|U.S. dollars in thousands          

|                                                                             | December 31,
|---------------------------------------------------------------------------- | ------------
|
|
|ASSETS                                                                       |             
|                                                                             |             
|CURRENT ASSETS:                                                              |             
|Cash and cash equivalents                                                    |             
|Marketable securities (Note 5)                                               |             
|Trade receivables (net of allowance for doubtful accounts of $ 3 and $ 38 at |             
|December 31, 2005 and 2004, respectively)                                    |             
|Other accounts receivable and prepaid expenses (Note 3)                      |             
|Inventories (Note 4)                                                         |             
|                                                                             |             
|                                                                             |             
|Total current assets                                                         |             
|                                                                             |             
|                                                                             |             
|LONG-TERM ASSETS:                                                            |             
|Long term marketable securities (note 5)                                     |             
|Severance pay fund                                                           |             
|Investment in an affiliated company (note 6)                                 |             
|Investment in other companies (note 7)                                       |             
|                                                                             |             
|                                                                             |             
|Total long-term assets                                                       |             
|                                                                             |             
|                                                                             |             
|OTHER ASSETS                                                                 |             
|                                                                             |             
|                                                                             |             
|PROPERTY, PLANT AND EQUIPMENT, NET (Note 8)                                  |             
|                                                                             |             
|                                                                             |             
|GOODWILL (Note 10)                                                           |             
|                                                                             |             
|                                                                             |             
|CUSTOMER LIST AND OTHER INTANGIBLE ASSETS, NET (Note 9)                      |             
|                                                                             |             
|                                                                             |             
|ASSETS RELATED TO DISCONTINUED OPERATIONS (Note 1c)                          |             
|                                                                             |             
|                                                                             |             
|                                                                             |             
|                                                                             |             

The accompanying notes are an
integral part of the consolidated financial statements.

F - 3

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                       
|----------------------------------------------------------
|AND ITS SUBSIDIARIES                                      
|CONSOLIDATED BALANCE SHEETS                               
|                                                          
|U.S. dollars in thousands, except share and per share data

|                                                                            | December 31,
|--------------------------------------------------------------------------- | ------------
|
|
|
|
|LIABILITIES AND SHAREHOLDERS' EQUITY                                        |             
|                                                                            |             
|CURRENT LIABILITIES:                                                        |             
|Short term loans from banks (Note 11)                                       |             
|Current maturities of long-term bank loans and convertible note             |             
|Trade payables                                                              |             
|Employees and payroll accruals                                              |             
|Deferred revenues                                                           |             
|Accrued expenses and other liabilities (Note 12)                            |             
|                                                                            |             
|                                                                            |             
|Total current liabilities                                                   |             
|                                                                            |             
|                                                                            |             
|LONG-TERM LIABILITIES:                                                      |             
|Bank loans (net of current maturities) (Note 13)                            |             
|Convertible note (net of current maturities) (Note 14)                      |             
|Put option issued to minority shareholders in a subsidiary                  |             
|Deferred taxes                                                              |             
|Accrued severance pay                                                       |             
|                                                                            |             
|                                                                            |             
|Total long-term liabilities                                                 |             
|                                                                            |             
|                                                                            |             
|MINORITY INTEREST IN A SUBSIDIARY                                           |             
|                                                                            |             
|                                                                            |             
|LIABILITIES RELATED TO DISCONTINUED OPERATIONS (Note 1c)                    |             
|                                                                            |             
|                                                                            |             
|COMMITMENTS AND CONTINGENT LIABILITIES (Note 15)                            |             
|                                                                            |             
|SHAREHOLDERS' EQUITY (Note 16):                                             |             
|Share capital                                                               |             
|Ordinary shares of NIS 4.00 par value: Authorized: 8,750,000 shares at      |             
|December 31, 2005 and 2004; Issued and outstanding: 6,589,385 and 4,737,658 |             
|shares at December 31, 2005 and 2004, respectively;                         |             
|Additional paid-in capital                                                  |             
|Deferred stock-based compensation                                           |             
|Accumulated other comprehensive income                                      |             
|Accumulated deficit                                                         |             
|                                                                            |             
|                                                                            |             
|Total shareholders' equity                                                  |             
|                                                                            |             
|                                                                            |             
|Total liabilities and shareholder's equity                                  |             
|                                                                            |             

The accompanying notes are an integral
part of the consolidated financial statements.

F - 4

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.             
|------------------------------------------------
|AND ITS SUBSIDIARIES                            
|CONSOLIDATED STATEMENTS OF OPERATIONS           
|                                                
|U.S. dollars in thousands, except per share data

|                                                                | Year ended December 31,
|--------------------------------------------------------------- | -----------------------
|
|
|
|
|Revenues                                                        |                        
|Cost of revenues                                                |                        
|Reversal of Royalties (Note 18a)                                |                        
|                                                                |                        
|                                                                |                        
|Gross profit                                                    |                        
|                                                                |                        
|                                                                |                        
|Operating costs and expenses:                                   |                        
|Research and development                                        |                        
|Less - grants and participation                                 |                        
|Sales and marketing                                             |                        
|General and administrative                                      |                        
|Restructuring and related costs                                 |                        
|                                                                |                        
|                                                                |                        
|Total operating costs and expenses                              |                        
|                                                                |                        
|                                                                |                        
|Operating loss                                                  |                        
|Financial income (expenses), net (Note 18b)                     |                        
|Other income, net (Note 1c)                                     |                        
|                                                                |                        
|                                                                |                        
|Loss before taxes on income                                     |                        
|Taxes on income (Note 17)                                       |                        
|                                                                |                        
|                                                                |                        
|Net loss after taxes                                            |                        
|                                                                |                        
|Equity in losses of an affiliated company                       |                        
|Minority interest in earnings of a subsidiary                   |                        
|                                                                |                        
|                                                                |                        
|Loss from continuing operations                                 |                        
|Income (loss) related to discontinued operations (Note 1c)      |                        
|                                                                |                        
|                                                                |                        
|Net loss                                                        |                        
|                                                                |                        
|                                                                |                        
|Basic and diluted net loss per share from continuing operations |                        
|(Note 18c)                                                      |                        
|                                                                |                        
|                                                                |                        
|Basic and diluted net income (loss) per share from discontinued |                        
|operations (Note 18c)                                           |                        
|                                                                |                        
|                                                                |                        
|Basic and diluted net loss per share (Note 18c)                 |                        
|                                                                |                        

The accompanying notes are an
integral part of the consolidated financial statements.

F - 5

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.          
|---------------------------------------------
|AND ITS SUBSIDIARIES                         
|STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
|                                             
|U.S. dollars in thousands, except share data 

|                               | Ordinaryshares | Sharecapital | Additionalpaid incapital | Deferredstock-basedcompensation | Accumulatedothercomprehensiveincome | Treasuryshares | Accumulateddeficit | Totalcomprehensiveloss | Totalshareholders'
equity
|------------------------------ | -------------- | ------------ | ------------------------ | ------------------------------- | ----------------------------------- | -------------- | ------------------ | ---------------------- | -------------------------
|
|
|
|
|Balance at January 1, 2003     |                |              |                          | 3,177,264                       |                                     | $              | 3,690              |                        | $                        
|                               |                |             
|Issuance of shares related to  |                |             
|share swap transaction         |                |              |                          | 633,102                         |                                     |                | 537                |                        |                          
|Issuance of shares related to  |                |             
|the private placement          |                |              |                          | 357,143                         |                                     |                | 82                 |                        |                          
|Stock-based compensation       |                |             
|related to warrants issued     |                |             
|to service providers           |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Net loss                       |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Total other comprehensive loss |                |              |                          | -                               |                                     |                | -                  |                        |                          
|                               |                |              |                          |                                 |                                     |                |                    |                        |                          
|Total comprehensive loss       |                |              |                          |                                 |                                     |                |                    |                        |                          
|                               |                |              |                          |                                 |                                     |                |                    |                        |                          
|                               |                |             
|Balance at December 31, 2003   |                |              |                          | 4,167,509                       |                                     |                | 4,309              |                        |                          
|                               |                |             
|Deferred employee share-based  |                |             
|compensation                   |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Amortization of deferred       |                |             
|employee stock-based           |                |             
|compensation                   |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Issuance of shares related to  |                |             
|the acquisitions of Quasar     |                |             
|and Odem, net                  |                |              |                          | 570,149                         |                                     |                | 514                |                        |                          
|Stock based compensation       |                |             
|related to warrants issued     |                |             
|to service providers           |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Warrants issued related to     |                |             
|convertible note               |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Other comprehensive loss       |                |             
|Net loss                       |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Unrealized gain on available   |                |             
|for sales marketable           |                |             
|securities                     |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Foreign currency translation   |                |             
|adjustments                    |                |              |                          | -                               |                                     |                | -                  |                        |                          
|                               |                |              |                          |                                 |                                     |                |                    |                        |                          
|Total comprehensive loss       |                |              |                          |                                 |                                     |                |                    |                        |                          
|                               |                |              |                          |                                 |                                     |                |                    |                        |                          
|                               |                |             
|Balance at December 31, 2004   |                |              |                          | 4,737,658                       |                                     |                | 4,823              |                        |                          
|                               |                |              |                          |                                 |                                     |                |                    |                        |                          

The accompanying notes are an integral
part of the consolidated financial statements.

F - 6

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.          
|---------------------------------------------
|AND ITS SUBSIDIARIES                         
|STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
|                                             
|U.S. dollars in thousands, except share data 

|                               | Ordinaryshares | Sharecapital | Additionalpaid incapital | Deferredstock-basedcompensation | Accumulatedothercomprehensiveincome | Treasuryshares | Accumulateddeficit | Totalcomprehensiveloss | Total
shareholders'
equity
|------------------------------ | -------------- | ------------ | ------------------------ | ------------------------------- | ----------------------------------- | -------------- | ------------------ | ---------------------- | --------------------------
|
|
|
|
|Balance at January 1, 2005     |                |              |                          | 4,737,658                       |                                     | $              | 4,823              |                        | $                         
|                               |                |             
|Amortization of deferred       |                |             
|employee stock-based           |                |             
|compensation                   |                |              |                          | -                               |                                     |                | -                  |                        |                           
|Conversion of convertible note |                |              |                          | 640,293                         |                                     |                | 570                |                        |                           
|Issuance of shares related to  |                |             
|acquisition of Odem, net       |                |              |                          | 232,603                         |                                     |                | 202                |                        |                           
|Issuance of shares related to  |                |             
|the private placement, net     |                |              |                          | 953,743                         |                                     |                | 815                |                        |                           
|Exercise of employee options   |                |              |                          | 25,088                          |                                     |                | 22                 |                        |                           
|Stock-based compensation       |                |             
|related to warrants issued     |                |             
|to service providers           |                |              |                          | -                               |                                     |                | -                  |                        |                           
|Warrants issued related to     |                |             
|convertible note               |                |              |                          | -                               |                                     |                | -                  |                        |                           
|Net loss                       |                |              |                          | -                               |                                     |                | -                  |                        |                           
|Loss on available for sales    |                |             
|marketable securities          |                |              |                          | -                               |                                     |                | -                  |                        |                           
|Foreign currency translation   |                |             
|adjustment                     |                |              |                          | -                               |                                     |                | -                  |                        |                           
|                               |                |              |                          |                                 |                                     |                |                    |                        |                           
|Total comprehensive loss       |                |              |                          |                                 |                                     |                |                    |                        |                           
|                               |                |              |                          |                                 |                                     |                |                    |                        |                           
|                               |                |             
|Balance at December 31, 2005   |                |              |                          | 6,589,385                       |                                     | $              | 6,432              |                        | $                         
|                               |                |              |                          |                                 |                                     |                |                    |                        |                           

The accompanying notes are an
integral part of the consolidated financial statements.

