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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549
   
                                   FORM 10-K/A
    
                      ____________________________________
   
                               AMENDMENT NO. 1
                      ____________________________________
    
[MARK ONE]
   
[X]    AMENDMENT TO ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
       SECURITIES EXCHANGE ACT OF 1934
    
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
                                       OR
[ ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
            FOR THE TRANSITION PERIOD FROM __________ TO __________

                         COMMISSION FILE NUMBER 1-11999
                   _________________________________________
                       ALTERNATIVE LIVING SERVICES, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

          DELAWARE                                        39-1771281
    (STATE OF INCORPORATION)                  (IRS EMPLOYER IDENTIFICATION NO.)
450 N. SUNNYSLOPE ROAD, SUITE 300
         BROOKFIELD, WI                                      53005
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                  (ZIP CODE)


       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (414) 789-9565
                             ______________________

          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:


   TITLE OF EACH CLASS                      NAME OF EXCHANGE ON WHICH REGISTERED
COMMON STOCK, PAR VALUE $.01                       AMERICAN STOCK EXCHANGE



          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                                      NONE
                                (TITLE OF CLASS)

     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 _____

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

     The aggregate market value of the voting stock held by non-affiliates of
the Registrant is $156,741,747 as of March 24, 1997.  The number of outstanding
shares of the Registrant's Common Stock is 12,996,496 shares as of March 24,
1997.
                         _____________________________



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<PAGE>   2
       
                           EXPLANATORY NOTE

        This Report on Form 10-K/A amends and restates in their entirety the
following Items of the Annual Report on Form 10-K of Alternative Living
Services, Inc. (the "Company") for the fiscal year ended December 31, 1996 (the
"1996 Form 10-K").

        Item 2 of the 1996 Form 10-K has been amended to correct the Date
Opened information relating to several of the Company's residences, and Item 8
of the 1996 Form 10-K has been amended to correct the transposition of certain
amounts between the 1995 and 1994 columns in the Company's Consolidated
Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994.
    

ITEM 2. PROPERTIES

     The table below sets forth certain information with respect to the
Company's residences which are operated by the Company as of December 31, 1996.
The Company owns, leases, holds equity interest in or manages, on behalf of
third parties, these residences.


<TABLE>
<CAPTION>
                                                   OWNERSHIP    RESIDENT    DATE
RESIDENCE MODEL  LOCATION          CARE LEVEL     (% OWNED)(1)  CAPACITY  OPENED(2)
---------------  ----------------  -------------  ------------  --------  ---------
OWNED/LEASED
WISCONSIN
<S>              <C>               <C>            <C>           <C>       <C>
Clare Bridge     Brookfield        Dementia Care   Leased             24     Nov-91
Clare Bridge     Middleton         Dementia Care   Owned              24     Mar-91
Wynwood          Madison           Frail Elderly   Leased             54     Feb-92
Wynwood          Brookfield        Frail Elderly   Leased             61     Mar-94
WovenHearts      Baraboo           Frail Elderly   Owned              20     Sep-96
WovenHearts      Brown Deer        Frail Elderly   Leased             15     Apr-95
WovenHearts(3)   Cambridge         Frail Elderly   Owned(50.0)        15     Jan-96
WovenHearts      Clintonville      Frail Elderly   Owned              18     Nov-94
WovenHearts      Edgerton          Frail Elderly   Owned              16     Aug-88
WovenHearts      Fond du Lac       Frail Elderly   Owned              19     Sep-96
WovenHearts      Janesville        Dementia Care   Owned              16     Mar-92
WovenHearts(3)   Janesville        Frail Elderly   Owned(50.0)        20     Nov-96
WovenHearts      Jefferson         Frail Elderly   Owned              16     Oct-95
WovenHearts      Jefferson         Dementia Care   Leased             16     May-91
WovenHearts      Kaukauna          Frail Elderly   Owned              16     Jul-95
WovenHearts      Manitowoc         Frail Elderly   Owned              20     Dec-95
WovenHearts      Medford           Frail Elderly   Owned              19     Jun-90
WovenHearts      Menomonie         Frail Elderly   Owned(19.0)        19     Mar-95
WovenHearts      Neenah            Frail Elderly   Owned              20     Apr-96
WovenHearts      New London        Frail Elderly   Owned              18     Jul-95
WovenHearts      New Richmond      Frail Elderly   Owned(19.0)        15     Mar-95
WovenHearts      Onalaska          Frail Elderly   Leased             19     Jun-95
WovenHearts      Oshkosh           Frail Elderly   Owned              20     Aug-96
WovenHearts      Platteville       Frail Elderly   Owned(72.7)        20     Nov-95
WovenHearts      Plover            Frail Elderly   Owned              37     Jun-92
WovenHearts      Plymouth          Frail Elderly   Owned(19.0)        15     Jun-94
WovenHearts      Rice Lake         Frail Elderly   Owned              19     Oct-95
WovenHearts      River Falls       Frail Elderly   Owned              20     Dec-96
WovenHearts      Shawano           Frail Elderly   Owned              15     Oct-93
WovenHearts      Sun Prairie       Frail Elderly   Owned              20     May-94
WovenHearts      Sussex            Frail Elderly   Leased             20     Aug-95
WovenHearts      Wausau            Frail Elderly   Owned              40     Jun-92
WovenHearts(3)   Whitewater        Frail Elderly   Owned(50.0)        20     Nov-96
WovenHearts      Wisconsin Rapids  Frail Elderly   Owned              20     Dec-95
WovenHearts      Wisconsin Rapids  Frail Elderly   Owned(19.0)        19     May-95
                                                                --------
                                                                     765 
                                                                --------
    
