<PAGE>
 
                                   FORM 10-K
               UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934

     For the quarterly period ended         December 31, 1996
                                    ---------------------------------------

                                       OR

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

     For the transition period from _________________ to ______________________

                        Commission file number 0-17686

            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
            (Exact name of registrant as specified in its charter)


                   WISCONSIN                      39-1606834
           (State or other jurisdiction of      (I.R.S. Employer
          incorporation or organization)        Identification No.)


          101 W. 11th Street, Suite 1110, Kansas City, Missouri 64105
         (Address of principal executive offices, including zip code)

                                (816) 421-7444
             (Registrant's telephone number, including area code)



     Securities registered pursuant to Section 12(b) of the Act:  None
     Securities registered pursuant to Section 12(g) of the Act: Limited
  Partnership Interests

     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 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 securities held by nonaffiliates
of the Registrant:  The aggregate market value of limited partnership interests
held by nonaffiliates is not determinable since there is no public trading
market for the limited partnership interests.

                Index to Exhibits located on page:      36 - 37
                                                   ------------------
<PAGE>
 
                                    PART I
ITEM 1.  BUSINESS

BACKGROUND
----------

The Registrant, DiVall Insured Income Properties 2 Limited Partnership (the
"Partnership"), is a limited partnership organized under the Wisconsin Uniform
Limited Partnership Act pursuant to an Agreement of Limited Partnership dated as
of November 18, 1987, and amended as of November 25, 1987, February 20, 1988,
June 21, 1988, February 8, 1993, May 26, 1993 and June 30, 1994. As of December
31, 1996, the Partnership consisted of one General Partner and 2,724 Limited
Partners owning an aggregate of 46,280.3 Limited Partnership Interests (the
"Interests") acquired at a public offering price of $1,000 per Interest before
volume discounts. The Interests were sold commencing February 23, 1988, pursuant
to a Registration Statement on Form S-11 filed under the Securities Act of 1933
(Registration 33-18794) as amended. On June 30, 1989, the former general
partners exercised their option to extend the offering period to a date no later
than February 22, 1990. On February 22, 1990, the Partnership closed the
offering at 46,280.3 Interests ($46,280,300), providing net proceeds to the
Partnership after volume discounts and offering costs of $39,358,468.

The Partnership is currently engaged in the business of owning and operating its
investment portfolio (the "Properties") of commercial real estate and recovering
the assets misappropriated by the former general partners and their affiliates.
The misappropriation is more fully discussed under Recent Developments. The
Properties are leased on a triple net basis to, and operated by, franchisors or
franchisees of national, regional and local retail chains under long-term
leases. The lessees consist of primarily fast-food, family style, and
casual/theme restaurants, but also include an auto tag agency, a video rental
store and a child care center. At December 31, 1996, the Partnership owned 36
properties with specialty leasehold improvements in 15 of these properties, as
more fully discussed in Item 2.

Prior to the disposal of the Properties, the Partnership's return on its
investment will be derived principally from rental payments received from its
lessees. Therefore, the Partnership's return on its investment is largely
dependent, among other factors, upon the business success of its lessees. The
business success of the Partnership's individual lessees can be adversely
affected on three general levels. First, the tenants rely heavily on the
management contributions of a few key entrepreneurial owners. The business
operations of such entrepreneurial tenants can be adversely affected by death,
disability or divorce of a key owner, or by such owner's poor business decisions
such as an undercapitalized business expansion. Second, changes in a local
market area can adversely affect a lessee's business operation. A local economy
can suffer a downturn with high unemployment. Socioeconomic neighborhood changes
can affect retail demand at specific sites and traffic patterns may change, or
stronger competitors may enter a market. These and other local market factors
can potentially adversely affect the lessees of Partnership properties. Finally,
despite an individual lessee's solid business plans in a strong local market,
the chain concept itself can suffer reversals or changes in management policy
which in turn can affect the profitability of operations for Partnership
properties. Therefore, there can be no assurance that any specific lessee will
have the ability to pay its rent over the entire term of its lease with the
Partnership.

Since over 90% of the Partnership's investment in properties and equipment
involves restaurant tenants, the restaurant market is the major market segment
with a material impact on Partnership operations. It would appear that the
management skill and potential operating efficiencies realized by Partnership
lessees will be a major ingredient for their future operating success in a very
competitive restaurant and food service marketplace.

There is no way to determine, with any certainty, which, if any, tenants will
succeed or fail in their business operations over the term of their respective
leases with the Partnership. It can be reasonably anticipated that some lessees
will default on future lease payments to the Partnership which will result in
the loss of expected lease income for the Partnership. Management will use its
best efforts to vigorously pursue collection of any defaulted amounts and to
protect the Partnership's assets and future rental income potential by trying to
re-lease any properties with rental defaults. External events which could impact
the Partnership's liquidity are 

                                       2
<PAGE>
 
the entrance of other competitors into the market areas of our tenants;
liquidity and working capital needs of the leaseholders; and failure or
withdrawal of any of the national franchises held by the Partnership's tenant.
Each of these events, alone or in combination, would affect the liquidity level
of leaseholders resulting in possible default by the tenant. Since the
information regarding plans for future liquidity and expansion of closely held
organizations, which are tenants of the Partnership, tend to be of a private and
proprietary nature, anticipation of individual liquidity problems is difficult,
and prediction of future events is nearly impossible.

A preliminary investigation during 1992 by the Office of the Commissioner of
Securities for the State of Wisconsin and the Securities and Exchange Commission
(the "Investigation"), revealed that during at least the four years ended
December 31, 1992, two of the former general partners of the Partnership, Gary
J. DiVall ("DiVall") and Paul E. Magnuson ("Magnuson") had transferred
substantial cash assets of the Partnership and two affiliated publicly
registered partnerships, DiVall Insured Income Fund Limited Partnership ("DiVall
1") and DiVall Income Properties 3 Limited Partnership ("DiVall 3")
(collectively the "Partnerships") to various other entities previously sponsored
by or otherwise affiliated with DiVall and Magnuson. The unauthorized transfers
were in violation of the respective Partnership Agreements. The aggregate amount
of the misappropriation, related costs and 9% interest accrued since January 1,
1993, is approximately $14,000,000, net of recoveries, of which $5,641,000 has
been allocated to the Partnership.