F - 7

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.  
|-------------------------------------
|AND ITS SUBSIDIARIES                 
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|                                                                     | Year ended December 31,
|-------------------------------------------------------------------- | -----------------------
|
|
|
|
|Cash flows from operating activities:                                |                        
|Net loss                                                             |                        
|Adjustments to reconcile net loss to net cash used in operating      |                        
|activities:                                                          |                        
|Loss (income) from discontinued operations                           |                        
|Depreciation and amortization of intangible assets                   |                        
|Amortization of premium and accretion of accrued interest on         |                        
|available-for-sale marketable securities                             |                        
|Impairment of property and equipment                                 |                        
|Increase (decrease) in accrued severance pay, net                    |                        
|Equity in losses of an affiliated company                            |                        
|Minority interest in earnings in a subsidiary                        |                        
|Stock based compensation related to employees                        |                        
|Capital gain from sale of product line                               |                        
|Capital gain from sale of Communication Division                     |                        
|Net loss from decrease in value of put options                       |                        
|Capital loss from sale of property and equipment                     |                        
|Gain on sale of marketable securities                                |                        
|Stock based compensation related to warrants issued to service       |                        
|providers                                                            |                        
|Financial expenses related to warrants issued in connection with     |                        
|long-term convertible note                                           |                        
|Decrease (increase) in trade receivables                             |                        
|Decrease in deferred taxes                                           |                        
|Decrease in other accounts receivable and prepaid expenses           |                        
|Increase in inventories                                              |                        
|Increase (decrease) in trade payables                                |                        
|Decrease in employees and payroll accruals, deferred revenues,       |                        
|accrued expenses and other liabilities                               |                        
|                                                                     |                        
|Net cash used in operating activities from continuing operations     |                        
|Net cash used in operating activities from discontinued operations   |                        
|                                                                     |                        
|Net cash used in operating activities                                |                        
|                                                                     |                        
|                                                                     |                        
|Cash flows from investing activities:                                |                        
|Purchase of property and equipment                                   |                        
|Proceeds from sale of property and equipment                         |                        
|Proceeds from sale of product line                                   |                        
|Payment on account of sale of Communication division                 |                        
|Investment in long-term marketable securities                        |                        
|Proceeds from redemption of marketable securities                    |                        
|Investment in an affiliated company                                  |                        
|Acquisitions, net of cash acquired (a,b)                             |                        
|Realization of restricted cash                                       |                        
|                                                                     |                        
|                                                                     |                        
|Net cash provided by (used in) investing activities                  |                        
|                                                                     |                        
|                                                                     |                        
|Cash flows from financing activities:                                |                        
|Repayment of short term and long term bank loans                     |                        
|Proceeds from short term bank loans                                  |                        
|Proceeds from long term convertible note and warrants, net of        |                        
|issuance expenses                                                    |                        
|Payment of  long term convertible note                               |                        
|Proceeds from issuance of shares and exercise of options, net        |                        
|Issuance expenses related to investment in an affiliated company     |                        
|                                                                     |                        
|Net cash provided by financing activities from continuing operations |                        
|Net cash used in financing activities from discontinued operations   |                        
|                                                                     |                        
|Net cash provided by financing activities                            |                        
|                                                                     |                        
|                                                                     |                        
|Decrease in cash and cash equivalents                                |                        
|Decrease in cash and cash equivalents from discontinued operations   |                        
|Effect of exchange rate changes on cash and cash equivalents         |                        
|Cash and cash equivalents at the beginning of the year               |                        
|                                                                     |                        
|                                                                     |                        
|Cash and cash equivalents at the end of the year                     |                        
|                                                                     |                        

The accompanying notes are an integral
part of the consolidated financial statements.

F - 8

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.  
|-------------------------------------
|AND ITS SUBSIDIARIES                 
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|                                                               | Year ended December 31,
|-------------------------------------------------------------- | -----------------------
|
|
|
|
|Supplemental disclosure of cash flow activities:               |                        
|                                                               |                        
|(i) Net cash paid during the year for:                         |                        
|Interest                                                       |                        
|                                                               |                        
|                                                               |                        
|Income tax                                                     |                        
|                                                               |                        
|                                                               |                        
|(ii) Non-cash activities:                                      |                        
|                                                               |                        
|Investment in an affiliated company against issuance of shares |                        
|                                                               |                        
|                                                               |                        
|Conversion of convertible note into shares                     |                        
|                                                               |                        
|                                                               |                        
|Sale of Communication division in consideration for shares in  |                        
|Qualmax                                                        |                        
|                                                               |                        
|                                                               |                        
|Sale of PrintBos                                               |                        
|Consideration                                                  |                        
|Disposal of fixed assets                                       |                        
|Disposal of liability                                          |                        
|Related expenses                                               |                        
|                                                               |                        
|                                                               |                        
|Capital gain                                                   |                        
|                                                               |                        
|                                                               |                        
|Sale of Communication division                                 |                        
|Consideration, net                                             |                        
|Disposal of tangible and intangible assets                     |                        
|Related expenses                                               |                        
|                                                               |                        
|                                                               |                        
|Capital gain                                                   |                        
|                                                               |                        
|                                                               |                        
|(a) Acquisition of Quasar:                                     |                        
|                                                               |                        
|Fair value of net assets acquired (excluding cash and cash     |                        
|equivalents) and liabilities assumed at acquisition date:      |                        
|                                                               |                        
|Less - amount acquired by issuance of shares                   |                        
|                                                               |                        
|                                                               |                        
|                                                               |                        
|                                                               |                        

F - 9

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.  
|-------------------------------------
|AND ITS SUBSIDIARIES                 
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|                                                            | Year ended December 31,
|----------------------------------------------------------- | -----------------------
|
|
|
|
|(b) Acquisition of Odem:                                    |                        
|                                                            |                        
|Fair value of net tangible assets acquired (excluding cash  |                        
|and cash equivalents) and liabilities assumed at            |                        
|acquisition date:                                           |                        
|Fair value of net intangible assets acquired at acquisition |                        
|date:                                                       |                        
|                                                            |                        
|Less -                                                      |                        
|Amount acquired by issuance of shares                       |                        
|Payables                                                    |                        
|Add-                                                        |                        
|Cancellation of Put and Call options                        |                        
|                                                            |                        
|                                                            |                        
|                                                            |                        
|                                                            |                        

The accompanying notes are an
integral part of the consolidated financial statements.

F - 10

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL
|------- | - | -------

| | a. | B.O.S.
Better Online Solutions Ltd. is an Israeli corporation (together with its
               subsidiaries the Company).
| | -- | ----------------------------------------------------------------------------------------------------------------------------

| | The
Companys wholly-owned subsidiary BOScom Ltd. (BOScom) develops high
technology connectivity solutions that provide PC emulation products for the IBM iSeries
(AS/400). BOScom was involved in cross platform printing solutions answering a demand for
central printing and output management solutions in organizations which was sold during
2005 (see note 1c).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B.O.S.
                     Communication Division Segment included: BOScoms business of
                    communication solutions which provide multi-path, intelligent routing
voice over                     IP gateways and the Companys wholly-owned subsidiary
Quasar Telecom (2004)                     Ltd. (Quasar), which provide
communication solutions based on                     cellular technology. The assets and
liabilities of the Communication Segment                     have been disposed of as
part of the disposal of the Communication Division (see                     note 1c)
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
September and November 2005, the Company purchased an additional 23.9% and 12.3%,
respectively, of the outstanding shares of Odem Electronic Technologies 1992 Ltd.
(Odem). Following these purchase, the Company owns 100% of Odem. Odem is a
solutions supplier of electronic components and systems to the technologies sector (see
note 1b).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys products are sold and supported directly and through a network of
distributors and value-added resellers.
| | -----------------------------------------------------------------------------------------------------------------------

| | In
addition, the Company holds shares in two affiliated companies:
| | ------------------------------------------------------------------

| | 1) | 8.7%
interest in Surf Communication Solutions Ltd. (Surf), a           developer
and supplier of access and network convergence software solutions to           the wire
line and wireless telecommunications and data communications           industries.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Approximately
16% interest in Qualmax Inc. a US corporation           (Qualmax) which is a
developer and supplier of Voice over IP           technology products and services. The
Companys holdings in Qualmax were           received as the consideration for the
sale of the communication division (See           note 1c).
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Business
combinations:
| | -- | ----------------------

| | 1) | Acquisition
of Quasar Communication systems Ltd. assets (QCS).
| | -- | ----------------------------------------------------------------

| | In
September 2004, the Company entered into an agreement with QCS, to purchase the assets of
QCS, for an aggregate consideration of $ 539 by the issuance of 285,000 of the
Companys ordinary shares. The assets of QCS were transferred to Quasar Telecom
(2004) Ltd., a wholly owned subsidiary of the Company. The results of Quasars
operations have been included in the consolidated financial statements since September
28, 2004 (the closing date). On December 31, 2005, the Company sold the
assets of Quasar as part of the disposal of the Communication Division.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL (Cont.)
|------- | - | ---------------

| | The
Company's  consolidated  financial statements reflect the purchase price
                             determined as follows:
| | --------------------------------------------------------------------------------------------------------------------------------

|                       | Quasar
|---------------------- | ------
|
|
|
|
|Issuance of shares (1) |       
|Transaction costs      |       
|                       |       
|                       |       
|Total purchase price   |       
|                       |       

| | (1) | The
value of the Ordinary shares issued was determined based on the average           market
price of the Companys Ordinary shares over the period of two days           before
and after the terms of the transaction were agreed to and announced.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
acquisition has been treated using the purchase method of accounting in accordance with
SFAS141 Business Combinations. The purchase price has been allocated to the
assets acquired and liabilities assumed based on their estimated fair value at the date
of acquisition. The excess of the purchase price over the estimated fair value of the
tangible and intangible assets acquired has been recorded as goodwill.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has allocated the total cost of the acquisition in 2004 as follows.
| | -------------------------------------------------------------------------------

|Allocation of purchase consideration | Quasar | Estimated
useful life
|------------------------------------ | ------ | ---------------------
|
|
|
|
|Tangible assets                      |        |                      
|Inventory purchase commitment (1)    |        |                      
|Trade name (2)                       |        |                      
|Core technology (3)                  |        |                      
|Distribution networks (4)            |        |                      
|Goodwill                             |        |                      
|                                     |        |                      
|                                     |        |                      
|Total purchase price                 |        |                      
|                                     |        |                      

| | (1) | The
Company purchased Quasar Communication Systems Ltd inventory in the           ordinary
course of business for a cash consideration of $ 517. The fair value of           Quasars
inventory at the purchase date amounted to $ 370. A provision           in the
amount of $ 147 has been recorded at the date of the acquisition.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | The
Companys allocation of purchase price valuated the acquired trade           name
using the relief from royalty approach.
| | --- | -----------------------------------------------------------------------------------------------------------------------------

| | (3) | The
Companys allocation of purchase price valuated the acquired core
          technology using the discounted cash flows to be derived from the sales of
these           products to present value.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL (Cont.)
|------- | - | ---------------

| | (4) | The
Companys allocation of purchase price valuated the acquired           distribution
networks by calculating the savings realized by the Company through           obtaining a
pre-existing distribution network.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Acquisition
of Odem:
| | -- | --------------------

| | On
November 18, 2004 the Company purchased 63.8% of the outstanding shares of Odem, from Odems
existing shareholders. In consideration for Odems shares the Company (i) issued
290,532 of the Companys ordinary shares subject to lock-upperiods of 2
to 4 years and (ii) paid an amount of $ 1,971 in cash. In addition, Odems selling
shareholders and the Company had certain put and call options, based on performance, with
respect to all of the remaining Odem shares held by such sellers, exercisable for a
consideration comprised of additional cash and issuance of additional ordinary shares of
the Company. The Company recorded assets and liability with respect to these options at
fair value. The put option liability will be measured periodically until it expires or is
exercised and the changes in the fair value will be charged to finance expenses.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
September 29, 2005 and November 1, 2005, the Company purchased an additional 23.9% and
12.3%of the outstanding shares of Odem respectively, from Odems minority
shareholders. Following these purchases, the Company owns 100% of Odem. In consideration
for the 12.3% of Odems shares purchased on November, 2005 the Company paid $ 554,
in cash and for the 23.9% of Odems shares purchase on September, 2005 the Company
(i) issued 232,603 of the Companys ordinary shares subject to lock upperiods
of 2 to 4 years and (ii) $ 716 to be paid in cash.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys consolidated financial statements reflect the purchase price determined as
follows:
| | -------------------------------------------------------------------------------------------------

|                        | Odem
|----------------------- | ----
|
|
|
|
|Issuance of shares (1)  |     
|Cash consideration      |     
|Transaction costs       |     
|Cancellation of put and |     
|call options            |     
|                        |     
|                        |     
|Total purchase price    |     
|                        |     

| | (1) | The
value of the Ordinary shares issued was determined based on the average           market
price of the Companys Ordinary shares over the period of two days           before
and after the terms of the transaction were agreed to and announced.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL (Cont.)
|------- | - | ---------------

| | The
acquisitions have been treated using the purchase method of accounting in accordance with
SFAS141 Business Combinations. The purchase price has been allocated to the
assets and liabilities assumed acquired based on their estimated fair value at the date
of acquisition. The excess of the purchase price over the estimated fair value of the
tangible and intangible assets acquired has been recorded as goodwill.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has allocated the total cost of Odem acquisition in 2005 as follows.
| | --------------------------------------------------------------------------------

|Allocation of purchase
consideration | November 1,
2005 | September 29,
2005 | Total | Estimated
useful life
|------------------------------------ | ---------------- | ------------------ | ----- | ---------------------
|
|
|
|
|Tangible assets                      |                  |                    | $     | 340                  
|Customer list (1)                    |                  |                    |       | 85                   
|Deferred tax liability               |                  |                    |       | (23                  
|Goodwill                             |                  |                    |       | 138                  
|                                     |                  |                    |       |                      
|                                     |                  |                   
|Total purchase price                 |                  |                    | $     | 540                  
|                                     |                  |                    |       |                      

| | (1) | The
Companys allocation of purchase price valuated the acquired customer           list
by calculating cash flow as a direct result of the customer relationship.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has allocated the total cost of the acquisition in 2004 as follows:
| | -------------------------------------------------------------------------------

|Allocation of purchase consideration     | Odem | Estimateduseful life
|---------------------------------------- | ---- | --------------------
|
|
|
|
|Cash                                     |      |                     
|Tangible assets                          |      |                     
|Put option to minority shareholders (2)  |      |                     
|Call option to minority shareholders (2) |      |                     
|Customer list (1)                        |      |                     
|Deferred tax liability                   |      |                     
|Goodwill                                 |      |                     
|                                         |      |                     
|                                         |      |                     
|Total purchase price                     |      |                     
|                                         |      |                     

| | (1) | The
Companys allocation of purchase price valuated the acquired customer           list
by calculating cash flow benefit as a direct result of the customer
          relationship.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | The
put and call options were valuated by using the Black & Scholes option
          pricing model.
| | --- | ---------------------------------------------------------------------------------------------------