</TABLE>
                                                                             




                                      8
<PAGE>   3
<TABLE>
<CAPTION>


                                        OWNERSHIP          RESIDENT         DATE
  RESIDENCE MODEL  LOCATION             CARE LEVEL         (% OWNED)(1)  CAPACITY    OPENED(2)
  ---------------  --------             -------------      ------------  --------    ---------
  OWNED/LEASED
  (CONTINUED)
  <S>              <C>                  <C>                <C>           <C>         <C>
  MINNESOTA
  WovenHearts      Austin               Frail Elderly      Owned               20     Dec-96
  WovenHearts      Mankato              Frail Elderly      Owned               20     Oct-96
  WovenHearts      Owatonna             Frail Elderly      Owned               20     Dec-96
                                                                         --------
                                                                               60
                                                                         --------                    
  OREGON
  Crossings        Albany               Support Services   Leased              74     Aug-90
  Crossings        Albany               Support Services   Leased              63     Jun-89
  Crossings        Forest Grove         Support Services/
                                        Frail Elderly      Leased              88     Sep-90
  Crossings        McMinnville          Support Services/
                                        Frail Elderly      Leased              87     May-91
  Crossings        Tualatin             Fruit Elderly      Leased             112     Feb-89
  Crossings        Gresham              Frail Elderly      Leased              78     Jan-90
  Crossings        Medford              Frail Elderly      Leased              76     Jan-91
                                                                         --------      
                                                                              578
                                                                         -------- 
  MICHIGAN
  Clare Bridge     Ann Arbor            Dementia Care      Leased              36     Jun-95
  Clare Bridge     Farmington Hills     Dementia Care      Leased              28     Jul-94
  Clare Bridge     Farmington Hills II  Dementia Cue       Leased              32     Oct-95
  Clare Bridge     Lansing              Dementia Cue       Leased              36     Jan-96
  Clare Bridge     Utica                Dementia Care      Leased              36     Jan-95
  Wynwood          Northville           Frail Elderly      Owned(76%)          72     Oct-96
  Wynwood          Utica                Frail Elderly      Owned(76%)          72     Dec-96
                                                                         --------     
                                                                              312 
                                                                         --------
  COLORADO
  Crossings        Aurora               Support Services   Leased             159     Apr-91
  Crossings        Aurora               Frail Elderly      Leased              60     Apr-91
  Crossings        Boulder              Support Services   Leased              82     Aug-88
  Crossings        Boulder              Frail Elderly      Leased              76     Jun-94
                                                                         --------
                                                                              377 
  FLORIDA                                                                --------
  Clare Bridge     Bradenton            Dementia Care      Leased              36     Oct-95
  Clare Bridge     Ft. Myers            Dementia Care      Leased              38     Dec-96
  Clare Bridge     Sarasota             Dementia Cue       Leased              38     Dec-95
  Wynwood          Sarasota             Frail Elderly      Owned               86     Jun-90
  Clare Bridge     Tampa                Dementia Care      Leased              38     Oct-96
                                                                         --------
                                                                              236 
                                                                         --------
  IDAHO
  Crossings        Boise                Frail Elderly      Leased              80     Jul-92
  Crossings        Boise                Frail Elderly      Leased              78     Nov-96
                                                                         --------
                                                                              158   
                                                                         --------
</TABLE>

                                      9

<PAGE>   4



<TABLE>
<CAPTION>
   
                                                               OWNERSHIP       RESIDENT       DATE
RESIDENCE MODEL      LOCATION              CARE LEVEL          (% OWNED)(1)    CAPACITY       OPENED(2)
---------------      --------              -----------------   ------------    --------       ---------
<S>                  <C>                   <C>                 <C>             <C>            <C>
OWNED/LEASED
(CONTINUED)
WASHINGTON
Crossings            Richland              Support Services/
                                           Frail Elderly           Leased           128          Jul-88
Crossings            Tacoma                Support Services        Leased           119          Jun-87
                                                                               --------
                                                                                    247 
                                                                               --------

NORTH CAROLINA
Wynwood              Chapel Hill           Frail Elderly           Owned(51%)        70          Dec-96
                                                                               -------- 

PENNSYLVANIA
Clare Bridge         Lower Makefield       Dementia Care           Leased            48          Feb-96
Clare Bridge         Montgomery            Dementia Care           Leased            48          Sep-96
Wynwood              Richboro              Frail Elderly/
                                           Dementia                Leased           113          Jun-90
                                                                               --------
                                                                                    209 
                                                                               --------
CALIFORNIA
Crossings (4)        Loma Linda            Support Services/
                                           Frail Elderly           Leased           140          Jun-91
                                                                               -------- 
MANAGED
WISCONSIN
WovenHearts (5)      Lodi                  Frail Elderly          Managed            15              --
Elm Grove House      Elm Grove             Dementia Care          Managed             8              --
Finch House          Greendale             Dementia Cue           Managed             8              --
North Shore House    Fox Point             Dementia Cue           Managed             8              --
Oak Ridge House      Wauwatosa             Dementia Cue           Managed             8              --
Parkway House        Milwaukee             Dementia Cue           Managed             8              --
Ridgefield House     Madison               Dementia Cue           Managed             8              --
                                                                               --------
                                                                                     63
                                                                               --------
   Total                                                                          3,215 
                                                                               ========
</TABLE>
   
(1)  Approximately 75% of the residences identified as being owned by the
     Company are subject to one or more mortgages or deeds of trust that
     typically mature within the next three to 20 years.
    
(2)  The dates in this table represent the dates the residences were
     originally opened by either ALS or an acquired company.
(3)  ALS shares management responsibility with its joint venture partner, 
     Memorial Community Hospital Association, Inc. of Edgerton, Wisconsin.
(4)  This residence is leased under a lease that expires upon the first to
     occur of (i) December 1998 or (ii) the achievement of a 95% occupancy
     rate.
(5)  The Company holds a 2.5% equity interest in, and has a right of first
     refusal to purchase, this residence.

     The Company occupies executive offices located in Brookfield, Wisconsin 
under a lease expiring in January 2000.  The Company also leases office space in
Nokomis, Florida; Chapel Hill, North Carolina; Yardley, Pennsylvania; Tacoma,
Washington; and Madison, Wisconsin.