Subsequent to discovery, and in response to the regulatory inquiries, a third-
party Permanent Manager, The Provo Group, Inc. ("TPG"), was appointed (effective
February 8, 1993) to assume the responsibility for daily operations and assets
of the Partnerships as well as to develop and execute a plan of restoration to
the Partnerships. As reported in the Partnership's report on Form 8-K dated May
26, 1993, effective as of that date, the Limited Partners, by written consent of
a majority of interests, elected the Permanent Manager, TPG, as General Partner.
Additional results of the solicitation included the approval of the Permanent
Manager Agreement ("PMA"), the acceptance of the resignations of the former
general partners, amendments to certain provisions of the Partnership Agreement
pertaining to general partner interests and compensation, and an amendment of
the Partnership Agreement providing for an Advisory Board (the "Board").

THE PERMANENT MANAGER AGREEMENT
-------------------------------

The PMA was entered into on February 8, 1993, between the Partnership, DiVall 1,
DiVall 3, the now former general partners DiVall and Magnuson, their controlled
affiliates, and TPG, naming TPG as the Permanent Manager. The PMA contains
provisions allowing the Permanent Manager to submit the PMA, the issue of
electing the Permanent Manager as General Partner, and the issue of acceptance
of the resignations of the former general partners to a vote of the Limited
Partners through a solicitation of written consents.

TPG, as the new General Partner, has been operating and managing the affairs of
the Partnership in accordance with the provisions of the PMA and the Partnership
Agreement, as amended.

ADVISORY BOARD
--------------

The concept of the Advisory Board was first introduced by TPG during the
solicitation of written consents for the Partnerships and is the only type of
oversight body known to exist for similar partnerships at this time. The first
Advisory Board was appointed in October 1993, and held its first meeting in
November 1993. The four person Board is empowered to, among other functions,
review operational policies and practices, review extraordinary transactions,
and advise and serve as an audit committee to the Partnership and the General
Partner. The Advisory Board does not have the authority to direct management
decisions or policies of the Partnership or remove the General Partner. The
powers of the Board are advisory only. The Board has full and free access to the
Partnership's books and records, and individual Board members have the right to
communicate directly with the Limited Partners concerning Partnership business.
Members of the Board are compensated $3,000 annually and $1,200 for each
quarterly meeting attended.

The Board currently consists of a broker dealer representative, D. Todd
Witthoeft of Nelson Witthoeft Financial; and a Limited Partner from each of the
three Partnerships: Gerhard Zoller from DiVall 1, Richard Otte from the
Partnership, and Dr. Albert Eschen from DiVall 3. The position of industry
representative was 

                                       3
<PAGE>
 
created for approximately a three (3) year period which ended January 31, 1996.
For a brief description of each Board member, refer to Item 10, Directors and
Executive Officers of the Registrant.

RESTORATION PLAN
----------------

TPG, upon commencement of its management of the Partnerships, developed a
strategy (the "Restoration Plan" or "Plan") for recovering as much of the
amounts misappropriated by the former general partners and their affiliates as
possible. The Plan focuses on recovery from the following sources: (a) personal
property, (b) promissory notes, (c) land contracts, (d) litigation, and (e) PMA
savings.

     A.   Personal Property.  DiVall and Magnuson appear to have very few
          -----------------                                              
          unencumbered personal assets which would materially benefit the
          Partnerships. The Partnerships have obtained security interests in
          substantially all of DiVall and Magnuson's assets which have been
          identified. The security interests included a mortgage on DiVall's
          residence and surrounding farm land which was subsequently sold to a
          third party .

     B.   Promissory Notes.  Pursuant to the PMA, DiVall, Magnuson, and entities
          ----------------                                                      
          owned by them, granted the Partnerships a security interest in certain
          promissory notes and mortgages due from other DiVall related entities
          (the "Private Partnerships"). Recovery of amounts due under these
          notes is substantially complete, but the amount of such recoveries has
          been significantly discounted because many of the Private Partnerships
          are involved in bankruptcy proceedings. See Item 3, Legal Proceedings,
          for additional information regarding the bankruptcy proceedings of the
          Private Partnerships.

     C.   Land Contracts.  The Partnerships were assigned two land contracts
          --------------
          from the Partnership's former general partners. These contracts were
          not originally identified nor assigned in connection with the PMA, and
          settlements have been received on these contracts.

     D.   Litigation.  The Partnerships  initiated lawsuits against the
          ----------                                                   
          Partnership's former auditors, former securities counsel, former
          general partners and a former affiliate. Settlements were received in
          these lawsuits during 1996. Refer to Item 3, Legal Proceedings, and
          Note 11 to the financial statements included in Item 8 below for
          additional information concerning the settlement of these lawsuits.

     E.   PMA Savings.  Pursuant to the terms of the PMA, The Provo Group, Inc.
          -----------
          is to account to the former general partners for all of the following
          which are avoided or reduced by implementation of the PMA: (i) Fees
          payable to the general partner or entities controlled by the general
          partner, (ii) brokerage commissions, and (iii) residuals. Under the
          PMA, all such savings shall be credited against the amount owed the
          Partnership by the former general partners.

Total amounts recovered at December 31, 1996, amounted to $5,161,000, of which
approximately $2,087,000 was allocated to the Partnership. Currently, there are
few potential sources of recovery remaining.

The total amount due the Partnerships from the former general partners and their
affiliates as of December 31, 1996, as a result of the misappropriation of
assets, approximates $14,000,000, net of recoveries, which includes the amount
of the misappropriation discovered to date, related costs, and 9% interest
accrued since January 1, 1993.

                                       4
<PAGE>
 
ITEM 2.  PROPERTIES

The Partnership's properties are leased under long-term leases, generally with
terms of approximately 20 years. All leases are triple net which require the
tenant to pay all property operating costs including maintenance, repairs,
utilities, property taxes, and insurance. A majority of the leases contain
percentage rent provisions which require the tenant to pay a specified
percentage (3% to 8%) of gross sales above a threshold amount.