F - 14

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL (Cont.)
|------- | - | ---------------

| | The
following unaudited pro forma financial information presents the Companys results
of operations as if the acquisitions had occurred as of the beginning of the fiscal years
2003 and 2004, after giving effect to certain adjustments, including amortization of
intangible assets. The unaudited pro forma financial information does not necessarily
reflect the results of operations that would have occurred, and is not necessarily
indicative of results which may be obtained in the future.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                               | Year endedDecember 31,2004
|-------------------------------------------------------------- | --------------------------
|
|
|
|
|Pro forma revenues                                             |                           
|                                                               |                           
|                                                               |                           
|Pro forma net loss from continuing operations                  |                           
|                                                               |                           
|                                                               |                           
|Pro forma basic and diluted net loss per share from continuing |                           
|operations                                                     |                           
|                                                               |                           

|c. | 1) | Sale
of product line
|-- | -- | --------------------

| | On
July 18, 2005, BOScom signed an asset purchase agreement with Consist Technologies Ltd.
and Consist International Inc. (collectively, Consist), for the sale of its
PrintBOS product line in consideration of $ 500 and a contingent payment in each of
the next three years equal to 6-10% of future revenues exceeding $1,000 per year,
generated by Consist from the PrintBOS product line. The Company has accounted for a gain
of $ 273 in 2005. As of December 31, 2005, the Company has received $ 375 and the
remaining $ 125 has been placed in escrow, pending repayment of royalties to the Office
of the Chief Scientist (OCS) on sales of PrintBOS products.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Sale
of Communication Division:
| | -- | -------------------------------

| | On
December 31, 2005, the Company sold its Communications Division Segment (hereinafter
Communications Division), including its property and equipment, goodwill,
technology, trade name, existing distribution channels and related contingent liability
to the Office of the Chief Scientist to IP Gear Ltd. (IP Gear), a wholly
owned Israeli subsidiary of Qualmax. The consideration paid to the Company in the
transaction was approximately 3.2 million Qualmax shares of common stock constituting
approximately 16% of Qualmaxs total issued and outstanding Common Stock and $800 in
royalties to be paid at a rate of 4% from future revenues IP Gear will generate from the
disposed division (Royalties) with the entire $ 800 due no later than 90 days
from the third anniversary of the closing of the transaction. Additional shares may be
issued to the Company at the end of four consecutive fiscal quarters following the
closing of the transaction, contingent upon IP Gear generating by then a certain level of
revenues from the disposed division (Earn Out Shares). The maximum number of
Earn Out Shares that may further be issued to the Company is approximately 1 million,
constituting an additional 5%, of Qualmax outstanding shares. The Company received
certain piggy-back registration rights with respect to the Qualmax shares. The Company
does not have a representative on the Board of Directors of Qualmax.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL (Cont.)
|------- | - | ---------------

| | The
Company accounted for its holdings in Qualmax shares on the cost basis since these shares
are restricted stock.
| | -------------------------------------------------------------------------------------------------------------------

| | In
addition, the Company and IP Gear entered into an Outsourcing Agreement, pursuant to
which the Company will provide IP Gear with certain operating services relating to the
sold Communications Division. The first three months of services will be provided for no
charge and IP Gear shall pay for these services starting from April 2006. IP Gear can
elect to pay for the services rendered in April thru June 2006 by issuance to the Company
of Qualmax shares valued at a predetermined price of $1.43 per share. The Company
undertook to provide these services at least until December 31, 2006 (12 months from
closing).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company also granted a bridge loan to IP Gear in the amount of $1,000. The term of the
loan is three years and it bears interest equal to the Prime rate plus 2.5%, up to a
maximum of 12%. In the first 18 months, IP Gear shall pay only the interest accrued on
the loan and monthly principal and interest payments shall commence thereafter. The loan
granted to IP Gear is secured by a first priority floating charge, which may be
subordinated to a charge in favor of Bank of America, NA in the event such charge is
recorded. In addition repayment is guaranteed by Qualmax Inc.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
loan agreement provides that if the disposed division would incur in the first quarter of
2006, losses that exceed $250, the principal amount to be repaid under the loan shall be
reduced by the excess losses. In such event, Qualmax shall issue to the Company
additional shares of Common Stock against such reduction, valued at a predetermined price
of $1.43 per share. In addition, the loan shall be immediately repaid in the event
Qualmax raises by way of equity financing (or a series of equity financings) an aggregate
amount equal to at least $ 4,500.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Qualmax
also issued to the Company a five-year warrant for the purchase of up to 107,143 shares,
constituting less than 1%, of its outstanding shares in Qualmax, at the exercise price of
$2.80 per share (Warrants). The Company received certain piggy-back
registration rights with respect to the shares underlying the warrant.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                            | December 31,2005
|--------------------------------------------------------------------------- | ----------------
|
|
|
|
|Consideration:                                                              |                 
|Approximately 3.2 million ordinary shares of Qualmax (1)                    |                 
|107,143 warrants (2)                                                        |                 
|Loan granted to IP Gear                                                     |                 
|                                                                            |                 
|Total consideration                                                         |                 
|                                                                            |                 
|                                                                            |                 
|Cost:                                                                       |                 
|Disposal  of  inventory,  property  and  equipment  and  intangible  assets |                 
|related to the Communication segment                                        |                 
|Transactions related cost                                                   |                 
|                                                                            |                 
|Total cost                                                                  |                 
|                                                                            |                 
|                                                                            |                 
|Capital gain                                                                |                 
|                                                                            |                 

| | (1) | Valuated
at $ 1.43 per share
| | --- | ----------------------------

| | (2) | Valuated
at $ 0.97 per warrant
| | --- | ------------------------------

F - 16

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL (Cont.)
|------- | - | ---------------

| | The
Company has not accounted for the Communication Division as a discontinued operation due
to its continuing involvement reflected in the loan and the outsourcing agreement, in
accordance with EITF 03-13.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Discontinued
operations:
| | -- | ------------------------

| | On
June 1, 1998, the Company acquired 100% of the share capital of Pacific Information
Systems Inc. (Pacinfo), a U.S. corporation. Pacinfo was a reseller of
computer networking products.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the fourth quarter of 2002, the Company initiated a plan to cease operations of Pacinfo.
| | -----------------------------------------------------------------------------------------------

| | The
results of operations including revenues, operating expenses and other income and
expenses of Pacinfo for 2004 and 2003 have been reclassified in the accompanying
statements of operations as discontinued operations. The Companys balance sheets at
December 31, 2005 and 2004 reflect the net assets and liabilities of Pacinfo as
liabilities and assets related to discontinued operations.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
carrying amounts of the major classes of assets and liabilities included as part of the
discontinued operations are:
| | ------------------------------------------------------------------------------------------------------------------------

|                                                          | December 31,
|--------------------------------------------------------- | ------------
|
|
|
|
|Cash                                                      |             
|Trade receivables, other receivables and prepaid expenses |             
|Property and equipment, net                               |             
|                                                          |             
|                                                          |             
|Assets of discontinued operations                         |             
|                                                          |             
|                                                          |             
|Trade payables                                            |             
|Accrued expenses and other liabilities                    |             
|                                                          |             
|                                                          |             
|Liabilities of discontinued operations                    |             
|                                                          |             

| | The
results of operations, including revenues, cost of revenues and operating expenses of
Pacinfos operations for 2004 and 2003 have been reclassified in the statements of
operations. Taxes were not attributed to the discontinued operations due to utilization
of losses from previous years, for which a valuation allowance was provided.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Summarized
selected financial information of the discontinued operations is as follows:
| | ---------------------------------------------------------------------------------------

|                  | Year ended December 31,
|----------------- | -----------------------
|
|
|
|
|Revenues          |                        
|                  |                        
|                  |                        
|Net income (loss) |                        
|                  |                        

F - 17

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES
|------- | - | -------------------------------

| | The
 consolidated  financial  statements are prepared  according to United States generally
              accepted accounting principles ("U.S. GAAP").
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | Use
of estimates:
| | -- | -----------------

| | The
preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results could differ
from those estimates.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Financial
statements in U.S. dollars (dollar):
| | -- | ------------------------------------------------

| | A
substantial portion of the Companys revenues is generated in U.S. dollar (dollars).
In addition, most of the Companys costs are incurred in dollars. Companys
management believes that the dollar is the primary currency of the economic environment
in which the Company operates. Thus, the functional and reporting currency of the Company
is the dollar.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Accordingly,
monetary accounts maintained in currencies other than the dollar are remeasured into U.S.
dollars in accordance with Statement No. 52 of the Financial Accounting Standards Board (FASB)
Foreign Currency Translation. All transactions gains and losses from the
remeasurement of monetary balance sheet items are reflected in the statements of
operations as financial income or expenses as appropriate.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
functional currency of the Odem subsidiary, whose functional currency as of December 31,
2004, was other than dollar and has been translated into U.S. dollars, has changed on
April 1, 2005, due to significant changes in circumstances initiated by management,
which consisting of; Odem transition from New Israeli Shekels (NIS) to U.S. dollars of
Odems majority sales, majority expenses and budget, which indicate a functional
currency change. In accordance with FAS 52, Foreign Currency Translation and
since the functional currency changed from a foreign currency to the reporting currency,
dollars, the translation adjustments as of March 30, 2005, prior to the change have not
been removed from equity and the translated amounts for nonmonetary assets as of March 30,
2005, prior to the change became the accounting basis for those assets in the periods
starting April 1, 2005.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Principles
of consolidation:
| | -- | ----------------------------

| | The
consolidated financial statements include the accounts of the Company and its
subsidiaries. Inter-company transactions and balances including profits from
inter-company sales not yet realized outside the Company have been eliminated upon
consolidation.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Cash
equivalents:
| | -- | -----------------

| | Cash
equivalents are short-term highly liquid investments that are readily convertible to cash
originally purchased with maturities of less than three months.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | e. | Marketable
securities:
| | -- | ----------------------

| | The
Company accounts for investments in debt securities in accordance with Statement of
Financial Accounting Standard No.115, Accounting for Certain Investments in Debt
and Equity Securities (FAS 115). Management determines the appropriate
classification of its investments in debt and equity securities at the time of purchase
and reevaluates such determinations at each balance sheet date. Until November 30, 2005,
debt securities have been classified as held-to-maturity since the Company had the
positive intent and ability to hold the securities to maturity and they are stated at
amortized cost. The amortized cost of held-to-maturity securities is adjusted for
amortization of premiums and accretion of discounts to maturity. Such amortization and
decline in value judged to be other than temporary and interest are included in financial
income, net. Beginning December 1, 2005, the debt securities are classified as available-for-sale since
the Company does not have the intent to hold the securities to maturity, and are stated
at fair value. Due to the change in classification of the securities to available-for-sale,
the unrealized holding gain at the date of transfer has been reported in other
comprehensive income.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Available-for-sale
securities are carried at fair value with unrealized gains, and are reported as a
separate item under other comprehensive loss.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------

| | f. | Inventories:
| | -- | ------------

| | Inventory
write-offs are provided to cover risks arising from slow-moving items or technological
obsolescence. As of December 31, 2005 and 2004, inventory is presented net of $ 100
and $ 300, respectively, for technological obsolescence and slow moving items (see
also Note 4).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Inventories
are valued at the lower of cost or market value. Cost is determined as follows:
| | -------------------------------------------------------------------------------------------

| | Raw
and packaging materials  moving average cost method. Products in progress and
finished products  on the production costs basis.
| | -------------------------------------------------------------------------------------------------------------------------------------

| | g. | Grants
and royalty-bearing grants:
| | -- | ----------------------------------

| | Grants
and royalty-bearing grants from the Chief Scientist of the Ministry of Industry and Trade
in Israel for funding certain approved research projects are recognized at the time the
Company is entitled to such grants, on the basis of the related costs incurred, and are
presented as a deduction of research and development costs.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | h. | Investment
in an affiliated company:
| | -- | ------------------------------------

| | An
affiliated company is a company in which the Company is able to exercise significant
influence, but that is not a consolidated subsidiary and is accounted for by the equity
method, net of write-down for decrease in fair value which is not of a temporary nature.
The Companys investment in Surf has been included as an affiliated company until
September 30, 2005 (see note 6).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 19