                                      10
<PAGE>   5
   
    
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


<TABLE>
<CAPTION>
                                                                                              Page
                                                                                              ----
<S>                                                                                           <C>
ALTERNATIVE LIVING SERVICES, INC. AND SUBSIDIARIES:
   Independent Auditors' Report ............................................................  18
   Consolidated Balance Sheets, as of December 31, 1996 and 1995 ...........................  19
   Consolidated Statements of Operations for years ended December 31, 1996, 1995 and 1994 ..  20
   Consolidated Statements of Changes in Stockholders' Equity for years ended December 31,
       1996, 1995 and 1994 .................................................................  21
   Consolidated Statements of Cash Flows for years ended December 31, 1996, 1995 and 1994 ..  22
   Notes to Consolidated Financial Statements ..............................................  23
</TABLE>






                                      17

<PAGE>   6


                         INDEPENDENT AUDITORS' REPORT

The Board of Directors
Alternative Living Services, Inc.:

     We have audited the accompanying consolidated balance sheets of
Alternative Living Services, Inc. and subsidiaries (the Company) as of December
31, 1996 and 1995, and the related consolidated statements of operations,
changes in stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1996.  These consolidated financial
statements are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

     We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated 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 management, as well as evaluating the overall
financial statement presentation.  We believe that our audits provide a
reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
at December 31, 1996 and 1995, and the results of their operations and their
cash flows for each of the years in the three-year period ended December 31,
1996 in conformity with generally accepted accounting principles.




                                 KPMG PEAT MARWICK LLP

Chicago, Illinois
February 21, 1997






                                      18
<PAGE>   7


             ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                           DECEMBER 31, 1996 AND 1995
                                 (IN THOUSANDS)


                                     ASSETS


<TABLE>
<CAPTION>
                                                                1996     1995
                                                                ----     ----
<S>                                                           <C>       <C>      
Current assets:
   Cash and cash equivalents ..............................   $25,796   $2,998
   Resident receivables, net ..............................     1,614       55  
   Other current assets                                         4,989      283
                                                             --------  -------
       Total current assets ...............................    32,399    3,336
                                                             --------  -------
Property, plant and equipment, net ........................    79,816   28,460
Long-term investments .....................................     1,171    1,183
Investments in and advances to unconsolidated affiliates ..     1,649    4,788
Other assets ..............................................    11,501    1,590
                                                             --------  -------
       Total assets .......................................  $126,536  $39,357
                                                             ========  =======  

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
   Current installments of long-term obligations ......         $769     $163
   Short-term notes payable ...........................        8,335       --
   Accounts payable ...................................        1,985      786
   Accrued expenses ...................................        8,130    1,180
                                                            --------  -------
          Total current liabilities ...................       19,219    2,129
Long-term obligations, less current installments ......       28,649   17,101
Other long-term liabilities ...........................          123      174
Deferred gain on sale .................................        6,763       --
Minority interest .....................................        5,888      610
Stockholders' equity :
   Common Stock and additional paid-in capital ........       76,108   21,746
   Accumulated deficit ................................      (10,214)  (2,403)
                                                            --------  -------
          Total stockholders' equity ..................       65,894   19,343
                                                            --------  -------
          Total liabilities and stockholders' equity ..     $126,536  $39,357
                                                            ========  =======
</TABLE>


          See accompanying notes to consolidated financial statements.



                                      19

<PAGE>   8


             ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                  YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)



<TABLE>
<CAPTION>
                                                       1996       1995       1994
                                                     --------  -----------  -------
<S>                                                  <C>       <C>          <C>

Revenue:
   Resident service fees ..........................   $38,634       $9,684   $4,506
   Other ..........................................       965          780      451
                                                     --------  -----------  -------
Operating revenue .................................    39,599       10,464    4,957
                                                     --------  -----------  -------
Operating expenses:
   Residence operations ...........................    25,710        7,207    2,934
   Lease expense ..................................     6,053          889      697
   General and administrative .....................     7,933        2,599    1,458
   Depreciation and amortization ..................     2,994          815      258
   Non-recurring charge ...........................       976           --       --
                                                     --------  -----------  -------
      Total operating expenses ....................    43,666       11,510    5,347
                                                     --------  -----------  -------
Operating loss ....................................    (4,067)      (1,046)    (390)
Other income (expense):
   Interest expense, net ..........................    (3,740)        (813)    (301)
   Gain on sale of land ...........................        --          439       --
   Equity in losses of unconsolidated affiliates ..       (52)        (438)      (1)
   Other expense ..................................       (28)          --       --
   Minority interest in losses of consolidated
    subsidiaries ..................................        76          112       49
                                                     --------  -----------  -------
      Total other expense, net ....................    (3,744)        (700)    (253)
                                                     --------  -----------  -------
      Net loss ....................................  $ (7,811) $    (1,746) $  (643)
                                                     ========  ===========  =======
Net loss per share ................................  $  (0.79) $     (0.30) $ (0.22)
                                                     ========  ===========  =======
Weighted average shares outstanding ...............     9,889        5,863    2,959
                                                     ========  ===========  =======
</TABLE>



          See accompanying notes to consolidated financial statements.





                                      20
<PAGE>   9


              ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

          CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                 YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
                                (IN THOUSANDS)
                                       

<TABLE>
<CAPTION>
                                                            COMMON STOCK
                                                            AND ADDITIONAL                         
                                                            PAID-IN CAPITAL                       STOCK
                                                        ----------------------   ACCUMULATED   SUBSCRIPTION
                                                          SHARES     AMOUNTS       DEFICIT      RECEIVABLE  TOTAL
                                                        ----------------------    --------      ----------  ------
<S>                                                     <C>            <C>        <C>          <C>         <C>
BALANCES AT DECEMBER 31, 1993 ..................          1,813         $2,539    $    (14)      $(2,200)  $   325
Receipt of stock subscription ..................             --             --          --         2,200     2,200
Contributed capital from majority
    stockholder ................................             --          2,678          --            --     2,678
Net loss .......................................             --             --        (643)           --      (643)
                                                         ------        -------    --------       -------   -------
BALANCES AT DECEMBER 31, 1994 ..................          1,813          5,217        (657)           --     4,560
                                                         ------        -------    --------       -------   -------
Net proceeds from private offering .............          4,303         19,029          --            --    19,029
Retirement of stock held by minority
    stockholder ................................           (381)        (2,500)         --            --    (2,500)
Common Stock issued for contributed
    capital ....................................            917             --          --            --        --
Net loss .......................................             --             --      (1,746)           --    (1,746)
                                                         ------        -------    --------       -------   -------
BALANCES AT DECEMBER 31, 1995 ..................          6,652         21,746      (2,403)           --    19,343
                                                         ------        -------    --------       -------   -------
Proceeds from issuance of Common Stock .........          3,873         41,648          --            --    41,648
Shares issued in connection with acquisitions ..          2,483         12,877          --            --    12.877
Purchase and retirement of Common Stock ........            (12)          (163)         --            --      (163)
Net loss .......................................             --             --      (7,811)           --    (7,811)
                                                         ------        -------    --------       -------   -------
BALANCES AT DECEMBER 31, 1996 ..................         12,996        $76,108    $(10,214)      $    --   $65,894
                                                         ======        =======    ========       =======   =======
</TABLE>


          See accompanying notes to consolidated financial statements.