The Partnership owned the following properties (including specialty leasehold
improvements for use in some of these properties) as of December 31, 1996:

<TABLE>
<CAPTION>
                                                                                                Lease             
Acquisi-   Property Name                                         Purchase       Rental Per      Expiration     Renewal
tion Date  & Address                        Lessee               Price (1)      Annum           Date           Options
---------  ---------                        ------               ---------      -----           ----           -------
<C>        <S>                              <C>                  <C>            <C>             <C>            <C>                  
03/11/88   Hallandale Tag Agency            Hallandale Auto      $  792,188     $   30,000         5/31/00          (3) 
           601 W Hallandale Beach Blvd      Tag Agency, Inc.                                                                        
           Hallandale, FL                                                                                                          
                                                                                                                                   
03/11/88   Miami Subs                       QSR, Inc.               743,625         39,000      03-31-2016        None              
           US-1 Near PGA Blvd                                                                                                      
           Palm Beach, FL                                                                                                          
                                                                                                                                   
05/09/88   Hardee's                         Hardee's Food           802,750         56,000      10-31-2001          (3)
           662 E Wisconsin Ave              Systems, Inc.                                                                          
           Oconomowoc, WI                                                                                                          
                                                                                                                                   
06/15/88   Denny's                          DenAmerica, Inc.      1,087,137(2)     115,200      08-20-2009          (3)
           8801 N 7th St                                                                                                           
           Phoenix, AZ                                                                                                             
                                                                                                                                   
06/15/88   Denny's (4)                      DenAmerica, Inc.        520,126(2)      93,000      01-30-1993          (3) 
           2201 W Camelback                                                                                                        
           Phoenix, AZ                                                                                                             
                                                                                                                                   
07/15/88   Hooter's                         TWI X, Inc.           1,346,719         95,000      07-14-2008        None              
           7669 Grapevine Hwy                                                                                                      
           N Richland Hills, TX                                                                                                    
                                                                                                                                   
07/22/88   Hardee's (5)                     Terratron, Inc.         591,038(2)      55,440      07-31-2007          (3)             
           9400 S 2000 E                                                                                                           
           Sandy, UT                                                                                                               
                                                                                                                                   
08/01/88   Hardee's                         Hardee's Food         1,091,190(2)      64,000      10-31-2001          (3)             
           106 N Chicago Ave                Systems, Inc.                                                                          
           S Milwaukee, WI                                                                                                         
                                                                                                                                   
08/15/88   Denny's                          First Foods, Inc.     1,155,965(2)     129,240      08-30-2009          (3)             
           2360 W Northern Ave                                                                                                     
           Phoenix, AZ                                                                                                             
                                                                                                                                   
08/22/88   Hardee's                         Terratron, Inc.         825,730(2)      77,880      08-31-2008        None              
           9039 S Redwood                                                                                                          
           West Jordan, UT                                                                                                         
                                                                                                                                   
09/09/88   Country Kitchen                  Vacant                  660,156              0               -           -              
           555 33rd Ave                                                                                                            
           Cedar Rapids, IA                                                                                                        
                                                                                                                                   
10/10/88   Kentucky Fried Chicken (5)       KFC National            451,230         60,000      06-30-2018        None 
           1014 S St Francis Dr             Management Co.                                                                         
           Santa Fe, NM                                                                                                            
                                                                                                                                   
12/22/88   Wendy's                          WenSouth Orlando,       596,781         76,920      12-31-2008        None

           1721 Sam Rittenburg Blvd         Ltd.                                                                    
           Charleston, SC                                                                                            
</TABLE> 
                                       5
 
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                                          Lease                 
Acquisi-   Property Name                                  Purchase         Rental Per     Expiration     Renewal          
tion Date  & Address                   Lessee             Price (1)          Annum        Date           Options          
---------  ---------                   ------             ---------          -----        ----           -------           
<C>        <S>                         <C>                <C>              <C>            <C>            <C>      
12/22/88   Wendy's                     WenSouth Orlando,       649,594         86,160     12-31-2008        None          
           3013 Peach Orchard Rd       Ltd.                                                                              
           Augusta, GA                                                                                                   
                                                                                                                         
12/29/88   Popeye's                    Stillman Mgmt.          580,938         77,280     12-31-2009        None          
           2562 Western Ave            Co., Inc.                                                                         
           Park Forest, IL                                                                                               
                                                                                                                         
02/21/89   Wendy's                     WenSouth Orlando,       776,344         96,780     01-31-2009        None          
           1901 Whiskey Rd             Ltd.                                                                              
           Aiken, SC                                                                                                     
                                                                                                                         
02/21/89   Wendy's                     WenSouth Orlando,       728,813         96,780     01-31-2009        None          
           1730 Walton Way             Ltd.                                                                              
           Augusta, GA                                                                                                   
                                                                                                                         
02/21/89   Wendy's                     WenSouth Orlando,       528,125         70,200     01-31-2009        None          
           347 Folly Rd                Ltd.                                                                              
           Charleston, SC                                                                                                
                                                                                                                         
02/21/89   Wendy's                     WenSouth Orlando,       580,938         77,280     01-31-2009        None          
           361 Hwy 17 Bypass           Ltd.                                                                              
           Mount Pleasant, SC                                                                                            
                                                                                                                         
03/14/89   Wendy's                     WenSouth Orlando,       633,750         90,480     01-31-2009        None          
           1004 Richland Ave           Ltd.                                                                              
           Aiken, SC                                                                                                     
                                                                                                                         
04/04/89   Denny's                     Cypress               1,029,844        136,800     11-30-2008        None          
           607 Internatl Speedway      Restaurants, Inc.                                                                 
           Daytona Beach, FL                                                                                             
                                                                                                                         
04/20/89   Hostetlers, BBQ             Hickory Park, Inc.      897,813(2)      55,584     12-31-1997          (3)        
           4875 Merle Hay                                                                                                
           Des Moines, IA                                                                                                
                                                                                                                         
04/28/89   Hardee's                    Hardee's Food           686,563         64,000     04-30-2009        None          
           1570 E Sumner St            Systems, Inc.                                                                     
           Hartford, WI                                                                                                  
                                                                                                                         
05/05/89   Hardee's                    Vacant                  940,063(2)           0              -           -         
           1265 E Geneva St                                                                                              
           Delavan, WI                                                                                                   
                                                                                                                         
10/18/89   Hardee's                    Hardee's Food         1,421,983(2)      76,000     04-30-2009        None          
           4000 S 27th St              Systems, Inc.                                                                     
           Milwaukee, WI                                                                                                 
                                                                                                                         
12/28/89   Village Inn                 Columbia VI,            845,000(2)      84,000     11-30-2009        None          
           2451 Columbia Rd            L.L.C.                                                                            
           Grand Forks, ND                                                                                               
                                                                                                                         
12/29/89   Wendy's                     WenSouth Orlando,       660,156         87,780     12-31-2009        None          
           1717 Martintown Rd          Ltd.                                                                              
           N Augusta, SC                                                                                                 
                                                                                                                         