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | The
investment in an affiliated company represents investments in Ordinary shares and
Preferred shares of that Company. The Company applies EITF 99-10, Percentage Used
to Determine the Amount of Equity Method Losses. Accordingly, losses of the
affiliated company are recognized based on the ownership level of the particular security
of the affiliated company held by the Company.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys investment in this company is reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of the investment may not be
recoverable, in accordance with Accounting Principle Board Opinion No. 18 The
Equity Method of Accounting for Investments in Common Stock (APB No. 18).
During 2005, an impairment of 1,385 has been recorded in equity in losses of an
affiliated company in the statement of operations. In 2004 and 2003, based on
managements analyses, no impairment losses were identified.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | i | Investment
in other companies:
| | - | ------------------------------

| | Investment
in companies are investments through which the Company is not able to exercise
significant influence over the investees financial policies and which do not meet
the fair value availability criteria of FAS 115 (readily determined sales price
currently available on a security exchange), consequently such investments are
accounted for by the cost method.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys investment in such companies is reviewed for impairment whenever events of
changes in circumstances indicate that the carrying amount of the investment may not be
recoverable in accordance with APB No. 18. No impairment has been identified during 2005.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | j. | Property
plant and equipment:
| | -- | -----------------------------

| | Property,
plant and equipment are stated at cost, net of accumulated depreciation. Depreciation is
calculated by using the straight-line method over the estimated useful lives of the
assets, at the following annual rates:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                               | %       |                                              
|------------------------------ | ------- | ---------------------------------------------
|
|
|
|
|Computers and software         | 20 - 33 | (mainly 33%)                                 
|Office furniture and equipment | 6 - 15  | (mainly 10%)                                 
|                               |         | (over the period of the lease 10 years or the
|Leasehold improvements-        | 10      | shorter of the life of the assets)           
|Vehicles                       | 15     
|Plant                          | 4      

| | k. | Impairment
of long-lived assets:
| | -- | --------------------------------

| | The
Companys long-lived assets are reviewed for impairment in accordance with Statement
of Financial Accounting Standard No. 144 Accounting for the Impairment or Disposal
of Long-Lived Assets (SFAS No. 144) whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the carrying
amount of an asset to the future undiscounted cash flows expected to be generated by the
assets. If such assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the fair value
of the assets. The Company has recorded impairment losses of $ 0, $ 0 and $ 110 for the
years ended December 31, 2005, 2004 and 2003, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | l. | Goodwill:
| | -- | ---------

| | Goodwill
represents excess of the costs over the net assets of businesses acquired. SFAS No. 142
requires goodwill to be tested for impairment at least annually or between annual tests
in certain circumstances, and written-down when impaired. Goodwill attributable to each
of the reporting units is tested for impairment by comparing the fair value of each
reporting unit with its carrying value. Fair value is determined using income and market
approaches. Significant estimates used in the methodologies include estimates of future
cash flows, future short-term and long-term growth rates, weighted average cost of
capital and estimates of market multiples for each of the reportable units. During 2005,
2004 and 2003 no impairment losses have been identified.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | m. | Research
and development costs:
| | -- | -------------------------------

| | Statement
of Financial Accounting Standards No. 86 Accounting for the Costs of Computer
Software to be Sold, Leased or Otherwise Marketed, (SFAS No. 86)
requires capitalization of certain software development costs subsequent to the
establishment of technological feasibility. Based on the Companys product
development process, technological feasibility is established upon completion of a
working model. Research and development costs incurred in the process of developing
product improvements or new products, are generally charged to expenses as incurred, net
of participation of the Office of the Chief Scientist of the Israeli Ministry of Industry
and Trade. Costs incurred by the Company between completion of the working model and the
point at which the product is ready for general releases are insignificant.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | n. | Severance
pay:
| | -- | --------------

| | The
Companys liability for severance pay for Israeli resident employees is calculated
pursuant to the Israeli severance pay law based on the most recent salary of the
employees multiplied by the number of years of employment as of the balance sheet date.
Employees are entitled to one months salary for each year of employment or a
portion thereof. The Companys liability for its Israeli resident employees is
covered by insurance policies designed solely for distributing severance pay. The value
of these policies is recorded as an asset in the Companys balance sheet.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
insurance policies include profits accumulated up to the balance sheet date. The
insurance policies may be withdrawn only upon complying with the Israeli severance pay
law or labor agreements. The value of the deposited funds is based on the cash
surrendered value of these policies and includes profits.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Severance
expenses for 2005, 2004 and 2003 amounted to $ 256, $ 214 and $ 178,
respectively.
| | --------------------------------------------------------------------------------------------

F - 21

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | o. | Revenue
recognition:
| | -- | --------------------

| | The
Company sells its products through direct sales, distributors and resellers channels.
| | -----------------------------------------------------------------------------------------

| | The
Company derives its revenues from the sale of products, license fees for its products,
commissions, support and services.
| | -----------------------------------------------------------------------------------------------------------------------------

| | Revenues
from product sales are recognized in accordance with Staff Accounting Bulletin No. 104
Revenue Recognition in Financial Statements (SAB 104) when
delivery has occurred, persuasive evidence of an arrangement exists, the vendors
fee is fixed or determinable, no further obligation exists, and collectibility is
reasonably assured.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenue
from license fees is recognized in accordance with Statement of Position (SOP) 97-2
Software Revenue Recognition, when persuasive evidence of an agreement
exists, delivery of the product has occurred, no significant obligations with regard to
implementation remain, the fee is fixed or determinable, and collectibility is probable.
The Company generally does not grant a right of return to its customers. When a right of
return exists, the Company defers revenue until the right of return expires, at which
time revenue is recognized provided that all other revenue recognition criteria have been
met.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
support are recognized ratably over the period of the support contract. The fair value of
the support is determined based on the price charged when it is sold separately or
renewed.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
from commissions are recognized upon their actual receipt, since under agreements with
suppliers consideration is received on the basis of collection from customers.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | p. | Warranty:
| | -- | ---------

| | BOScom
provides a warranty of between 3 to 36 months at no extra charge, whereby defective
hardware covered by the warranty should be sent back to the Company. The Company
estimates the costs that may be incurred under its warranty and records a liability in
the amount of such costs at the time product revenue is recognized. Factors that affect
the Companys warranty liability include the number of installed units, historical
and anticipated rates of warranty claims, and cost per claim. The Company periodically
assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as
necessary. As of December 31, 2005 and 2004, the Companys product warranty amounted
to $ 73 and $ 132, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | q. | Income
taxes:
| | -- | -------------

| | The
Company accounts for income taxes in accordance with Statement of Financial Accounting
Standards No 109, Accounting for Income Taxes. This Statement prescribes the
use of the liability method whereby deferred tax assets and liability account balances
are determined based on differences between financial reporting and tax bases of assets
and liabilities and are measured using the enacted tax rates and laws that will be in
effect when the differences are expected to reverse. The Company has provided valuation
allowances, in respect of deferred tax assets resulting from tax loss carryforward and
other reserves and allowances due to its history of operating losses and current
uncertainty concerning its ability to realize these deferred tax assets in the future.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | r. | Concentrations
of credit risk:
| | -- | ------------------------------

| | Financial
instruments that potentially subject the Company to concentrations of credit risk consist
principally of cash and cash equivalents, trade receivables, other accounts receivable
and marketable securities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Cash
and cash equivalents are invested mainly in U.S. dollars in deposits with major banks in
Israel. Management believes that the financial institutions that hold the investments of
the Company are financially sound and, accordingly, minimal credit risk exists with
respect to these investments.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
trade receivables of the Company are derived from sales to customers located primarily in
Israel, United States and Europe. The Company generally does not require collateral;
however, in certain circumstances, the Company may require letters of credit, other
collateral, additional guarantees or advanced payments. An allowance for doubtful
accounts is determined with respect to specific debts that are doubtful of collection.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Investments
in marketable securities are conducted through a bank in Israel and include investments
in corporate and governmental debentures. Management believes that the financial
institutions that hold the Companys investments are financially sound, the
portfolio is well diversified and accordingly, minimal credit risk exists with respect to
these investments.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
loan granted to IP Gear is secured by a first priority floating charge, which may be
subordinated to a charge in favor of Bank of America, NA in the event such charge is
recorded. In addition repayment is guaranteed by Qualmax Inc. (see note 1c(2)).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has no off-balance-sheet concentrations of credit risk such as foreign exchange
contracts, option contracts or other foreign hedging arrangements.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------

| | s. | Basic
and diluted net loss per share:
| | -- | -------------------------------------

| | Basic
net loss per share is calculated based on the weighted average number of Ordinary shares
outstanding during each year. Diluted net loss per share is calculated based on the
weighted average number of Ordinary shares outstanding during each year, plus dilutive
potential Ordinary shares considered outstanding during the year, in accordance with SFAS No.
128, Earnings Per Share.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
total number of shares related to the outstanding options and warrants excluded from the
calculations of diluted net loss per share, since they would have an anti-dilutive
effect, were 1,506,803, 855,783 and 505,178 for the years ended December 31, 2005, 2004
and 2003, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | t. | Accounting
for stock-based compensation:
| | -- | ----------------------------------------

| | The
Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees (APB-25), and Interpretation No. 44,
Accounting for Certain Transactions Involving Stock Compensation (FIN 44),
in accounting for its employee stock option plan. Under APB-25, when the exercise price
of the Companys employee stock options equals or is above than the market price of
the underlying shares on the date of grant, no compensation expense is recognized.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | Pro-forma
disclosure is required by SFAS No. 123, had the compensation expense for stock options
granted under the Companys plans been determined based on the fair value at the
date of grant. The Companys net loss and loss per Ordinary share in 2005, 2004 and
2003 would have changed to the pro forma amounts shown below:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                 | Year ended December 31,
|------------------------------------------------ | -----------------------
|
|
|
|
|Net loss from continuing operations as reported  |                        
|Add: stock-based compensation expense determined |                        
|under intrinsic value method                     |                        
|Deduct: stock-based compensation expense         |                        
|determined under fair value method for all       |                        
|awards                                           |                        
|                                                 |                        
|Pro forma net loss from continuing operations    |                        
|Pro forma net income (loss) from discontinued    |                        
|operations                                       |                        
|                                                 |                        
|                                                 |                        
|Pro forma net loss                               |                        
|                                                 |                        
|                                                 |                        
|Basic and diluted earning (loss) per share as    |                        
|reported:                                        |                        
|Continuing operations                            |                        
|                                                 |                        
|Discontinued operations                          |                        
|                                                 |                        
|Net loss                                         |                        
|                                                 |                        
|                                                 |                        
|Pro forma earning (loss) per share:              |                        
|Continuing operations                            |                        
|                                                 |                        
|Discontinued operations                          |                        
|                                                 |                        
|Net loss                                         |                        
|                                                 |                        

| | The
fair value of each option granted is estimated on the date of grant, using the Black &Scholes
option pricing model with expected volatility of approximately 120%, 68% and 64% in 2005,
2004 and 2003, respectively and using the following weighted average assumptions: (1)
Dividend yield of zero percent for each year; (2) Risk-free interest rate of 4%, 2.5% and
1.8% in 2005, 2004 and 2003, respectively and (3) Expected average lives of the options
of three years from the date of grant as of 2005, 2004 and 2003.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company applies SFAS No. 123 Accounting for stock Based Compensation(SFAS
No. 123) and EITF 96-18, Accounting for Equity Instruments that are Issued to
Other than Employees for Acquiring, or in Conjunction With, Selling, Goods or Services,
with respect to warrants issued to non-employees. SFAS No. 123 requires the use of option
valuation models to measure the fair value of the warrants at the date of grant.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 24