                                      21
<PAGE>   10


              ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                  YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                  1996             1995         1994
                                                                               ----------        --------      -------
<S>                                                                            <C>               <C>           <C>
Cash flows from operating activities:
     Net loss ....................................................             $   (7,811)       $ (1,746)     $  (643)
Adjustments to reconcile net loss to net cash used in operating activities:
     Depreciation and amortization ...............................                  2,994             815          258
     Gain on sale of land ........................................                     --            (439)          --
     Minority interest in losses of consolidated subsidiaries ....                    (76)           (112)         (49)
     (Increase) decrease in net resident receivables .............                 (1,290)             15          (93)
     Increase in other current assets ............................                 (1,742)            (93)        (172)
     Increase (decrease) in accounts payable .....................                   (687)            343           58
     Increase in accrued expenses ................................                  3,452             223          168
                                                                               ----------        --------      -------
Net cash used in operating activities ............................                 (5,160)           (994)        (473)
                                                                               ----------        --------      -------
Cash flows from investing activities:
     Purchase of short-term investments ..........................                     --              --          (50)
     Net proceeds from sale of land ..............................                     --              --          972
     Acquisitions of affiliates and facilities, net of cash ......                 (7,798)           (850)         (67)
     Payments for property, plant and equipment and project
          development costs ......................................                (56,346)        (12,667)      (1,772)
     Investments in and advances to unconsolidated affiliates ....                   (252)         (3,187)      (1,486)
     Increase in long-term investments ...........................                      --             --       (1,183)
     Payments for deferred costs .................................                      --           (208)         (30)
     Changes in other long-term assets and liabilities ...........                   3,836           (102)         116
                                                                                                 --------      -------
Net cash used in investing activities ............................                 (60,560)       (17,225)      (3,289)
                                                                               -----------       --------      -------
Cash flows from financing activities:
     Contributions by minority partner and minority stockholder ..                      --          1,275          745
     Purchase of remaining limited partners ......................                      --             --         (605)
     Payments for financing costs ................................                      --           (221)         (37)
     Repayment of line of credit and short-term note payable .....                  (1,369)        (4,208)          --
     Repayments of long-tem obligations ..........................                 (37,618)        (6,575)      (1,321)
     Proceeds from issuance of long-term obligations .............                  33,863         15,890           --
     Changes in advances from and notes payable to
          unconsolidated affiliates ..............................                      --         (1,834)         217
     Proceeds from sale/leaseback transactions ...................                  51,996             --           --
     Issuance of Common Stock and other capital contributions ....                  41,648         19,029        2,677
     Retirement of stock held by minority stockholder ............                      --             --       (2,500)
     Stock subscription received .................................                      --             --        2,200
                                                                               -----------       --------      -------
Net cash provided by financing activities ........................                  88,520         20,856        3,877
                                                                               -----------       --------      -------
Net increase in cash and cash equivalents ........................                  22,798          2,637          115
Cash and cash equivalents:
     Beginning of period .........................................                   2,998            311          196
                                                                               -----------       --------      -------
     End of period ...............................................             $    25,796       $  2,998      $   311
                                                                               ===========       ========      =======

Supplemental disclosure of cash flow information:
     Cash paid for interest, including amounts capitalized .......             $     4,047       $  1,045      $   142
                                                                               -----------       --------      -------
</TABLE>



          See accompanying notes to consolidated financial statements.



                                      22
<PAGE>   11


             ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 1996 AND 1995


(1) BUSINESS

     Alternative Living Services, Inc. (the Company) was organized in December
1993 and develops, owns, and operates assisted living residences.  As of
December 31, 1996, the Company operated  77 residences totaling 3,215 living
units located in Wisconsin, Michigan, Minnesota, Florida, Pennsylvania, Oregon,
Colorado, California, Washington, Idaho and North Carolina.

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      The significant accounting policies of the Company are as follows:

      (A) Principles of Consolidation

           The consolidated financial statements include the accounts of the
      Company and its majority-owned subsidiaries.  Results of operations of
      the majority-owned  subsidiaries are included from the date of
      acquisition.  All significant intercompany balances and transactions with
      such subsidiaries have been eliminated in the consolidation.

     (B) Cash Equivalents

           The Company considers all highly liquid investments with original
      maturities of three months or less to be cash equivalents for purposes of
      the consolidated statements of cash flows.

     (C) Property, Plant and Equipment

           Property, plant and equipment are stated at cost, net of accumulated
      depreciation.  Plant and equipment under capital leases are stated at the
      present value of minimum lease payments.  Depreciation is computed over
      the estimated lives of the assets using the straight-line method.
      Buildings and improvements are depreciated over 20 to 40 years, and
      furniture, fixtures and equipment are depreciated over seven to twelve
      years.  Maintenance and repairs are expensed as incurred.

      (D) Intangible Assets

           Intangible assets, which are included in other assets, are composed
      of organization costs and  deferred financing costs.  Organization costs
      are amortized on a straight-line basis over five years.  Deferred
      financing costs are amortized on the effective-interest method over the
      term of the related debt.

      (E) Goodwill

           Goodwill represents the cost of acquired net assets in excess of
      their fair market values.  Amortization of goodwill is computed using the
      straight-line method over the expected periods to be benefitted,
      generally forty years.  The Company's management periodically evaluates
      goodwill for impairment based upon expectations of nondiscounted
      operating cash flows in relation to the net capital investment in the
      subsidiary.




                                      23
<PAGE>   12


             ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


     (F) Revenue

           Revenue, which is recorded primarily when services are rendered,
      consists primarily of resident service fees which are reported at net
      realizable amounts.  Other revenue consists primarily of management and
      development fees from unconsolidated  affiliates.  Management fees are
      recognized as earned in accordance with signed management agreements, and
      reported at net realizable amounts.  Development fees are deferred and
      recognized as earned over the life of the development.