12/29/89   Wendy's                     WenSouth Orlando,       580,938         77,280     12-31-2009        None          
           1515 Savannah Hwy           Ltd.                                                                              
           Charleston, SC                                                                                                
                                                                                                                         
12/29/89   Wendy's                     WenSouth Orlando,       633,750         84,120     12-31-2009        None          
           3869 Washington Rd          Ltd.                                                                              
           Martinez, GA                                                                                                  
                                                                                                                         
01/01/90   Sunrise Preschool           Sunrise               1,182,735(2)     127,920     05-31-2009        None           
           4111 E Ray Rd               Preschools,                                                                       
           Phoenix, AZ                 Inc.                                                                               
</TABLE> 

                                       6
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                                                Lease                              
Acquisi-   Property Name                                       Purchase       Rental Per        Expiration      Renewal             
tion Date  & Address                        Lessee             Price (1)        Annum           Date            Options             
---------  ---------                        ------             ---------        -----           ----            -------             
<C>        <S>                              <C>                <C>            <C>               <C>             <C> 
01/05/90   Denny's                          Cypress                 1,025,830        133,380     09-30-2009        None         
           1820 State Road 44               Restaurants, Inc.                                                                   
           New Smyrna Beach, FL                                                                                                 
                                                                                                                                
01/05/90   Hardee's                         Hardee's Food           1,140,236(2)      88,000     11-30-2009        None         
           20 N Pioneer Rd                  Systems, Inc.                                                                       
           Fond du lac, WI                                                                                                      
                                                                                                                                
01/31/90   Blockbuster Video                Blockbuster               646,425        100,554     01-31-2001          (3)        
           336 E 12th St                    Videos, Inc.                                                                        
           Ogden, UT                                                                                                            
                                                                                                                                
03/21/90   Denny's                          DenAmerica, Inc.        1,179,501(2)      83,200     04-30-2012          (3)        
           688 N Blue Lakes Blvd                                                                                                
           Twin Falls, ID                                                                                                       
                                                                                                                                
05/02/90   Denny's (4)                      DenAmerica, Inc.          514,259(2)      90,000     05-30-1998          (3)        
           3752 E Ind School                                                                                                    
           Phoenix, AZ                                                                                                          
                                                                                                                                
05/31/90   Applebee's                       Thomas & King,          1,434,434(2)     135,780     10-31-2009        None          
           2770 Brice Rd                    Inc.
           Columbus, OH
</TABLE>

     Footnotes:

     (1)  Purchase price includes all costs incurred to acquire the property.
     (2)  Purchase price includes cost of specialty leasehold improvements.
     (3)  Renewal option available.
     (4)  Ownership of lessee's interest under a ground lease. The Partnership
          is responsible for payment of all rent obligations under the ground
          lease.
     (5)  Ownership of lessee's interest under a ground lease. The tenant is
          responsible for payment of all rent obligations under the ground
          lease.

Terratron, Inc., the lessee of eight (8) Hardee's restaurants has experienced
sales difficulties over the past three years. Effective December 31, 1995,
management entered into a one-year lease modification with the tenant which
reduced base rents for 1996 by approximately $200,000. Additionally, delinquent
rent totaling $112,000 was capitalized into a five (5)-year note accruing
interest at 10% per annum. The amount of rent capitalized was also written off
as uncollectible.

During the Fourth Quarter of 1996, management terminated the leases in six (6)
of the properties with Terratron and entered into new leases on five (5) of the
properties with Hardee's Food Systems, Inc. In connection with this transaction,
the capitalized rent was received. The new leases resulted in annual rents which
were $255,000 lower than Terratron's contract rent and $106,000 lower than 1996
adjusted rents. In connection with the transaction, Terratron terminated their
equipment leases in three of the properties and the equipment was sold to the
new tenant for $80,000, resulting in a loss to the Partnership of $95,000.
Additionally, purchase options were granted on three of the properties. Those
properties were written down to the option price at December 31, 1996.

Item 3.  Legal Proceedings

On March 16, 1993, the Partnership, along with DiVall 1 and DiVall 3, initiated
a lawsuit against Ernst & Young LLP ("E&Y"), a certified public accounting firm,
in the Circuit Court of Dane County, Wisconsin, in connection with the audits of
the Partnerships performed by E &Y for the years 1989, 1990 and 1991. The
Partnerships requested the payment of damages in the amount of $9,000,000, plus
interest, attorneys fees and 

                                       7
<PAGE>
 
costs, and whatever additional relief the court deemed just and proper. The
Partnerships hired legal counsel under a contingent fee arrangement to prosecute
all of the Partnerships' claims. E & Y filed an Answer denying that it was
negligent.

E & Y also filed third-party claims alleging fraud and negligence on the part of
the Partnerships' former securities law firm, Quarles & Brady. The Partnerships
also filed claims against Magnuson, DiVall, DiVall Real Estate Investment
Corporation, David Shea, and Quarles & Brady.

The trial of the case was scheduled to take place in Iowa County, Wisconsin,
beginning on March 20, 1996. Shortly before trial, the Partnerships reached a
resolution of their claims against Quarles & Brady. A resolution of the claims
against Ernst & Young was reached after opening statements. As a result of these
settlements, net proceeds to the Partnership, after the payment of contingent
legal fees and related expenses, totaled approximately $900,000.

As part of the Permanent Manager Agreement, DiVall, Magnuson, and entities owned
by them, granted the Partnership a security interest in certain promissory notes
and mortgages from other DiVall related entities (the "Private Partnerships").
In the aggregate, the face amount of these notes were equal to a minimum of
$8,264,932. In addition, DiVall, Magnuson, and related entities owned by them,
granted the Partnership a security interest in their general partner interests
in the Private Partnerships. The foregoing security interests were to secure the
repayment of the funds which were diverted by DiVall and Magnuson from the
Partnership. The Partnership shares such security interests with DiVall 1 and
DiVall 3. These promissory notes and mortgages are not recorded on the balance
sheets of the Partnerships, but are recorded as recoveries on a cash basis upon
settlement.

On July 23, 1993, nineteen (19) of the Private Partnerships sought the
protection of the Bankruptcy Court in the Eastern District of Wisconsin. Seven
(7) of these bankruptcies were voluntary and twelve (12) of these bankruptcies
were involuntary. Several of the Private Partnerships seeking bankruptcy owe
promissory notes to DiVall, Magnuson, or entities owned by them, in which the
Partnership has a security interest. These cases were subsequently transferred
to the Western District Bankruptcy Court located in Madison, Wisconsin.