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | u. | Fair
value of financial instruments:
| | -- | ------------------------------------

| | The
following methods and assumptions were used by the Company in estimating fair value
disclosures for financial instruments:
| | ------------------------------------------------------------------------------------------------------------------------------

| | The
carrying amounts of cash and cash equivalents, trade receivables, other accounts
receivable, and trade payables approximate their fair value due to the short-term
maturities of such instruments. The fair value for marketable securities is based on
quoted market prices. The fair value of investments in other companies is based on
independent third-party evaluations.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | v. | Reclassification:
| | -- | -----------------

| | Certain
amounts from prior years have been reclassified to conform to the current year
presentation.
| | ----------------------------------------------------------------------------------------------------

| | w. | Impact
of recently issued accounting pronouncements:
| | -- | ----------------------------------------------------

| | In
November 2004, the FASB issued Statement of Financial Accounting Standard No. 150, Inventory
Costs, an Amendment of ARB No. 43, Chapter 4. (SAFS No. 151). SFAS No.
151 amends Accounting Research Bulletin (ARB) No. 43, Chapter 4, to clarify
that abnormal amounts of idle facility expense, freight handling costs and wasted
materials (spoilage) should be recognized as current-period charges. In addition, SFAS
No.151 requires that the allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. SAFS No. 151 is
effective for inventory costs incurred during fiscal years beginning after September 15,
2005. As of December 31, 2005, the Company does not expect that the adoption of SFAS No.
151 will have a material effect on its financial position or results of operations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement No.
123 (revised 2004), Share-Based Payment (Statement 123R), which
is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation(Statement
123). Generally, the approach in Statement 123R is similar to the approach
described in Statement 123. However, Statements 123 permitted, but did not require,
share-based payments to employees to be recognized based on their fair values while
Statement 123R requires all share-based payments to employees to be recognized based on
their fair values. Statement 123R also revises, clarifies and expands guidance in several
areas, including measuring fair value, classifying an award as equity or as a liability
and attributing compensation cost to reporting periods. The new Standard will be
effective for the Company in the first fiscal year beginning after December 15, 2005. On
March 29, 2005, the SEC published Staff Accounting Bulletin (SAB) No. 107,
which provides the staffs views on a variety of matters relating to stock-based
payments. SAB 107 requires stock-based compensation to be classified in the same expense
line items as cash compensation.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company will adopt Statement 123R and SAB 107 as of the financial statements of the first
quarter of 2006.
| | --------------------------------------------------------------------------------------------------------------

F - 25

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT
ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | In
May 2005, the FASB issued Statement of Financial Accounting Standard No. 154 (FAS
154), Accounting Changes and Error Corrections  a replacement of
APB No. 20, Accounting Changes and FAS NO. 3, Reporting Accounting Changes in
Interim Financial Statement. FAS 154 provides guidance on accounting for and
reporting of accounting changes and error corrections.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | APB
Option 20 previously required that most voluntary changes in accounting principle be
recognized by including in net income of the period of the change the cumulative effect
of changing to the new accounting principle. FAS 154 requires retrospective application
to prior periods financial statements of a voluntary change in accounting principle
unless it is impracticable. FAS 154 is effective for accounting changes and corrections
of errors made in fiscal years beginning after December 15, 2005. The Company is
currently assessing the impact of FAS 154 on its results of operations, financial
condition and liquidity.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
June 29, 2005, the FASB issued FSP FAS 115-1 and FAS 124-1. The guidance in FSP FAS 115-1
and FAS 124-1 addresses the determination of when an investment is considered impaired,
whether that impairment is other than temporary, and the measurement of an impairment
loss. The FSP also includes accounting considerations subsequent to the recognition of an
other-than-temporary impairment and requires certain disclosures about unrealized losses
that have not been recognized as other-than-temporary impairments. The guidance in this
FSP amends FASB Statement No. 115, Accounting for Certain Investments in Debt and
Equity Securities, and FASB Statement No. 124, Accounting for Certain
Investments Held by Not-for-Profit Organizations, and adds a footnote to APB
Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. The
guidance in this FSP nullifies certain requirements of EITF Issue No. 03-1 and supersedes
EITF. Abstracts, Topic D-44, Recognition of Other-Than-Temporary Impairment upon
the Planned Sale of a Security Whose Cost Exceeds Fair Value. The guidance in this
FSP is required to be applied to reporting periods beginning after December 15, 2005.
Because the impact of adopting the provisions of FSP FAS 115-1 will be dependent on
future events and circumstances, management cannot predict such impact.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 3: |  | OTHER
ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
|------- | - | ----------------------------------------------

|                                                       | December 31,
|------------------------------------------------------ | ------------
|
|
|
|
|Government authorities - Income tax advances and V.A.T |             
|Grants receivables                                     |             
|Accrued interest on marketable securities              |             
|Prepaid expenses                                       |             
|Other                                                  |             
|                                                       |             
|                                                       |             
|                                                       |             
|                                                       |             

F - 26

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 4: |  | INVENTORIES
|------- | - | -----------

|                                              |  | 
|--------------------------------------------- |  | 
|
|
|
|
|Raw materials (including packaging materials) |  | 
|Products in progress                          |  | 
|Finished products                             |  | 
|                                              |  | 
|                                              |  | 
|                                              |  | 
|                                              |  | 

| | The
inventories are presented net of provision for technological obsolescence and slow-moving
items of $ 100 and $ 300 as of December 31, 2005 and 2004, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 5: |  | MARKETABLE
SECURITIES
|------- | - | ---------------------

| | The
following is a summary of securities:
| | -----------------------------------------

|                    | December 31,
|------------------- | ------------
|
|
|
|
|Available-for-sale: |             
|                    |             
|Corporate           |             
|debentures          |             
|                    |             
|                    |             
|Held-to-maturity:   |             
|                    |             
|Corporate           |             
|debentures          |             
|                    |             

| | Aggregate
maturities of available-for-sale securities for years subsequent to December 31, 2005 are:
| | ----------------------------------------------------------------------------------------------------

|                    | Amortized cost | Estimated fair
market value
|------------------- | -------------- | ---------------------------
|
|
|
|
|Available for sale: |                |                            
|                    |                |                            
|2006                |                |                            
|2007                |                |                            
|2008                |                |                            
|                    |                |                            
|                    |                |                            
|                    |                |                            
|                    |                |                            

|NOTE 6: |  | INVESTMENT
IN AN AFFILIATED COMPANY
|------- | - | -----------------------------------

| | Investment
in Surf:
| | -------------------

| | In
November 2001, the Company invested $ 1,000 as part of a private placement in Surf
Communication System Ltd. (Surf). At the same time, the Company converted its
convertible loan in the amount of $ 1,042 (principal and accrued interest) into
Preferred shares in Surf at an exercise price equal to Surfs fair value as
determined in the investment agreement. As a result of this private placement, the Companys
holding in Surf was diluted to 17%. Accordingly, the investment was accounted based on
the cost accounting method.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 6: |  | INVESTMENT
IN AN AFFILIATED COMPANY (Cont.)
|------- | - | -------------------------------------------

| | In
March 2003, the Company engaged with Catalyst Investors L.P. (Catalyst), in
order to purchase additional 191,548 series C Preferred shares of Surf. In consideration,
the Company issued to Catalyst 633,102 Ordinary shares, at a purchase price of $ 2.77,
aggregating to $ 1,755 and incurred transaction cost of $ 155. The value of the Ordinary
shares issued was determined based on the average market price of the Companys
ordinary shares over the period including two days before and after the terms of the
transaction were agreed to and announced.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Catalyst
also granted the Company, at no additional consideration, an option to purchase on or
prior to January 31, 2006, any shares of Surf then held by Catalyst at an exercise
price of $ 9.1632 plus interest of 4.75% and until such purchase shall be granted voting
rights in Surf shares. In the event that Catalyst will sell its remaining shares in Surf
in or prior to January 31, 2006 (or by July 31, 2007, provided that the negotiations with
respect to the sale commenced before January 31, 2006), the Company will be entitled to
the gain that will be realized in such sale. To the best of the Companys knowledge,
Catalyst has not sold its Surf securities as of January 31, 2006, nor entered into
negotiations for their sale. The Company has not exercised the option and it expired on
January 31, 2006.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
a result of this investment, the Company had the ability to exercise significant
influence over Surf. As a result the investment in Surf had become qualified to be
accounted for under the equity method. According to APB 18 when an investment qualifies
for use of the equity method, the investor should adopt the equity method of accounting
by adjusting retroactively the investment, results of operations (current and prior
periods presented), and retained earnings, in a manner consistent with the accounting for
a step-by-step acquisition of a subsidiary.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
September 2005, Surf completed a private placement that is considered an event of change
in circumstances that has a significant adverse effect on the fair value of the
investment. Therefore, the Company has evaluated its investment in Surf and determined
that it amounts to $ 722 as of December 31, 2005 based on managements analysis
(supported by an independent third-party valuation). As a result, the Company has
recorded an impairment of $ 1,385, which has been included in the equity in losses of an
affiliated company in the statement of operations for the year December 31, 2005.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Moreover,
following the private placement in Surf, the Companys voting rights have been
diluted to 8.7% of the total voting rights in Surf. As a result, the Company ceased to
have the ability to exercise significant influence over Surf and, accordingly, the
adjusted carrying amount of the investment of $ 722 is accounted for based on the cost
accounting method.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 28

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 6: |  | INVESTMENT
IN AN AFFILIATED COMPANY (Cont.)
|------- | - | -------------------------------------------

| | Summarized
combined financial information of surf for the year in which the investment was accounted
using the equity method was as follows:
| | --------------------------------------------------------------------------------------------------------------------------------------------

|                        | December 31,
2004
|----------------------- | -----------------
|
|
|
|
|Balance sheet items:    |                  
|                        |                  
|Current assets          |                  
|                        |                  
|                        |                  
|Non-current assets      |                  
|                        |                  
|                        |                  
|Current liabilities     |                  
|                        |                  
|                        |                  
|Non-current liabilities |                  
|                        |                  
|                        |                  
|Shareholders' equity    |                  
|                        |                  

|                                             | Year ended December 31,
|-------------------------------------------- | -----------------------
|
|
|
|
|Statement of operations items:               |                        
|                                             |                        
|Revenues                                     |                        
|                                             |                        
|                                             |                        
|Cost of sales                                |                        
|                                             |                        
|                                             |                        
|Operating expenses from continuing operation |                        
|                                             |                        
|                                             |                        
|Net loss                                     |                        
|                                             |                        

|NOTE 7: |  | INVESTMENT
IN OTHER COMPANIES
|------- | - | -----------------------------

| | The
Companys investments in companies comprise of:
| | ---------------------------------------------------

|                                                             | December 31,
2005
|------------------------------------------------------------ | -----------------
|
|
|
|
|Qualmax (see Note 1(b) - disposal of Communication Division) |                  
|                                                             |                  

F - 29

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 8: |  | PROPERTY
AND EQUIPMENT
|------- | - | ----------------------

|                                 | December 31,
|-------------------------------- | ------------
|
|
|
|
|Cost:                            |             
|Computers and software           |             
|Office furniture and equipment   |             
|Leasehold improvements and plant |             
|Vehicles                         |             
|                                 |             
|                                 |             
|                                 |             
|                                 |             
|Accumulated depreciation:        |             
|Computers and software           |             
|Office furniture and equipment   |             
|Leasehold improvements and plant |             
|Vehicles                         |             
|                                 |             
|                                 |             
|                                 |             
|                                 |             
|                                 |             
|Depreciated cost                 |             
|                                 |             

| | Depreciation
expenses amounted to $ 345, $ 300 and $ 307 for the years ended December 31,
2005, 2004 and 2003, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------

|NOTE 9: |  | INTANGIBLE
ASSETS
|------- | - | -----------------

|                          | December 31,
|------------------------- | ------------
|
|
|
|
|Cost:                     |             
|Trade name                |             
|Core technology           |             
|Distribution network      |             
|Customer list             |             
|                          |             
|                          |             
|                          |             
|                          |             
|Accumulated amortization: |             
|Trade name                |             
|Core technology           |             
|Distribution network      |             
|Customer list             |             
|                          |             
|                          |             
|                          |             
|                          |             
|                          |             
|Amortized cost            |             
|                          |             

| | Amortization
expenses amounted to $ 236 and $ 50 for the years ended December 31, 2005 and
2004, respectively.
| | --------------------------------------------------------------------------------------------------------------

F - 30

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 9: |  | INTANGIBLE
ASSETS (Cont.)
|------- | - | -------------------------

| | Estimated
amortization expenses for the years ended:
| | ----------------------------------------------------

|          | December 31,
|--------- | ------------
|
|
|
|
|2006      |             
|2007      |             
|2008      |             
|2009      |             
|2010      |             
|2011-2014 |             

|NOTE 10: |  | GOODWILL
|-------- | - | --------

| | Goodwill
attributed to operating segments for the years ended December 31, 2005 and 2004 is as
follows:
| | -------------------------------------------------------------------------------------------------------

|                                        | Communication | Electronic
component | Total
|--------------------------------------- | ------------- | -------------------- | -----
|
|
|
|
|Balance as of January 1, 2004           |               |                      | $    
|                                        |               |                     
|Acquisition of Odem                     |               |                      |      
|Acquisition of Quasar                   |               |                      |      
|                                        |               |                      |      
|                                        |               |                     
|Balance as of December 31, 2004         |               |                      |      
|                                        |               |                     
|Foreign currency translation adjustment |               |                      |      
|Exercise of options in Odem             |               |                      |      
|Disposal of Communication Division      |               |                      |      
|                                        |               |                      |      
|                                        |               |                     
|Balance as of December 31, 2005         |               |                      | $    
|                                        |               |                      |      

|NOTE 11: |  | SHORT
TERM BANK LOANS
|-------- | - | ---------------------

|    | Weighted
interest
rate | December 31,
|--- | ---------------------- | ------------
|
|
|
|
|NIS |                        |             
|    |                        |             

| | Regarding
collateral given to insure short-term credit and loans see note 13c.
| | ------------------------------------------------------------------------------