     (G) Income Taxes

           Income taxes are accounted for under the asset and liability method.
      Deferred tax assets and liabilities are recognized for the expected
      future tax consequences attributable to temporary differences between the
      financial statement carrying amounts of existing assets and liabilities
      and their respective tax bases.  Deferred tax assets and liabilities are
      measured using enacted tax rates expected to apply to taxable income in
      the years in which those temporary differences are expected to be
      recovered or settled.  The effect on deferred tax assets and liabilities
      of a change in tax rates is recognized in income in the period that
      includes the enactment date.

     (H) Fair Value of Financial Instruments

           The carrying amounts of cash, cash equivalents and short-term
      investments approximate fair value due to the short-term nature of the
      accounts and due to the accounts earning interest at current market
      rates.  The carrying amount of the Company's debt approximates fair value
      due to the interest rates approximating the current rates available to
      the Company for similar borrowing arrangements.

     (I) Use of Estimates

           The financial statements of the Company have been prepared in
      accordance with generally accepted accounting principles.  The
      preparation of the financial statements in conformity with generally
      accepted accounting principles requires management to make estimates and
      assumptions that affect the reported amounts of assets and liabilities
      and disclosure of contingent assets and liabilities at the date of the
      financial statements and the reported amounts of revenue and expenses
      during the reporting period.  Actual results could differ from those
      estimates.

     (J) Net Loss Per Share

           Net loss per share is based upon the weighted average number of the
      Company's common and common equivalent shares outstanding during each
      period.  Common equivalent shares include stock options, which have been
      included using the treasury stock method only when their effect is
      dilutive.

           In connection with the initial public offering (IPO), which became
      effective on August 9, 1996 and pursuant to the requirements of the
      Securities and Exchange Commission, for purposes of net loss per share,
      Common Stock issued and Common Stock options granted at per share amounts
      less than the IPO price per share subsequent to May 1995 have been
      reflected as outstanding for all periods prior to the effective date of
      the IPO.  Accordingly, weighted average shares outstanding was increased
      by 1,146,928 shares for the effect of such Common Stock and stock
      options.




                                      24
<PAGE>   13
             ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


     (K)   Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed
           of

           The Company adopted the provisions of SFAS No. 121, Accounting for
      the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
      Disposed Of, on January 1, 1996.  This Statement requires that long-lived
      assets and certain identifiable intangibles be reviewed for impairment
      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 future net cash flows expected to be generated by the asset.  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 exceed the fair value of the assets.  Assets to be disposed of are
      reported at the lower of the carrying amount or fair value less costs to
      sell.  Adoption of this Statement did not have a material impact on the
      Company's financial position, results of operations, or liquidity.

     (L)   Stock Option Plan

           Prior to January 1, 1996 the Company accounted for its stock option
      plan in accordance with the provisions of Accounting Principles Board
      ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and
      related interpretations.  As such, compensation expense would be recorded
      on the date of grant only if the current market price of the underlying
      stock exceeded the exercise price.  On January 1, 1996, the Company
      adopted SFAS No. 123, Accounting for Stock-Based Compensation, which
      permits entities to recognize as expense over the vesting period the fair
      value of all stock-based awards on the date of grant.  Alternatively,
      SFAS No. 123 also allows entities to continue to apply the provisions of
      APB Opinion No. 25 and provide pro forma net income and pro forma
      earnings per share disclosures for employee stock option grants made in
      1995 and future years as if the fair-value-based- method defined in SFAS
      No. 123 had been applied.  The Company has elected to continue to apply
      the provisions of APB Opinion No. 25 and provide  the pro forma
      disclosure provisions of SFAS No. 123.

(3)   PROPERTY, PLANT AND EQUIPMENT

      A summary of property, plant and equipment at December 31, follows (in
thousands):


<TABLE>
<CAPTION>
                                                     1996     1995
                                                    -------  -------
            <S>                                     <C>      <C>

            Land .................................   $9,919   $4,592
            Land improvements ....................       86      529
            Buildings ............................   54,343   16,563
            Furniture, fixtures and equipment ....    7,204    3,275
            Construction in progress .............   12,744    5,259
                                                    -------  -------
            Total property, plant and equipment ..   84,296   30,218
            Less accumulated depreciation ........    4,480    1,758
                                                    -------  -------
            Property, plant and equipment, net ...  $79,816  $28,460
                                                    =======  =======
</TABLE>


     At December 31, 1996, property and equipment includes $10,608,402 of
buildings and improvements and $592,000 of fixtures and equipment held under
capital leases and related financing obligations.  Related accumulated
amortization totaled $2,077,929.

     Interest is capitalized in connection with the construction of residences
and is amortized over the estimated useful lives of the residences.  Interest
capitalized in 1996 and 1995 was approximately $490,718 and $62,000,
respectively.


                                      25


<PAGE>   14
              ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


     Construction in process at December 31, 1996 consisted principally of
costs related to the construction of  assisted living residences, with
outstanding construction commitments totaling approximately $72.8 million.

(4) ACQUISITIONS

     On March 31, 1995, the Company acquired the Palmer Ranch, an 86-unit
assisted living residence in Sarasota, Florida.  The total purchase cost of
$850,000, including acquisition costs of $52,000, was paid in cash.  This
transaction was accounted for as a purchase.

     On January 26, 1996, the Company acquired Heartland Retirement Services,
Inc. (Heartland) for $5,500,000 cash plus 261,424 shares of the Company's
Common Stock with an estimated market value of $1,749,000.   The acquisition
was effective as of January 1, 1996.  This acquisition was financed by a bridge
loan of approximately $8,700,000 which was obtained from a private financial
management firm whose president is a director of the Company.  As of January 1,
1996, Heartland operated 20 assisted living residences.  This transaction was
accounted for as a purchase.

     On May 24, 1996, the Company acquired New Crossings International
Corporation, a company which operated 15 assisted living facilities as of May,
1996.  The total purchase consideration was 2,007,049 shares of the Company's
Common Stock with an estimated value of $9,281,000.   This transaction was
accounted for as a purchase.