The Partnership's experience in those bankruptcy cases that have concluded,
either through the approval of Plans of Reorganization, dismissal of the
bankruptcies, settlements or a combination of the foregoing, is that (i) the
value of the obligations of the Private Partnerships assigned to the
Partnerships have been at a significant discount to their face amounts, and (ii)
the General Partner interests in such Private Partnerships often have little
economic value. The Partnership's recoveries in these bankruptcies have been on
a steeply discounted basis.

Plans of reorganization have been filed in the bankruptcies, and settlement
agreements in all of the Private Partnerships have been reached. Settlements in
the bankruptcies resulted in cash payments to the Partnerships of a total of
$720,000 and notes secured by subordinated mortgages in the aggregate amount of
$625,000. The Partnerships subsequently sold the secured notes for a total of
$175,000.

The Partnerships have been named as defendants in certain foreclosure actions
brought in state courts in Wisconsin. In each of these actions, the plaintiff
seeks to foreclose on real property owned by one of the Private Partnerships.
The Partnerships were named as subordinate lienholders on the properties. It is
believed that none of these cases constitute a claim against the individual
Public Partnerships. However, if the foreclosures are successful, the Private
Partnerships' interest in the underlying real estate may be extinguished,
rendering individual obligations to the Partnerships uncollectible. Such a
foreclosure has occurred in one instance and is pending in at least one other
situation.

ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

                                       8
<PAGE>
 
                                    PART II

ITEM 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

(a)  Although some interests have been traded, there is no active public market
     for limited partnership interests, and it is not anticipated that an active
     public market for limited partnership interests will develop.

(b)  As of December 31, 1996 there were 2,724 record holders of limited
     partnership interests in the Partnership.

(c)  The Partnership Agreement, as amended, provides for distributable net cash
     receipts of the Partnership to be distributed on a quarterly basis, 99% to
     the Limited Partners and 1% to the General Partner, subject to the
     limitations on distributions to the General Partner described in the
     amended Partnership Agreement. During 1996 and 1995, $6,825,000 and
     $3,430,000, respectively, were distributed in the aggregate to the Limited
     Partners. The General Partner received aggregate distributions of $13,110
     and $5,080 in 1996 and 1995, respectively.

ITEM 6.   SELECTED FINANCIAL DATA

DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
(a Wisconsin limited partnership)

December 31, 1996, 1995, 1994, 1993, and 1992
(not covered by Independent Auditor's Report)

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------
                                1996         1995         1994         1993          1992
--------------------------------------------------------------------------------------------
<S>                          <C>          <C>          <C>          <C>          <C>
Total Revenue                $ 5,316,853  $ 3,932,498  $ 4,190,932  $ 4,133,668  $ 4,196,272
--------------------------------------------------------------------------------------------
Net Income (Loss)              3,277,512    1,782,105    2,158,283      804,920     (731,703)
--------------------------------------------------------------------------------------------
Net Income (Loss) per              70.11        38.12        46.17        17.19       (14.22)
 Limited Partner Interest
--------------------------------------------------------------------------------------------
Total Assets                  23,379,356   27,134,604   29,455,349   31,288,856   33,584,432
--------------------------------------------------------------------------------------------
Total Partners' Capital       22,903,880   26,464,478   28,117,453   29,146,593   30,695,089
--------------------------------------------------------------------------------------------
Cash Distributions per            147.47        74.11        68.68        50.76        55.20
 Limited Partnership
 Interest
--------------------------------------------------------------------------------------------
</TABLE>

(a)  The above selected financial data should be read in conjunction with the
     financial statements and the related notes appearing elsewhere in this
     annual report.

                                       9
<PAGE>
 
ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS

LIQUIDITY AND CAPITAL RESOURCES:
--------------------------------

INVESTMENT PROPERTIES AND NET INVESTMENT IN DIRECT FINANCING LEASES
-------------------------------------------------------------------

The investment properties, including equipment held by the Partnership at
December 31, 1996, were originally purchased at a price, including acquisition
costs, of approximately $29,963,000.

The tenant of the Country Kitchen restaurant in Cedar Rapids, Iowa vacated the
property during 1995 and ceased paying rent. Management is currently marketing
the property for sale or lease.

Apple South, Inc. the tenant of two Applebee's restaurants in Tennessee and
Florida, notified management of their intent to exercise an option in their
lease to purchase those properties. The Tennessee property was sold to Apple
South during January 1996. The sale of the Florida property took place during
September 1996.

Terratron, Inc., the lessee of eight (8) Hardee's restaurants has experienced
sales difficulties over the past three years. Effective December 31, 1995,
management entered into a one-year lease modification with the tenant which
reduced base rents for 1996 by approximately $200,000. Additionally, delinquent
rent totaling $112,000 was capitalized into a five (5)-year note accruing
interest at 10% per annum. The amount of rent capitalized was also written off
as uncollectible. During the Fourth Quarter of 1996, management terminated the
leases in six (6) of the properties with Terratron and entered into new leases
on five (5) of the properties with Hardee's Food Systems, Inc. In connection
with this transaction, the capitalized rent was received. The new leases
resulted in annual rents which are $255,000 lower than Terratron's contract
rents and $106,000 lower than 1996 adjusted rents. In connection with the
transaction, Terratron terminated their equipment leases in three of the
properties and the equipment was sold to the new tenant for $80,000, resulting
in a loss to the Partnership of $95,000. Additionally, purchase options were
granted on three of the properties. Those properties were written down to the
option price at December 31, 1996.

The net investment in direct financing leases, which includes the Partnership's
specialty leasehold improvement leases, amounted to $109,000 at December 31,
1996, compared to $591,000 at December 31, 1995. The decrease of $482,000 was a
result of principal and residual payments received during the year as well as
the termination of the equipment leases with Terratron and sale of the leased
equipment to the replacement tenant.