F - 31

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 12: |  | ACCRUED
EXPENSES AND OTHER LIABILITIES
|-------- | - | --------------------------------------

|                                                     | December 31,
|---------------------------------------------------- | ------------
|
|
|
|
|Government of Israel - royalties and V.A.T           |             
|Provision for warranty                               |             
|Issuance cost related to accrued convertible note    |             
|Inventory purchase commitment liability              |             
|Accrued expenses on account of business combinations |             
|Other                                                |             
|                                                     |             
|                                                     |             
|                                                     |             
|                                                     |             

|NOTE 13: |  | LONG-TERM
BANK LOANS
|-------- | - | --------------------

| | a. | Classified
by linkage terms and interest rates, the total amount of the loans           is as
follows:
| | -- | ------------------------------------------------------------------------------------------------------

|                              | Weighted
interest
rate | December 31,
|----------------------------- | ---------------------- | ------------
|
|
|
|
|NIS linked to the Israeli CPI |                        |             
|NIS                           |                        |             
|                              |                        |             
|                              |                        |             
|                              |                        |             
|Less - current maturities     |                        |             
|                              |                        |             
|                              |                        |             
|                              |                        |             
|                              |                        |             

| | b. | The
loans mature in the following years after the balance sheet dates:
| | -- | ----------------------------------------------------------------------

|                                | December 31,
|------------------------------- | ------------
|
|
|
|
|First year (current maturities) |             
|Second year                     |             
|Third year                      |             
|Fourth year                     |             
|                                |             
|                                |             
|                                |             
|                                |             

| | c. | Odem
has registered fixed pledges on its real estate, plant and equipment and
          vehicles.
| | -- | -------------------------------------------------------------------------------------------------

F - 32

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 14: |  | LONG-TERM
CONVERTIBLE NOTE
|-------- | - | --------------------------

| | On
June 10, 2004, the Company entered into a Securities Purchase Agreement (the
Purchase Agreement), with Laurus Master Fund Ltd. (the Investor), under
which the Company issued to the Investor in a private placement (i) a Secured Convertible
Term Note of a $ 2,000 principal amount, due June 10, 2007 (the Note); and
(ii) a warrant to purchase 130,000 ordinary shares at an exercise price of $ 4.04 per
share (the Warrant). According to the agreement, several fees in the amount
of $ 115 were paid to the Investor. These fees are presented as discount of the principal
convertible loan. The Note is convertible into Ordinary shares at a price of $ 3.08 per
share. The principal amount of the Note is repayable in monthly installments, commencing
September, 2004, in the initial amount of $ 20 eventually increasing to $ 74. The Note
bears prime interest rate plus 3% which subject to reduction in certain conditions. The
Warrant is exercisable, in whole or in part, until June 10, 2011.Pursuant to its
undertaking in the Registration Rights Agreement with the Investor the Company filed with
the Securities and Exchange Commission a registration statement on Form F-3 covering the
resale of Ordinary Shares that are issuable upon conversion of the Note and/or exercise
of the Warrants, and/or issuable in payment of principal and interest on the Note. The
Registration Rights Agreement provided that any delay in registration and/or
effectiveness of the underlying shares of the transaction, or failure to maintain their
effectiveness, will result in penalties to be paid in cash, as liquidated damages. The
registration statement became effective on March 11, 2005. Due to the delay in the
effectiveness of the registration of the shares, the Company paid the Investor liquidated
damages of $92.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Note conversion price is subject to proportional adjustment in the event of stock splits,
combinations, subdivisions of the Ordinary shares or if dividend is paid on the Ordinary
shares in ordinary shares. In addition, if the Company issues stock in certain types of
transactions at a price lower than the initial conversion price, then the conversion
price will be adjusted to a lower price based on a weighted average formula.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of the warrants was calculated using the Black and Scholes Option Pricing
Model with the following assumptions: a risk-free interest rate of 3.34%, a dividend
yield of 0%, a volatility of the expected market price of the Companys Ordinary
shares of 100% and a weighted-average contractual life of 7 year. The fair value of the
warrants in the amount of $ 99 is presented as a component in shareholders equity.
Since the effective conversion price was grater than the share price at the commitment
date, no beneficial conversion feature exists.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
March 2005, the Investor elected to convert $ 308 of the Convertible note principal into
100,000 Ordinary shares of the Company. Due to the private placement agreement secured by
the Company in June 2005, the conversion price was adjusted to $2.94 per share, and in
July 2005, the Investor completed the conversion of the balance of the Convertible Note
principal, which had not been previously converted or repaid, and the accrued interest
into an additional 540,293 Ordinary shares for approximately $ 1,580.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 33

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 14: |  | LONG-TERM
CONVERTIBLE NOTE (Cont.)
|-------- | - | ----------------------------------

| | In
September 2005, the Company entered into a Second Securities Purchase Agreement (the
Purchase Agreement) with the Investor, under which the Company issued to the
Investor in a private placement (i) a Secured Convertible Term Note of a $ 1,500
principal amount, due September 2008 (the Note), and (ii) a warrant to
purchase 73,052 ordinary shares at an exercise price of $ 4.04 per share (the
Warrant). According to the agreement, several fees in the total amount of $ 116
were paid to the Investor. These fees are presented as a discount of the principal
convertible loan. The Note is convertible into Ordinary shares at a price of $ 3.08 per
share. The principal amount of the Note is repayable in monthly installments, commencing
as of January 2006, in the initial amount of $ 15 eventually increasing to $ 55. The Note
bears prime interest rate plus 1.5% which is subject to reduction under certain
conditions. The Warrant is exercisable, in whole or in part, until September 29, 2012.
Pursuant to its undertaking in the Registration Rights agreement with the Investor the
Company filed with the Securities and Exchange Commission a registration statement on
Form F-3 covering the resale of Ordinary Shares that is issuable upon conversion of the
Note and/or exercise of the Warrants, and/or issuable in payment of principal and
interest on the Note. The Registration Rights agreement provided that any delay in
registration and/or effectiveness of the underlying shares of the transaction, or failure
to maintain their effectiveness, will result in penalties to be paid in cash, as
liquidated damages. The registration statement became effective on February 8, 2006.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
note conversion price is subject to proportional adjustment in the event of stock splits,
combinations, subdivisions of the Ordinary shares or if dividend is paid on the Ordinary
shares in Ordinary shares. In addition, if BOS issues stock in certain types of
transactions at a price lower than the initial conversion price, then the conversion
price will be adjusted to a lower price based on a weighted average formula.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of the warrants was calculated using the Black- Scholes Option Pricing Model
with the following assumptions: a risk-free interest rate of 4.08%, a dividend yield of
0%, a volatility of the expected market price of the Companys Ordinary shares of
100% and a weighted-average contractual life of seven years. The fair value of the
warrants in the amount of $ 144 is offset against the note, amortized over the
period of the note and presented as a component in shareholders equity.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The maturity of the loan is as
follows:

|                                | December 31,
2005 | December 31,
2004
|------------------------------- | ----------------- | -----------------
|
|
|
|
|First year (current maturities) |                   |                  
|Second year                     |                   |                  
|Third year                      |                   |                  
|                                |                   |                  
|                                |                   |                  
|                                |                   |                  
|Less - discount                 |                   |                  
|                                |                   |                  
|                                |                   |                  
|                                |                   |                  
|                                |                   |                  

F - 34

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 15: |  | COMMITMENTS
AND CONTINGENT LIABILITIES
|-------- | - | --------------------------------------

| | a. | Commitments:
| | -- | ------------

| | 1. | Royalty
commitments:
| | -- | --------------------

| | a) | Under
the Companys research and development agreements with the Office of           the
Chief Scientist (OCS) and pursuant to applicable laws, the           Company
is required to pay royalties at the rate of 3.5% of sales of products           developed
with funds provided by the OCS, up to an amount equal to 100% of the           research
and development grants (dollar-linked) received from the OCS. The           obligation to
pay these royalties is contingent upon actual sales of the           products. Royalties
payable with respect to grants received under programs           approved by the OCS
after January 1, 1999, are subject to interest on the U.S.           dollar-linked value
of the total grants received at the annual rate of LIBOR           applicable to U.S.
dollar deposits at the time the grants are received.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2005, the Company has an outstanding contingent obligation to pay
royalties in the amount of approximately $ 3,500, in respect of these grants.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | The
Israeli Government, through the Overseas Marketing Fund, awarded the           Company
grants for participation in expenses for overseas marketing. The Company           is
committed to pay royalties to the Fund for Encouragement of Marketing
          Activities at the rate of 3% of the increase in export sales, up to the amount
          of the grants received by the Company linked to the dollar and bearing interest
          of LIBOR (for a period of six months).
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2005, the Company has an outstanding contingent obligation to pay
royalties of $ 110 with respect to these grants.
| | -------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Other
commitments:
| | -- | ------------------

| | The
facilities of the Company are rented under operating lease agreements that expire on
various dates ending in 2009. Minimum future rental payments for 2006 are $ 51, for
2007 $10, for 2008 $10 and for 2009 $6.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys motor vehicles are rented under various cancelable operating lease
agreements. The lease agreements for the motor vehicles expire on various dates ending in
2008. The maximum breach of contract fees can amounted to $ 74.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Lease
payments for the facilities occupied by the Company and the Companys motor vehicles
in 2005, 2004 and 2003 amounted to $ 408, $ 385 and $ 426, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 35

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 15: |  | COMMITMENTS
AND CONTINGENT LIABILITIES (Cont.)
|-------- | - | ----------------------------------------------

| | b. | (1) | In July 2002, the Company received a claim letter from a car leasing           vendor,
under which it claims that the Companys termination notice of the           leasing
agreement in March 2002 constitutes a breach of the agreement and the           vendor is
demanding compensation in which the nominal claim amount is of           $ 292. No
legal proceeding has yet been filed. At this stage, according to           the Companys
counsel assessment, the prospects of vendor to prevail and           recover a
significant amount, seem remote. The financial statements do not           include any
provision in that regard.
| | -- | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | In
September 2003, a supplier filed a legal claim in the amount of $107 against
          the Companys subsidiary. The claim alleges the breach of an agreement for
          the purchase of products. The Companys legal counsel is unable to
          reasonably estimate the outcome of this claim. In addition, the Companys
          management believes that the chances of the claim are remote. Accordingly, no
          provision has been included in the financial statements in respect of this
          claim.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | In
1998, as part of Pacinfo Share Purchase Agreement between the Company and           Mr.
Lee and Ms. Lee (the Seller), the Company may be obligated to           grant
the Sellers a loan on a full recourse basis for certain tax payments the
          Sellers may be liable for and reimburse the Sellers for certain interest on
          taxes that they may owe, currently estimated at approximately $ 2
millions.           The Company will receive a security interest in shares of the Company
that the           Sellers holds at the time of the loan with a fair market value as of
the date of           the loan of at least 125% of the amount of the loan as security for
the           repayment of the loan. It is possible that the windup of PacInfo during
2002 and           2003 may have triggered such a tax event for the Sellers, which would
result in           an obligation by the Company to lend the Sellers such amount and to
reimburse           them for interest expenses incidental to the tax event. Based on the
          Companys legal consul opinion and management estimation, no provision was
          recorded.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (4) | In
March 2006, BOSâNOVA EURL, a French company and former distributor of           the
Company, field against the Company and others a claim with the French           Tribunal.
The claim is on amount of 1.4 million Euros and it alleges breach of           exclusive
distributor rights in France. An initial hearing is scheduled to take           place in
France on June 29, 2006. This claim follows a previous motion for           temporary
injunctive relief that was field against the Companys new French
          distributor, said motion ultimately denied by French Trade Tribunal. The
Company           assesses the prospects of claim to prevail and recover a significant
amount, are           remote. The financial statements do not include any provision in
that regard.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 16: |  | SHAREHOLDERS EQUITY
|-------- | - | --------------------

| | a. | Private
placement:
| | -- | ------------------

| | In
June 2005, the Company completed a private placement for the Companys Ordinary
shares. The Company issued to the investors 953,698 Ordinary Shares at a purchase price
of $ 2.30 per share, for a consideration of approximately $ 2,040 (net of $ 154
in issuance expenses).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 36