     On May 24, 1996, the Company acquired the limited partnership interest in
five Michigan limited partnerships owned by unrelated investors for aggregate
consideration of 115,024 shares of  Common Stock valued at $1,000,000 for
accounting purposes and promissory notes in the aggregate principal amount of
$2,900,000.  These promissory notes are due and payable on January 31, 1997 and
bear interest at the rate of 8% per annum.    The Company also acquired 100% of
the outstanding stock of ALS-Midwest pursuant to a merger transaction whereby
the shareholders of ALS-Midwest, other than the Company, received, in exchange
for their shares of ALS-Midwest, $300,000 in cash and 57,512 shares of the
Company's  Common Stock valued at $500,000 for accounting purposes.
Contemporaneously with the merger, the Company refunded certain advances made
to the partnership by a cash payment of $700,000 and delivery of a promissory
note in the amount of $1.4 million which was paid in 1996.

     On August 9, 1996, the Company acquired the 40% partnership interests not
already owned by it in three partnerships for an aggregate purchase price of
$3.2 million.  This transaction has been accounted for as a purchase.

     On August 13, 1996, the Company acquired a residence it leased for $1.1
million.  This transaction was accounted for as a purchase.

     On September 13, 1996, the Company acquired a residence it managed and had
a 0.5% equity interest in for $800,000. This transaction has been accounted for
as a purchase.

     On September 30, 1996, the Company acquired a residence it managed and had
a 2.5% equity interest in for $1.1 million.  This transaction has been
accounted for as a purchase.

     On December 19, 1996, the Company acquired  6 assisted living residences
for $5.5 million.  This transaction has been accounted for as a purchase.

     As of December 31, 1996, the Company had an 80% ownership interest in four
development  projects and a 51% ownership interest in ten development projects.
The 20% and 49% interests in these consolidated affiliates not held by the
Company and the losses therefrom have been reflected as minority interest in
the consolidated balance sheets and as minority interest in losses of
consolidated subsidiaries in the consolidated statements of operations.



                                      26
<PAGE>   15


             ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


(5) LONG-TERM INVESTMENTS

    Long-term investments are comprised of the following at December 31 (in
    thousands):


<TABLE>
<CAPTION>
                                                                1996    1995
                                                               ------  ------
   <S>                                                         <C>     <C>
   Collateral reserve fund, $1,000,000 certificate of deposit
   required to be maintained until July 10, 2000 ............  $1,005  $1,016
   Debt reserve fund, $112,000 certificate of deposit
   required to be maintained until July 10, 2000 ............     113     114
   Debt reserve fund, $53,000 certificate of deposit
   required to be maintained until August 15, 2002 ..........      53      53
                                                               ------  ------
   Total long-term investments ..............................  $1,171  $1,183
                                                               ======  ======
</TABLE>


(6) INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED AFFILIATES

    Investments in and advances to unconsolidated affiliates consist of the
    following at December 31, 1995 (in thousands):


<TABLE>
      <S>                                                  <C>     <C>
                                                             1996    1995
                                                           ------  ------
      Investments in unconsolidated affiliates ..........    $285  $1,581
      Advances to unconsolidated affiliates:
         Partnerships ...................................   1,089   2,540
         Notes receivable ...............................     275     383
         Other ..........................................      --     284
                                                           ------  ------
      Total advances to unconsolidated affiliates .......   1,364   3,207
                                                           ------  ------
      Total investments in and advances to unconsolidated
         affiliates .....................................  $1,649  $4,788
                                                           ======  ======
</TABLE>



     Advances to unconsolidated affiliates also includes management fees
pursuant to an agreement with an affiliate, which is 50% owned and controlled
by an officer and a shareholder.  Under the terms of the agreement, this
affiliate is obligated to pay a monthly management fee of 11% of
gross operating revenue.  During 1996 and 1995, the management fees, included
in other revenue, were $175,000 and $252,000 respectively.

     Notes receivable at December 31, 1996 includes $200,000 due from an
officer and a shareholder of the Company which accrues interest at 6% and is
payable in full on December 30, 1999.  Notes receivable at December 31, 1995
included $150,000 due from an officer and a shareholder of the Company, which
was repaid on December 31, 1996.



                                      27
<PAGE>   16


     ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

(7) OTHER ASSETS

     Other assets are comprised of the following at December 31 (in thousands):


<TABLE>
<CAPTION>
            <S>                                                                      <C>      <C>   
                                                                                        1996    1995
                                                                                        ----    ----
            Goodwill, net ....................................................        $5,216    $955
            Organizational and other costs, net ..............................         1,982      89
            Deferred financing costs, net ....................................           948     273
            Deposits and other ...............................................         3,355     273
                                                                                     -------  ------
            Total other assets ...............................................       $11,501  $1,590
                                                                                     =======  ======
</TABLE>


      Accumulated amortization of goodwill was $163,134 and $800 as of December
      31, 1996 and 1995, respectively.

(8) LONG-TERM DEBT, CAPITAL LEASE AND FINANCING OBLIGATIONS

     Long-term debt, capital leases, and financing obligations consist of the
following at December 31 (in thousands):



<TABLE>
<CAPTION>                 

<S>                                                                                     <C>    <C>     
                                                                                        1996    1995  
Mortgage payable, due in 25 quarterly installments, the first                           ----    ----  
four quarterly installments represent interest only, interest at                                       
8% through June 30, 1996, thereafter interest at the prime rate                                        
plus 1% not to exceed 10% (9.25% at December 31, 1996),                                                
outstanding principal balance due on March 31, 2000.................                     $998  $1,000  
                                                                                  
Mortgage payable, due in 25 quarterly installments, the first                                          
four quarterly installments represent interest only, interest at                         
8% through June 30, 1996, thereafter interest at the prime rate                                        
plus 1% not  to exceed 10% (9.25% at December 31, 1996),                                               
outstanding principal balance due on April 2, 2000..................                      391     400  
                                                                                                       
Mortgage payable, due in 60 monthly installments including                                
interest at 9.21%, outstanding principal balance
due on July 10, 2000................................................                    4,234   4,279
                                                                                                       
Mortgage payable, due in 83 monthly installments including interest                       
at 9.985%, outstanding principal balance due on August 15, 2002.....                    1,875   1,914 
                                                                                                       
Mortgages payable, due in 300 monthly installments including                              
interest at 9.75%...................................................                    2,945      -- 
                                                                                                       
Mortgage payable, interest at the prime rate plus 1% (9.25%                               
at December 31, 1996) 36 interest only payments                                                        
with all remaining interest and principal due on                                                       
April 1, 1999.......................................................                    3,355      --