OTHER ASSETS
------------

Cash and cash equivalents, including cash restricted for real estate taxes held
by the Partnership, was approximately $1,555,000 at December 31, 1996, compared
to $1,067,000 at December 31, 1995. The Partnership designated cash of
$1,000,000 to fund the Fourth Quarter 1996 distributions to Limited Partners
paid in February 1997, $300,000 for the payment of year-end accounts payable and
accrued expenses, and the remainder represents reserves deemed necessary to
allow the Partnership to operate normally. The increase is primarily due to
recoveries received during the Fourth Quarter of 1996 and cash received from the
sale of equipment. Cash generated through the operations of the Partnership's
investment properties, sales of investment properties, and any recoveries of
misappropriated funds by the former general partners will provide the sources
for future fund liquidity and Limited Partner distributions.

The Partnership established an Indemnification Trust (the "Trust") during the
Fourth Quarter of 1993, deposited $100,000 in the Trust during 1993 and
completed funding of the Trust with $150,000 during 1994. The provision to
establish the Trust was included in the Permanent Manager Agreement for the
indemnification of TPG, in the absence of fraud or gross negligence, from any
claims or liabilities that may arise from TPG acting as Permanent Manager. The
Trust is owned by the Partnership. For additional information regarding the
Trust refer to Note 9 to the financial statements included in Item 8 of this
report.

                                      10
<PAGE>
 
DUE FROM AFFILIATED PARTNERSHIPS, DUE FROM FORMER AFFILIATES, ALLOWANCE FOR
---------------------------------------------------------------------------
UNCOLLECTIBLE AMOUNTS DUE FROM FORMER AFFILIATES
------------------------------------------------

Due from former affiliates represented misappropriated assets due from the
former general partners and their affiliates in the amount of $1,743,461 at
December 31, 1996. The receivable decreased from the prior year due to
$1,786,000 of recoveries received during the year from the former general
partners and their affiliates including a settlement received from the
Partnership's former accountants and attorneys.

The Partnership maintains a record of costs incurred in identifying or
recovering the misappropriated assets. These amounts are expensed when incurred,
and then, recorded on the balance sheet as a restoration cost receivable with a
corresponding allowance for such receivable deemed uncollectible. These costs
are considered due from the former general partners and their affiliates.
Interest has been accrued on the misappropriated funds since January 1, 1993, at
a rate of 9% per annum and has been included in the restoration cost receivable.
The receivable increased from approximately $2,824,000 at December 31, 1995, to
$3,898,000 at December 31, 1996, and includes $1,918,000 of cumulative accrued
interest.

In 1993, the current General Partner estimated an aggregate recovery of $3
million for the Partnerships. At that time, an allowance was established against
amounts due from former general partners and their affiliates reflecting the
estimated $3 million receivable. This net receivable was allocated among the
Partnerships based on each Partnership's pro rata share of the total
misappropriation. Through December 31, 1996, $5,160,000 of recoveries have been
received which exceeded the original estimate of $3 million. As a result, the
Partnership has recognized $864,000 as income, which represents its share of the
excess recovery. The current General Partner continues to pursue recoveries of
the misappropriated funds, however no further significant recoveries are
anticipated.

The restoration costs are allocated among the Partnerships based on each
Partnership's respective share of the misappropriation as discussed in Note 10
of the financial statements included in Item 8 of this report. The allocation is
adjusted periodically to reflect any changes in the entire misappropriation. The
Partnership's percentage of the allocation was reduced in 1993. Consequently,
the Partnership had been paying more than its pro rata share of the costs.
Accordingly, the Partnership recorded a receivable at December 31, 1993, in the
amount of $192,000 due from DiVall 3 with a corresponding reduction reflected in
professional expenses related to the Investigation, former general partner
removal expenses, and interim fund manager fees and expenses. Recoveries
allocated to DiVall 3 have been used to partially repay amounts owed to the
Partnership. During 1996, the amount due from DiVall 3 was fully repaid.

LIABILITIES
-----------

The equipment note payable in the amount of $77,000 at December 31, 1995, was
repaid during 1996 with the proceeds from the sale of the Applebee's property in
Memphis, Tennessee.

Accounts payable and accrued expenses at December 31, 1996, in the amount of
$68,000, primarily represented the year-end accruals of legal and auditing fees.
The decrease from December 31, 1995 is a result of the payment of accrued 
out-of-pocket costs associated with the litigation against the Partnerships'
former accountants and attorneys.

Due to the Current General Partner amounted to $87,000 at December 31, 1996,
representing a true-up of the general partner's management fee, leasing
commissions for the lease of the Hardee's restaurants, and the Fourth Quarter
distribution, all of which were paid in 1997.

Real estate taxes payable increased from $57,000 at December 31, 1995, to
$119,000 at December 31, 1996, primarily due to the collection of all 1996 real
estate taxes due in 1997 from Terratron, the former tenant of the Partnership's
Hardee's restaurants.

                                      11
<PAGE>
 
PARTNERS' CAPITAL
-----------------

Net income for the year was allocated between the General Partner and the
Limited Partners, 1% and 99%, respectively, as provided in the Partnership
Agreement and the Amendment to the Partnership Agreement, as discussed more
fully in Note 4 of the financial statements included in Item 8 of this report.
The former general partners' deficit capital account balance was reallocated to
the Limited Partners at December 31, 1993. Refer to Note 12 to the financial
statements included in Item 8 of this report for additional information
regarding the reallocation.

Cash distributions paid to the Limited Partners and to the General Partner
during 1996 of $6,825,000 and $13,110, respectively, have also been in
accordance with the amended Partnership Agreement. The Fourth Quarter 1996
distribution of $1,000,000 was paid to the Limited Partners on February 15,
1997.

RESULTS OF OPERATIONS:
----------------------

Management believes that the financial results of 1996 are not indicative of
"normal" Partnership operations. There are many events which occurred since the
discovery of the misappropriations in 1992 which have had a negative impact on
the financial results. Some of these events will continue to have a negative
impact on the Partnership in the future. However, the settlement of litigation
against the Partnerships' former accountants and attorneys should result in
operating results going forward which more closely represent "normal" operations
than what has been experienced during the past four years.

The Partnership reported net income for the year ended December 31, 1996, in the
amount of $3,278,000 compared to net income for the years ended December 31,
1995 and 1994, of $1,782,000 and $2,158,000, respectively. Results for all three
years were different than would be expected from "normal" operations, primarily
because of costs associated with the misappropriation of assets by the former
general partners and their affiliates, tenant defaults, non-cash write-offs, and
real estate taxes on vacant properties. Results for 1996 were also impacted by a
gain on the sale of two Applebee's properties and the reversal of a portion of
the former general partner receivable write-off. The costs associated with the
misappropriation increased significantly during 1995 and 1996 as the lawsuit
against the former general partner accountants and attorneys got closer to trial
and as a result of contingent fee payments made in connection with the
settlement.