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 16: |  | SHAREHOLDERS EQUITY
(Cont.)
|-------- | - | ----------------------------

| | The
private placement included warrants of 572,219 for ordinary shares. The exercise price of
the warrants is $2.50 per ordinary share during the first year from their issue date, and
increasing to $2.75 per ordinary share and $3.03 per ordinary share, on the first and
second anniversaries of the issue date, respectively. The warrant is exercisable, in
whole or in part during a period of three years from issuance, of the warrants. Pursuant
to its undertaking in the Registration Rights Agreement, the Company filed with the
Securities and Exchange Commission a registration statement on Form F-3 covering the
Ordinary Shares (including those underlying the warrants). The registration statement
became effective with no delay on February 8, 2006.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys outstanding warrants to shareholders as of December 31, 2005 are as
follows:
| | ------------------------------------------------------------------------------------------

|Issuance date | Warrants for
Ordinary
shares | Exercise
price per
share | Warrants
exercisable | Exercisable
through
|------------- | ---------------------------- | ------------------------ | -------------------- | -------------------
|
|
|
|
|June 2005     |                              |                          |                      | 441,785            
|July 2005     |                              |                          |                      | 130,434            
|              |                              |                          |                      |                    
|              |                              |                         
|              |                              |                          |                      | 572,219            
|              |                              |                          |                      |                    
|              |                              |                          |                      |                    

| | (*) | The
exercise price of the warrants is $2.50 per ordinary share during the first
          year from their issue date, and increasing to $2.75 per ordinary share and
$3.03           per ordinary share, on the first and second anniversaries of the issue
date.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b | Stock
option plans:
| | - | -------------------

| | During
1994, 1995, 1999, 2000, 2001, the Board of Directors of the Company adopted stock option
plans (the Plans) pursuant to which 656,250 options for the purchase of the
Companys Ordinary shares may be granted to officers, directors, consultants and
employees of the Company. The Board of Directors has resolved that no further grants
shall be made from the above mentioned plans. In May 2003, the Companys
shareholders approved the adoption of the 2003 Stock Option Plan, pursuant to which
625,000 Ordinary shares are reserved for purchase by employees, directors, consultants
and service providers of the Company. As of December 31, 2005 an aggregate 27,410 these
options are still available for future grant. Each option granted under the Plans expires
between 5-10 years from the date of the grant. The options vest gradually over a period
of up to four years. Options, that are cancelled or forfeited, become available for
future grants.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
June 2005 the Companys shareholders approved an increase of the number of Ordinary
shares reserved for issuance under the 2003 Israeli Stock Option Plan, to 1,000,000. The
additional shares shall be reserved after the registered share capital of the Company is
increased.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
November 18, 2004, upon acquisition of Odem, the Company granted 73,000 options to one of
Odems key employee. Each option can be exercised to purchase one ordinary share of
the Company without consideration. The options vest at the end of three years from the
grant date and expire ten years from the date of the grant. The market price of the
Companys shares on the date of grant was $ 2.5. Accordingly, the Company recorded
in the year ended December 31, 2005, a compensation expense of $ 62. This expense
was included as part of general and administrative expenses.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 37

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 16: |  | SHAREHOLDERS EQUITY
(Cont.)
|-------- | - | ----------------------------

| | Except
for these options, all other options granted to employees in 2005, 2004 and 2003, have an
exercise price equal to or higher than the market value of the Ordinary shares at the
date of grant. The weighted average fair values of the options granted during 2005, 2004
and 2003 were $ 2.13, $ 2.58 and $ 3.91, respectively.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following is a summary of the Companys stock options granted to officers,
directors, and employees among the various plans:
| | --------------------------------------------------------------------------------------------------------------------------------

|                    | Year ended December 31,
|------------------- | -----------------------
|
|
|
|
|Options outstanding |                        
|at beginning of     |                        
|year                |                        
|Changes during the  |                        
|year:               |                        
|Granted             |                        
|Exercise            |                        
|Forfeited or        |                        
|cancelled           |                        
|                    |                        
|                    |                        
|Options outstanding |                        
|at end of year      |                        
|                    |                        
|                    |                        
|Options exercisable |                        
|at the end of the   |                        
|year                |                        
|                    |                        

| | The
options outstanding as of December 31, 2005, have been separated into ranges of exercise
price as follows:
| | --------------------------------------------------------------------------------------------------------------

|Range of
exercise
price | Options
outstanding
as of
December 31,
2005 | Weighted
average
exercise
price | Weighted
average
remaining
contractual
life (years) | Options
exercisable
as of
December 31,
2005 | Weighted
average
exercise
price of
options
exercisable
|----------------------- | ------------------------------------------- | ------------------------------- | --------------------------------------------------- | ------------------------------------------- | ------------------------------------------------------
|
|
|
|
|$            0          |                                             |                                 |                                                     | 73,000                                      |                                                       
|$ 1.84-2.00             |                                             |                                 |                                                     | 140,221                                     |                                                       
|$ 2.28-3                |                                             |                                 |                                                     | 113,000                                     |                                                       
|$          6.8          |                                             |                                 |                                                     | 31,241                                      |                                                       
|$ 17.00-18.00           |                                             |                                 |                                                     | 9,463                                       |                                                       
|$        28.00          |                                             |                                 |                                                     | 33,325                                      |                                                       
|                        |                                             |                                 |                                                     |                                             |                                                       
|                        |                                             |                                
|                        |                                             |                                 |                                                     | 400,250                                     |                                                       
|                        |                                             |                                 |                                                     |                                             |                                                       

| | c. | Options
issued to service providers:
| | -- | ------------------------------------

| | The
Company accounts for these options in accordance with the provisions of SFAS 123 and EITF
96-18. The fair value for these options was estimated at the date of grant using
Black-Scholes option pricing model with the following assumptions: risk-free interest
rate of 1.5%, dividend yields of 0% volatility of 70%, and an expected life of 2.5 years.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 38

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 16: |  | SHAREHOLDERS EQUITY
(Cont.)
|-------- | - | ----------------------------

| | The
compensation expenses that have been recorded in the consolidated financial statements
regarding these warrants for the years 2005, 2004 and 2003 were $ 348, $ 117
and $ 23, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys outstanding warrants to service providers as of December 31, 2005 are as
follows:
| | -----------------------------------------------------------------------------------------------

|Issuance date  | Warrants for
Ordinary
shares | Exercise
price per
share | Warrants
exercisable | Exercisable
through
|-------------- | ---------------------------- | ------------------------ | -------------------- | -------------------
|
|
|
|
|October 2002   |                              |                          |                      | 75,000             
|January 2004   |                              |                          |                      | 216,282            
|June 2004      |                              |                          |                      | 130,000            
|March 2005     |                              |                          |                      | 10,000             
|March 2005     |                              |                          |                      | 10,000             
|June 2005      |                              |                          |                      | 20,000             
|September 2005 |                              |                          |                      | 73,052             
|               |                              |                          |                      |                    
|               |                              |                         
|               |                              |                          |                      | 534,334            
|               |                              |                          |                      |                    

|NOTE 17: |  | TAXES
ON INCOME
|-------- | - | ---------------

| | a. | Reduction
in corporate tax rate:
| | -- | --------------------------------

| | On
June 2004, the Israeli Parliament approved an amendment to the Income Tax Ordinance (No.
140 and Temporary Provision) (the Amendment), which progressively reduces the
regular corporate tax rate from 36% to 35% in 2004, 34% in 2005, 32% in 2006 and to a
rate of 30% in 2007. The amendment was signed and published in July 2004 and is,
therefore, considered enacted in July 2004.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
July 25, 2005, the Knesset (Israeli Parliament) passed the Law for the Amendment of the
Income Tax Ordinance (No. 147), 2005, which prescribes, among others, a gradual decrease
in the corporate tax rate in Israel to the following tax rates: in 2006  31%, in
2007  29%, in 2008  27%, in 2009  26% and in 2010 and thereafter 25%.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Odem
and Quasar operations are subject to regular income tax rate while the Company and BOScom
enjoy the status of an Approved Enterprise, as described below.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Tax
benefits under the Law for the Encouragement of Capital Investments, 1959           (the
Investment Law):
| | -- | ---------------------------------------------------------------------------------------------------------------

| | The
Companys production facilities have been granted an Approved Enterprisestatus
under the Investment Law, with respect to four separate investment programs. According to
the Investments Law, the Company has elected to receive for the first program
state-guaranteed loans and grants and for the second and third programs, the Company has
elected to receive only state-guaranteed loans. As for the fourth program, the Company
has elected the alternative benefits and has waived Government grants in
return for a tax exemption.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 39

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 17: |  | TAXES
ON INCOME (Cont.)
|-------- | - | -----------------------

| | The
Company is also a Foreign Investors Company, as defined by the
abovementioned law, and as such, is entitled to a 10-year period of benefits and to an
additional reduction in tax rates, up to 10% or 25% (based on the percentage of foreign
ownership in each taxable year).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Income
from the second, third and fourth programs, which commenced operations in 1992, 1994,
1997, respectively, are exempt from income tax for a period of ten years commencing with
the first year in which they generate taxable income. During 2002, as part of the
transfer of operations from the Company to BOScom, all tax benefits that were related to
the Approved Enterprise of the Company were transferred to BOScom. In addition, since
2002, the Companys investments are not subject to the Approved Enterprise program.
Accordingly, taxable income generated in that period will be split by the assets ratio
into a taxable income that is entitled to the benefits of the approved enterprise and
into an income that will be taxed at the corporate tax rate as described in article a
above.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | BOScom
also has a production facility, which was granted an Approved Enterprisestatus
and had a separate investment program. BOScom elected to receive the alternative
benefits. Income derived from BOScoms investment programs, which commenced
operations in 1997 and 2002, is exempt from income tax for a period of ten years
commencing with the first year in which taxable income is generated.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
period of tax benefits detailed above is subject to limits of the earlier of 12 years
from commencement of production, or 14 years from receiving the approval. Accordingly,
the period of benefits relating to all investment programs expire in the years 2001
through 2014.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
entitlement to the above benefits is conditional upon the Companys and BOScoms
fulfilling the conditions stipulated by the above law, regulations published thereunder
and the instruments of approval for the specific investments in Approved Enterprises.
In the event of failure to comply with these conditions, the benefits may be canceled and
the Company and BOScom may be required to refund the amount of the benefits, in whole or
in part, including interest.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
tax-exempt income attributable to the Approved Enterprise can be distributed
to shareholders without imposing tax liability on the Company only upon the complete
liquidation of the Company. In the event of a distribution of such tax-exempt income as a
cash dividend in a manner other than in the complete liquidation of the Company and
BOScom, the Company and BOScom will be required to pay tax at the rate of 10% to 25% on
the amount distributed. In addition, these dividends will be subject to 15% withholding
tax. Since there was no distribution of dividends with respect to the period ended on
December 31, 2005, the Company did not record a deferred tax liability.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | If
the Company and BOScom derive income from sources other than an Approved Enterprise,
such income will be taxable at the regular corporate tax rate as described in article (a)
above.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 40

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 17: |  | TAXES
ON INCOME (Cont.)
|-------- | - | -----------------------

| | On
April 1, 2005, an amendment to the Investment Law came into effect (the Amendment)
and has significantly changed the provisions of the Investment Law. The Amendment limits
the scope of enterprises which may be approved by the Investment Center by setting
criteria for the approval of a facility as an Approved Enterprise, such as provisions
generally requiring that at least 25% of the Approved Enterprises income will be
derived from export. Additionally, the Amendment enacted major changes in the manner in
which tax benefits are awarded under the Investment Law so that companies no longer
require Investment Center approval in order to qualify for tax benefits.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | However,
the Investment Law provides that terms and benefits included in any certificate of
approval already granted will remain subject to the provisions of the law as they were on
the date of such approval. Therefore the Israeli subsidiarys existing Approved
Enterprise will generally not be subject to the provisions of the Amendment. As a result
of the amendment, tax-exempt income generated under the provision of the new law will
subject the Company to taxes upon distribution or liquidation and the Company may be
required to record deferred tax liability with respect to such tax-exempt income. As of
December 31, 2005, the Company did not generate income subject to the provision of the
new law.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Loss
carryforward:
| | -- | ------------------

| | Domestic
(Israel):
| | ------------------

| | The
Company and its Israeli subsidiary have accumulated losses for Israel income tax purposes
as of December 31, 2005, in the amount of approximately $ 21,600. These losses may
be carryforward (linked to the Israeli Consumer Price Index (CPI)) and offset
against taxable income in the future for an indefinite period.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Foreign:
| | --------

| | As
of December 31, 2005, the U.S. subsidiaries which were classified as discontinued
operations had U.S. Federal and State net operating loss carryforward of approximately $ 10,264,
that can be carried forward and offset against taxable income and expire through 2022.
Utilization of U.S. net operating losses may be subject to substantial annual limitations
due to the change in ownership provisions of the Internal Revenue Code of
1986 and similar state law provisions. The annual limitations may result in the
expiration of net operating losses before utilization.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2005, B.O.S. U.K. had net operating loss carryforward of approximately $ 3,500.
In February, 2006 B.O.S. U.K. the Company filed with the UK Companies House an
application to dissolve BOS U.K.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Deferred
income taxes:
| | -- | ----------------------

| | Deferred
income taxes reflect the net tax effect of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes. Significant components of the Companys deferred tax
liabilities and assets are as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 41