</TABLE>
                                                                
                                                                



                                      28
<PAGE>   17

ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES


            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


<TABLE>
<CAPTION>

<S>                                                                             <C>                  <C>  
Mortgage payable, interest at the prime rate plus 1% (9.25%                                               
at December 31, 1996) 36 interest only payments                                                           
with all remaining interest and principal due on                                                          
April 1, 1999 ......................................................              2,636                 --
                                                                                                          
Mortgage payable, due December 10, 2000, the first 13 of 60                                               
total payments represent interest only, interest at LIBOR                                                 
plus applicable LIBOR margin based on debt service coverage                                               
ratio ..............................................................              2,137                 --
                                                                                                          
Sale/leaseback financing obligation, variable interest                                                    
at the 11th District FHLB rate plus 2 3/4% payable in                                                     
monthly installments, due 2000 .....................................              5,316                 --
                                                                                                          
Capital lease obligations, interest at rates between 3.4%                                                 
and 23% payable in monthly installments, due                                                              
through 2000 .......................................................                114                 --

Mortgage payable, due in 120 monthly installments including interest                                      
at 8.46% through June 30, 2000, thereafter at the five-year                                               
U.S. Treasury rate plus 2.5% .......................................                 --              6,567
                                                                                                          
Note payable, due November 20, 2020, first twelve monthly payments                                        
represent interest only, interest at the prime rate plus 1% ........                 --              3,104
                                                                                                          
Debt refinanced long-term through a sale/leaseback                                                        
financing transaction:                                                                                    
    Mortgage notes payable, fixed interest rates                                                          
         of 8% to 10.9% ............................................              3,290                 --
    Equity participation notes, including contingent                                                      
         participation obligations .................................              2,127                   
                                                                                -------            -------
                                                                                                          
Total long-term obligations ........................................             29,418             17,264
Less current installments ..........................................                769                163
                                                                                -------            -------
Total long-term obligations less current installments ..............            $28,649            $17,101
                                                                                =======            =======
</TABLE>


     The mortgages payable are secured by security agreements and guarantees by
the Company.  In addition, certain security agreements require the Company to
maintain collateral and debt reserve funds (see Notes 5 and 13).

     Principal payments on long-term debt, capital leases and financing
obligations for the next five years and thereafter are as follows  (in
thousands):


<TABLE>
    <S>                                                                               <C>      
    1997 .....................................................................          $   769
    1998 .....................................................................              802
    1999 .....................................................................           12,150
    2000 .....................................................................           13,917
    2001 .....................................................................               30
    Thereafter ...............................................................            1,750
                                                                                        -------
    Total long-term debt, capital leases and financing obligations ...........          $29,418
                                                                                        =======                                   
</TABLE>



                                      29
<PAGE>   18

             ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


(9) ACCRUED EXPENSES

    Accrued expenses are comprised of the following at December 31  (in
    thousands):


<TABLE>
<CAPTION>
                                                 1996    1995
                                                ------  ------
    <S>                                         <C>     <C>
    Accrued salaries and wages ...........      $2,071  $  332
    Advance rents and deposits ...........       2,754     546
    Other ................................       3,305     302
                                                ------  ------
    Total accrued expenses ...............      $8,130  $1,180
                                                ======  ======
</TABLE>


(10) STOCKHOLDERS' EQUITY

     The Company was organized in December 1993, and was initially capitalized
by Evergreen Healthcare, Inc. ("Evergreen") and Care Living Centers, Inc.
("CLC"), two unrelated companies.

     The Company completed a private placement equity offering on May 26, 1995,
resulting in net proceeds of $19,029,080 for 4,302,994 shares of its Common
Stock.  Simultaneously, the Company issued 917,150 shares of its stock to
Evergreen as consideration for $2,677,342 cash received during 1994, which is
reflected as Common Stock and additional paid-in capital in the accompanying
balance sheet.  Subsequent to the issuance of stock in May 1995 the Company was
no longer a majority-owned subsidiary of Evergreen.

     In August 1996, the Company completed an initial public offering of
6,000,000 shares of Common Stock, of which 3,443,206  shares were sold by the
Company and 2,556,794 shares were sold by existing stockholders.  After
deducting underwriting discounts, commissions and offering expenses, the net
proceeds to the Company were approximately $40 million.

     The authorized capital stock of the Company consists of 30,000,000 shares
of Common Stock, $.01 par value, and 5,000,000 shares of $.01 par value
preferred stock. At December 31, 1996, there were 13,008,135 shares of Common
Stock issued, of which 12,996,496 were outstanding. 11,639 are held in
treasury.  At December 31, 1995 there were 6,652,059 shares of Common Stock
issued and outstanding.  At December 31, 1996 and 1995 no shares of preferred
stock were issued and outstanding.

(11) STOCK OPTION PLAN

     In 1995, the Company adopted a stock option plan (the "1995 Plan")
pursuant to which the Company's Board of Directors may grant stock options to
officers and key employees.  The Plan authorizes grants of options to purchase
up to 1,425,000  shares of  authorized but unissued Common Stock.  Stock
options are granted with an exercise price equal to the stock's fair market
value at the date of grant.  Generally,  stock options have 10-year terms and
vest 25% per year and become fully exercisable after 4 years from the date of
grant.

     At December 31, 1996, 786,821 additional shares were available for grant
under the 1995 Plan.  The per share weighted-average fair value of stock
options granted during 1996 and 1995 was $3.49 on the date of grant using the
Black Scholes option-pricing model with the following weighted-average
assumptions: 1996 - expected dividend yield 0.0%, risk-free interest rate of
6.5% and an expected life of 7 years; 1995 - expected dividend yield 0.0%,
risk-free interest rate of 6.5%, and an expected life of 7 years.