REVENUES
--------

Total revenues were $5,317,000, $3,932,000, and $4,191,000, for the years ended
December 31, 1996, 1995, and 1994, respectively. A decrease in fixed rents
resulted from tenant turnover and modified leases. However, during 1996, a gain
was recognized on the sale of two Applebee's restaurants, and an $864,000
recovery was recognized for a portion of the former general partner receivable
which had previously been written-off.

Total revenues should approximate $3,000,000 annually based on leases currently
in place. Future revenues may decrease with tenant defaults and/or sales of
Partnership properties. They may also increase with additional rents due from
tenants, if those tenants experience sales levels which require the payment of
additional rent to the Partnership.

EXPENSES
--------

For the years ended December 31, 1996, 1995, and 1994, cash expenses amounted to
approximately 25%, 29%, and 27%, of total revenues, respectively. Total
expenses, including non-cash items, amounted to approximately 38%, 55%, and 49%,
of total revenues for the years ended December 31, 1996, 1995, and 1994,
respectively. Items negatively impacting expenses during the last three years
include expenses incurred primarily in relation to the misappropriation of
assets by the former general partners and their affiliates, non-cash write-offs,
property write-downs, real estate taxes, and equipment losses.

                                      12
<PAGE>
 
For the years ended December 31, 1996, 1995, and 1994, expenses incurred in
relation to the misappropriated assets amounted to $526,000, $417,000, and
$216,000, respectively. Future expenses incurred in relation to the
misappropriation should have a minimal impact on the Partnership.

Additional expenses impacting operating results are provisions for uncollectible
rent, losses on equipment leases, and write-downs of property to their estimated
net realizable values. All of these items, including depreciation, are non-cash
items and do not affect current operating cash flow of the Partnership or
distributions to the Limited Partners.

Write-offs for uncollectible rents and receivables amounted to $0, $112,000, and
$48,000 at December 31, 1996, 1995, and 1994, respectively. The write-offs are
the result of defaults as well as modifications to several property leases since
inception of the Partnership.

During 1996, two Hardee's properties were written down to their estimated net
realizable values based on purchase option prices granted to the tenant of the
properties.

During 1995, the Miami Subs restaurant in Palm Beach, Florida, was written down
$255,000 to its estimated net realizable value of $400,000. The poor location of
this property has required lease modifications for the tenant.

During 1994, the Arby's restaurant in Champaign, Illinois, was written down
$34,000 to the purchase option price included in the lease of $300,000. The
tenant notified the Partnership during 1994 of its intent to exercise this
option. The sale took place during the Second Quarter of 1995. The Partnership
also wrote down the carrying value of the former Wendy's in Hallandale, Florida,
in the amount of $136,000 at December 31, 1994, resulting in a carrying value at
December 31, 1994, of $250,000. The write-down is a non-cash event which
management believes more appropriately reflects the property's estimated net
realizable value. The Partnership re-leased the property in 1995.

Equipment lease terminations created losses during 1996, in the amount of
$95,000. The equipment leases were terminated by the tenant of eight (8)
Hardee's restaurants which had been experiencing sales difficulties. During
1995, write-downs were taken on the residual values of all equipment leases to
more closely reflect their estimated fair market value.

Partnership management fees increased during 1996 primarily due to the
prepayment of rent in connection with the lease terminations on the Hardee's
properties.

Disposition fees were incurred during 1996 as a result of the sale of two of the
Partnership's Applebee's properties.

Real estate tax expenses for 1995 and 1994 were inordinately high as former
management allowed these taxes to become delinquent for several years while
interest and penalties accumulated along with new liabilities incurred on vacant
properties and defaulted tenants. The Partnership incurred real estate taxes on
behalf of tenants in the amounts of $30,000, and $128,000, for the years ended
December 31, 1995, and 1994, respectively.

INFLATION:
----------

Inflation has a minimal effect on operating earnings and related cash flows from
a portfolio of triple net leases. By their nature, such leases actually fix
revenues and are not impacted by rising costs of maintenance, insurance, or real
estate taxes. Although the majority of the Partnership's leases have percentage
rent clauses, revenues from percentage rents represented only 7% of fixed rental
income for 1996. If inflation causes operating margins to deteriorate for
lessees if expenses grow faster than revenues, then, inflation may well
negatively impact the portfolio through tenant defaults.

                                      13
<PAGE>
 
It would be misleading to associate inflation with asset appreciation for real
estate, in general, and the Partnership's portfolio, specifically. Due to the
"triple net" nature of the property leases, asset values generally move
inversely with interest rates.

ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
            ------------------------------------------------------

                       (a Wisconsin limited partnership)
                       ---------------------------------

                  INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
                  -------------------------------------------

<TABLE>
<CAPTION>
                                                                         Page
                                                                         ----
<S>                                                                      <C>
 
   Report of Independent Public Accountants      ..................      15
 
   Balance Sheets, December 31, 1996 and 1995    ..................      16 - 17
 
   Statements of Income for the Years
   Ended December 31, 1996, 1995, and 1994       ..................      18
 
   Statements of Partners' Capital for the
   Years Ended December 31, 1996, 1995, and 1994 ..................      19
 
   Statements of Cash Flows for the Years
   Ended December 31, 1996, 1995, and 1994       ..................      20 - 21
 
   Notes to Financial Statements                 ..................      22 - 32
 
   Schedule III--Real Estate and Accumulated     
   Depreciation                                  ..................      38 - 39
</TABLE>

                                      14
<PAGE>
 
                              Arthur Andersen LLP

                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To the Board of Directors of
Divall Insured Income Fund Limited Partnership:

We have audited the accompanying balance sheets of Divall Insured Income Fund 
Limited Partnership (the Partnership) as of December 31, 1996 and 1995, and the 
related statements of income, partners' capital and cash flows for each of the 
three years in the period ended December 31, 1996. These financial statements 
are the responsibility of the Partnership's management. Our responsibility is 
to express an opinion on these 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 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 financial statements referred to above present fairly, in 
all material respects, the financial position of Divall Insured Income Fund 
Limited Partnership as of December 31, 1996 and 1995, and the results of its 
operations and its cash flows for each of the three years in the period  ended 
December 31, 1996, in conformity with generally accepted accounting principles.