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 17: |  | TAXES
ON INCOME (Cont.)
|-------- | - | -----------------------

|                                                         | December 31,
|-------------------------------------------------------- | ------------
|
|
|
|
|Assets  in respect of:                                   |             
|                                                         |             
|Property, plant and equipment                            |             
|Allowances and provisions                                |             
|Net operating loss carry forward                         |             
|                                                         |             
|                                                         |             
|                                                         |             
|Liabilities in respect of intangible assets and goodwill |             
|                                                         |             
|                                                         |             
|Net deferred tax assets before valuation allowance       |             
|Valuation allowance (1)                                  |             
|                                                         |             
|                                                         |             
|Net deferred tax liability                               |             
|                                                         |             
|                                                         |             
|Presented in balance sheet:                              |             
|                                                         |             
|Current assets                                           |             
|Long-term assets                                         |             
|Current liabilities                                      |             
|Long-term liabilities                                    |             
|                                                         |             
|                                                         |             
|Net deferred tax liability                               |             
|                                                         |             
|                                                         |             
|Net deferred tax - domestic                              |             
|                                                         |             

| | (1) | The
Company has provided valuation allowances, for BOS, BOScom and Quasar in
          respect of deferred tax assets resulting from tax loss carryforward and other
          reserves and allowances due to its history of operating losses and current
          uncertainty concerning its ability to realize these deferred tax assets in the
          future.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | Income
(loss) before taxes on income:
| | -- | -------------------------------------

|         | Year ended December 31,
|-------- | -----------------------
|
|
|
|
|Domestic |                        
|Foreign  |                        
|         |                        
|         |                        
|Total    |                        
|         |                        

F - 42

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 17: |  | TAXES
ON INCOME (Cont.)
|-------- | - | -----------------------

| | f. | Effective
tax
| | -- | -------------

|                                                | Year ended December 31,
|----------------------------------------------- | -----------------------
|
|
|
|
|Loss before taxes on income, as reported in the |                        
|consolidated statements of operation            |                        
|                                                |                        
|                                                |                        
|Statutory tax rate                              |                        
|                                                |                        
|                                                |                        
|Provision at statutory tax rate                 |                        
|Non deductible expenses                         |                        
|Valuation allowance                             |                        
|                                                |                        
|                                                |                        
|Total tax expenses                              |                        
|                                                |                        

| | g. | Tax
assessments:
| | -- | ----------------

| | BOS,
BOScom and Odem have final assessments through the 2000 tax year.
| | ----------------------------------------------------------------------

|NOTE 18: |  | SUPPLEMENTARY
INFORMATION TO STATEMENTS OF OPERATIONS
|-------- | - | -----------------------------------------------------

| | a. | Royalty
reversal:
| | -- | -----------------

| | Certain
research and development activities of the Company are supported by the OCS. In return
for the OCSs participation, the Company was committed to pay royalties as described
in Note 14 a.1. During the third quarter of 2003, the OCS completed its examination of
the Companys technology and use of grant funding for the years 1991 through 1999,
which reduced the royalties expenses provision. Accordingly, the Company reversed $
339 of accrued royalties as a reduction in cost of sales during the third quarter of
2003. During the fourth quarter of 2005, the Company reversed an additional amount of $84
related to a balance report received from the OCS in the fourth quarter of 2005.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |    |                                            | Year ended December 31,
| | -- | ------------------------------------------ | -----------------------
|
|
|
|
| | b. | Financial income (expenses), net:          |                        
| |    |                                            |                        
| |    | Financial income:                          |                        
| |    | Interest on bank deposits and marketable   |                        
| |    | securities                                 |                        
| |    | Other (mainly foreign currency translation |                        
| |    | income)                                    |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        
| |    | Financial expenses:                        |                        
| |    | In respect of long-term bank loans and     |                        
| |    | convertible note                           |                        
| |    | Other (mainly foreign currency translation |                        
| |    | losses)                                    |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        

F - 43

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 18: |  | SUPPLEMENTARY
INFORMATION TO STATEMENTS OF OPERATIONS (Cont.)
|-------- | - | -------------------------------------------------------------

| | c. | Loss
per share:
| | -- | ---------------

| | 1. | Numerator:
| | -- | ----------

| |    |                                          |  |  |  
| | -- | ---------------------------------------- |  |  | -
|
|
|
|
| |    | Numerator for basic and diluted net loss |  |  |  
| |    | per share -                              |  | 
| |    | Net loss from continuing operations      |  |  | $
| |    |                                          |  |  |  
| |    |                                          |  | 
| |    | Net income (loss) from discontinued      |  | 
| |    | operation                                |  |  | $
| |    |                                          |  |  |  
| |    |                                          |  | 
| |    | Net loss available to Ordinary           |  | 
| |    | shareholders                             |  |  | $
| |    |                                          |  |  |  
| |    |                                          |  | 
| | 2. | Denominator (in thousands):              |  | 
| |    |                                          |  | 
| |    | Denominator for basic and diluted net    |  | 
| |    | loss per share -                         |  | 
| |    |                                          |  | 
| |    | Weighted average number of shares        |  |  |  
| |    |                                          |  |  |  

|NOTE 19: |  | SEGMENTS
AND GEOGRAPHICAL INFORMATION
|-------- | - | -------------------------------------

| | Commencing
in 2004 and subsequent to the acquisition of Odem and Quasar, the Company managed its
business on three reportable segments, which consisted of Connectivity solutions,
Communication solution and supply of Electronic Components.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys management makes financial decisions and allocates resources, based on the
information it receives from its internal management system. The Company allocates
resources and assesses performance for each operating segment using information about
revenues, gross profit and operating income (loss) before interest and taxes.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Segment
information for prior years was not presented on the new basis of segmentation since it
is impracticable to do so.
| | --------------------------------------------------------------------------------------------------------------------------

| | a. | Revenues,
gross profit and operating profit (loss) for operating segments for           the year
ended 2005 and 2004 were as follow:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------

|                  | Year ended December 31, 2005
|----------------- | ----------------------------
|
|
|
|
|Revenues          |                             
|                  |                             
|Gross profit      |                             
|                  |                             
|Operating profit  |                             
|(loss)            |                             
|                  |                             
|Assets related to |                             
|segment           |                             

F - 44

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 19: |  | SEGMENTS
AND GEOGRAPHICAL INFORMATION (Cont.)
|-------- | - | ---------------------------------------------

|                  | Year ended December 31, 2004
|----------------- | ----------------------------
|
|
|
|
|Revenues          |                             
|                  |                             
|Gross profit      |                             
|                  |                             
|Operating profit  |                             
|(loss)            |                             
|                  |                             
|Assets related to |                             
|segment           |                             

| | * | In
December 2005 the Company has disposed of the Communication Division (see note 1(c)).
| | - | ----------------------------------------------------------------------------------------

| | b. | The
following presents total revenues and long-lived assets for the years ended
          December 31, 2005, 2004 and 2003 based on the customers location:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------

|                  | Year ended December 31,
|----------------- | -----------------------
|
|
|
|
|United States     |                        
|Far East          |                        
|Europe            |                        
|Israel and others |                        
|                  |                        
|                  |                        
|                  |                        
|                  |                        

| | Total
revenues are attributed to geographic areas based on the location of customers in
accordance with Statement of Financial Accounting No. 131, Disclosures about
Segments of an Enterprise and Related Information (SFAS 131).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | *) | Long-lived
assets comprise goodwill intangible assets, property and equipment.
| | -- | ------------------------------------------------------------------------------

| | **) | Reclassified.
| | --- | -------------

| | c. | Major
customers data as a percentage of total revenues:
| | -- | --------------------------------------------------------

|           | Year ended December 31,
|---------- | -----------------------
|
|
|
|
|Customer A |                        
|           |                        
|           |                        
|Customer B |                        
|           |                        

| | Major
customers debt balances as of December 31, 2005 and 2004 are $ 1,433 and $ 603,
respectively.
| | ----------------------------------------------------------------------------------------------------

F - 45

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 20: |  | RELATED
PARTIES
|-------- | - | ---------------

| | a. | M&A
Addendum to the Services Agreement of Cukierman & Co.
| | -- | ---------------------------------------------------------

| | In
2003, the Companys audit committee and Board of Directors approved the engagement
of Cukierman & Co. Investment House Ltd., to provide non-exclusive investment-banking
services and business development services to the Company, effective April 15, 2003.
Cukierman & Co. is a company indirectly controlled by Mr. Edouard Cukierman. Since
June 26, 2003, serves as Chairman of the Companys Board of Directors, and he is
also a co-manager of the Catalyst Fund, the Companys largest shareholder. For its
services, Cukierman & Co. is paid a monthly sum of $10,000 plus VAT, in addition to a
success fee of 4-6% for a consummated private placement. According to its terms the
Company may terminate the agreement at any time, by giving one month prior written
notice. The agreement provided that the success fees for securing M&A transactions
shall be discussed and drafted as an Addendum to the Services Agreement. Such an Addendum
was approved on August 22, 2004, and it provides for a success fee of 3.5% of the
proceeds exchanged in such a transaction.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
payments the Company paid according to the Service Agreement are:
| | ---------------------------------------------------------------------

|                                                        | December 31,
|------------------------------------------------------- | ------------
|
|
|
|
|Business development                                    |             
|Success fee in respect of issuance of convertible loan, |             
|investment in Odem and private placements               |             
|                                                        |             
|                                                        |             
|                                                        |             
|                                                        |             

| | Current
liabilities in respect of related parties as of December 31, 2005 and 2004 were $ 23
and $ 234, respectively.
| | ---------------------------------------------------------------------------------------------------------------------

| | b. | Assignment
of Voting Rights to Mr. Yair Shamir
| | -- | ----------------------------------------------

| | On
February 5, 2004 the Audit Committee and Board of Directors approved an Assignment and
Assumption Agreement, between the Company, Catalyst Investments L.P, and Mr. Yair Shamir
(who was at the time director of the Company and the Chairman of Catalyst Investments),
according to which the voting rights in all but one of the Surf shares that the Company
has an option to purchase from Catalyst (see Note 6), have been assigned to Yair Shamir.
Pursuant to the agreement, Yair Shamir irrevocably undertook to assign the voting rights
to the Company immediately upon the earlier to occur of the following, and subject to the
receipt of a written request from the Company to effect such assignment: a) at the time
Surfs shares are offered to the public in a public offering pursuant to a
registration statement filed by Surf under the Securities Act of 1933 or a similar act of
another jurisdiction, or b) the Company exercises its option to purchase the additional
shares from Catalyst. In January 2006, the option to purchase from Catalyst shares in
Surf has expired.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 46

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 21: |  | SUBSEQUENT
EVENT (UNAUDITED)
|-------- | - | ----------------------------

| | On
May 10, 2006 the Company received a written demand from IDEAL Software GmbH (IDEAL),
a German corporation, in which it claims that the Company owes IDEAL 1.13 million EUR for
license fees including interest. In 1999, the Company and IDEAL entered into a license
agreement according to which the Company was granted the right to distribute IDEALs
print engine embedded into the Companys PrintBOS product, and was to buy IDEALs
license for each installation for an agreed upon price. IDEAL claims that the number of
installations performed by the Company in its PrintBOS product during the period of 1999
thru 2005, exceeded the licenses bought by the Company. The parties agreed that Company
will cooperate with an Auditor appointed by IDEAL to check the number of licenses
distributed by the Company. Based upon the Auditors report rendered on May 1, 2006,
IDEAL sent the above-mentioned demand letter. The Company rejects IDEALs demand,
inter alia due to the fact that it is based on erroneous findings contained in the Auditors
report. On June 11, 2006 the Company filed with the Haifa District Court in Israel a
claim seeking, among other remedies, a declaratory judgment stating that the Auditors
report is materially flawed and should be disregarded. The Companys German counsel
is of the opinion that a German court, if and when IDEAL files a claim against the
Company in Germany pursuant to its demand, might very well summarily bar such a claim and
transfer the matter to the jurisdiction of an Israeli court or stay such a claim until a
verdict is handed down in the claim filed by the Company with the Haifa District
Court. However, if such a claim is ultimately tried in Germany, then German counsel is of
the opinion that there is a fair probability that the Company will be able to
successfully defend a portion of the claim, the size of which cannot yet be determined.
At this early stage the Company is not yet able to assess the final outcome of this
demand. The financial statements do not include any provision in respect of this claim.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 47

---

---