                                      30



<PAGE>   19


              ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

     The Company applies APB Opinion No. 25 in accounting for its 1995 Plan
and, accordingly, no compensation cost has been recognized for its stock
options in the financial statements.  Had the Company determined compensation
cost based on the fair value at the grant date for its stock options under SFAS
No. 123, the Company's net loss and net loss per share would have been
increased to the pro forma amounts indicated below, (in thousands, except per
share data):


<TABLE>
<CAPTION>
                                         Net Loss                       Net Loss Per Share
                                    1996            1995               1996             1995
                                   -------         -------            ------            ------   
     <S>                           <C>             <C>                <C>               <C>
     As reported                   $(7,811)        $(1,746)           $(0.79)           $(0.30)
     Pro forma                     $(8,406)        $(1,922)           $(0.85)           $(0.33)

</TABLE>

     Stock option activity during the periods indicated is as follows:

<TABLE>
<CAPTION>
                                                                     Number of  Weighted-Average
                                                                     Shares     Exercise Price
                                                                     ---------  ----------------
     <S>                                                              <C>                <C>
     Balance at December 31, 1994                                          --                --
         Granted                                                      430,883            $ 4.67
         Exercised                                                         --                --
         Forfeited                                                         --                --
         Expired                                                           --                --
                                                                      -------            ------

     Balance at December 31, 1995                                     430,883              4.67
         Granted                                                      279,799              9.21
         Exercised                                                         --             (7.22)
         Forfeited                                                     (2,175)            (4.65)
         Expired                                                           --               --
                                                                      -------            ------
     Balance at December 31, 1996                                     708,507            $ 6.31
                                                                      =======            ======
</TABLE>


     At December 31, 1996, the range of exercise prices and weighted-average
remaining contractual life of outstanding options was $2.92 - $13.00 and 8
years, respectively.

     At December 31, 1996 and 1995, the number of options exercisable was
145,922 and 103,483, respectively, and the  weighted-average exercise price of
those options was $4.22 and $5.92, respectively.





                                      31
<PAGE>   20



              ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

(12) INCOME TAXES

     Deferred tax assets and liabilities consist of the following at December
     31 (in thousands):


<TABLE>
<CAPTION>
                                                            1996   1995
                                                           ------  -----
       <S>                                                 <C>     <C>
       Deferred tax assets:
         Net operating loss carryforwards ...............  $1,928  $ 800
         Investment in unconsolidated affiliates ........     104    105
         Deferred gain sale/leaseback ...................   2,887     --
         Vacation accrual ...............................     198     --
         Tax versus book depreciation ...................     107     --
         Other accruals - Crossings' purchase ...........     270     --
         Investment in consolidated affiliates ..........   1,566     --
         AMT credit carryover ...........................      31
         Other ..........................................     184    104
                                                           ------  -----
       Total deferred tax assets ........................   7,275  1,009
       Less valuation allowance .........................   5,539    917
                                                           ------  -----
       Deferred tax assets, net of valuation allowance ..  $1,736  $  92
                                                           ======  =====
       Deferred tax liabilities:
         Tax versus book depreciation ...................      --     92
         Book versus tax basis (Crossings' purchase) ....   1,736     --
                                                           ------  -----
       Tax deferred tax liabilities .....................  $1,736  $  92
                                                           ======  =====
</TABLE>


     The valuation allowance for deferred tax assets as of January 1, 1996 and
1995 was  $5,538,500  and  $917,500, respectively.   In assessing the
realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be
realized.  The  ultimate realization of deferred tax assets is dependent upon
the generation of future taxable income during the periods in which those
temporary differences become deductible.  Management considers the scheduled
reversal of deferred tax liabilities, projected future taxable income, and tax
planning strategies in making this assessment.  As a result of acquisitions
during 1996, subsequent recognition of $537,000 of tax benefits relating to the
valuation allowance for deferred tax assets will be allocated to goodwill.

     The Company has approximately $4,881,000 of net operating loss
carryforwards at December 31, 1996.  Unused net operating loss carryforwards of
approximately $3,222,650 will expire commencing in the year 2001 through 2009.
The remaining $1,658,350 of net operating loss carryforwards will begin to
expire, if unused, beginning in the year 2008 through 2010.  The utilization of
net operating loss carryforwards may be further limited as to future use due to
the change in control provisions in the Internal Revenue Code which apply
because of the Crossings purchase in May 1996.  In addition, the Company has
alternative minimum tax credit carryforwards of approximately $31,000 which are
available to reduce future federal regular income taxes, if any, over an
indefinite period.

(13) COMMITMENTS AND CONTINGENCIES

     The Company leases certain properties under noncancelable operating and
capital leases that expire at various dates through the year 2014.



<PAGE>   21


             ALTERNATIVE LIVING SERVICES, INC.  AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

<TABLE>
<CAPTION>

     Future annual minimum operating lease payments and future minimum capital
lease payments as of  December 31, 1996 are as follows (in thousands):

                                                           Capital Operating  
   <S>                                                     <C>      <C>
   1997 .................................................  $ 1,359  $ 12,857
   1998 .................................................    1,341    12,924
   1999 .................................................    6,118    12,979
   2000 .................................................    4,922    13,051
   2001 .................................................       --    12,892
   Thereafter ...........................................       --   129,275
                                                           -------  --------
   Total minimum lease payments .........................   13,740  $193,978
   Less amount representing interest ....................    2,894  ========
                                                           -------
   Present value of net minimum capital lease payments ..   10,846
   Less current portion .................................      345
                                                           -------
   Long-term capital lease obligations ..................  $10,501
                                                           =======
</TABLE>


(14) SALE/LEASEBACK TRANSACTIONS

     On January 22, 1996, the Company sold two assisted living residences for
approximately $7,022,000 and leased them back under a ten-year sale and
leaseback agreement.  The transaction produced a gain of approximately
$1,083,000, which was deferred and is being amortized over the lease period.

     On December 31, 1996, the Company sold twelve assisted living residences
for approximately $45.0 million and leased them back under a twelve-year sale
and leaseback agreement.  The transaction produced a gain of approximately $5.7
million which will be deferred and amortized over the lease period.

(15) SUBSEQUENT EVENTS

     On February 12, 1997, the Company entered into an agreement to acquire
interests in three recently constructed assisted living residences in upstate
New York with an aggregate capacity of 313 residents.  The acquisition will
represent an investment by the Company of approximately $21.5 million (cash and
assumed debt).





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                                  Signature


     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amendment to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Brookfield, State of Wisconsin, on the 12th day of May, 1997.

                                            ALTERNATIVE LIVING SERVICES, INC.


                                           By:   /s/ THOMAS E. KOMULA   
                                    -----------------------------------------
                                     Senior Vice President, Treasurer, Chief
                                    Financial Officer and Assistant Secretary




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