Our audit was made for the purpose of forming an opinion on the basic financial 
statements taken as a whole. The schedule listed in the index of financial 
statements is presented for purpose of complying with the Securities and 
Exchange Commission's rules and is not part of the basic financial statements. 
This scheduled has been subjected to the auditing procedures applied in the 
audit of the basic financial statements and, in our opinion, fairly states in 
all material respects the financial data required to be set forth therein in 
relation to the basic financial statements taken as a whole.

/s/ Arthur Andersen LLP

Chicago, Illinois
March 13, 1997
<PAGE>
 
            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP


                                BALANCE SHEETS

                          DECEMBER 31, 1996 AND 1995
                          --------------------------

                                    ASSETS

<TABLE>
<CAPTION>
                                                                       December 31,   December 31,
                                                                           1996           1995
                                                                       -------------  -------------
<S>                                                                    <C>            <C>
INVESTMENT PROPERTIES AND EQUIPMENT:(NOTE 3)
   Land                                                                 $ 9,141,303    $10,027,077
   Buildings                                                             16,488,654     18,153,026
   Equipment                                                                707,378        669,778
   Accumulated depreciation                                              (5,550,940)    (5,491,806)
                                                                        -----------    -----------
 
       Net investment properties and equipment                           20,786,395     23,358,075
                                                                        -----------    -----------
 
NET INVESTMENT IN DIRECT FINANCING LEASES:(NOTE 7)                          108,826        590,527
                                                                        -----------    -----------
 
OTHER ASSETS:
   Cash and cash equivalents                                              1,444,326      1,005,764
   Cash restricted for real estate taxes                                    110,625         61,217
   Cash held in Indemnification Trust (NOTE 9)                              289,637        275,231
   Rents and other receivables (net of allowance of  $0 in 1996 and
       $254,543 in 1995)                                                    218,051        459,213
   Due from current General Partner                                               0            275
   Deferred rent receivable                                                 259,326        296,482
   Due from affiliated partnerships (NOTE 10)                                     0         96,088
   Prepaid insurance                                                         22,262         19,631
             Deferred charges                                                53,620              0
   Unsecured notes receivable from lessees                                   86,288         50,000
                                                                        -----------    -----------
       Total other assets                                                 2,484,135      2,263,901
                                                                        -----------    -----------
 
DUE FROM FORMER AFFILIATES: (NOTES 2 AND 10)
   Due from former general partner affiliates                             1,743,461      3,529,205
   Allowance for uncollectible amounts
      due from former affiliates                                         (1,743,461)    (2,607,104)
   Restoration cost receivable                                            3,897,981      2,823,862
   Allowance for uncollectible
     restoration receivable                                              (3,897,981)    (2,823,862)
                                                                        -----------    -----------
 
       Due from former affiliates, net                                            0        922,101
                                                                        -----------    -----------
 
       Total assets                                                     $23,379,356    $27,134,604
                                                                        ===========    ===========
</TABLE>

       The accompanying notes are an integral part of these statements.

                                      16
<PAGE>
 
            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

                                BALANCE SHEETS

                          DECEMBER 31, 1996 AND 1995
                          --------------------------

                       LIABILITIES AND PARTNERS' CAPITAL

<TABLE>
<CAPTION>
                                                              December 31,   December 31,
                                                                  1996           1995
                                                              -------------  -------------
<S>                                                           <C>            <C>
LIABILITIES:
 Equipment note payable                                       $          0   $     77,255
 Accounts payable and accrued expenses                              67,589        266,715
 Due to current General Partner                                     86,727            496
 Security deposits                                                 144,290        250,577
 Unearned rental income                                             57,739         18,065
 Real estate taxes payable                                         119,131         57,018
                                                              ------------   ------------
 
    Total liabilities                                              475,476        670,126
                                                              ------------   ------------
 
CONTINGENT LIABILITIES: (NOTE 8)
 
PARTNERS' CAPITAL: (NOTES 1, 4 AND 12)
 Current General Partner -
  Cumulative net income                                             80,064         47,289
  Cumulative cash distributions                                    (31,355)       (18,245)
                                                              ------------   ------------
                                                                    48,709         29,044
                                                              ------------   ------------
 Limited Partners (46,280.3 interests outstanding)
  Capital contributions, net of offering costs                  39,358,468     39,358,468
  Cumulative net income                                         14,292,200     11,047,463
  Cumulative cash distributions                                (29,955,268)   (23,130,268)
  Reallocation of former general partners' deficit capital        (840,229)      (840,229)
                                                              ------------   ------------
 
                                                                22,855,171     26,435,434
                                                              ------------   ------------
 
   Total partners' capital                                      22,903,880     26,464,478
                                                              ------------   ------------
 
   Total liabilities and partners' capital                    $ 23,379,356   $ 27,134,604
                                                              ============   ============
</TABLE>

       The accompanying notes are an integral part of these statements.

                                      17
<PAGE>
 
            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

                             STATEMENTS OF INCOME

             FOR THE YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
             -----------------------------------------------------

<TABLE>
<CAPTION>
                                                                           1996         1995          1994
                                                                        -----------  -----------  -----------
REVENUES:                                                          
<S>                                   <C>                               <C>          <C>          <C>
     Rental income(NOTE 5)                                              $3,262,082   $3,770,280    $3,868,972
     Interest income on direct financing leases                             57,028      102,101        98,736
     Other interest income                                                  98,393       69,287       109,239
     Net other income (NOTE 3)                                             105,710      (10,899)       69,323
     Recovery of amount previously written off (NOTE 11)                   863,643            0             0
     Net gain on disposal of assets                                        929,997        1,729        44,662
                                                                        ----------   ----------   -----------
                                                                         5,316,853    3,932,498     4,190,932
                                                                        ----------   ----------   -----------
EXPENSES:                                                          
     Partnership management fees (NOTE 6)                                  202,587      164,350       171,256
     Disposition fees (NOTE 6)                                              66,750        3,000         3,300
     Disposition fees - Restoration                                         20,550        3,000         6,728
     Restoration fees (NOTE 6)                                              33,408        2,616         8,971
     Selling commissions - Nonaffiliate                                          0        9,900             0
     Appraisal fees                                                          2,268        2,500             0
     Insurance                                                              36,594       48,180        59,103
     General and administrative                                            125,634      103,142       130,208
     Advisory Board fees and expenses                                       16,703       17,351        19,860
     Interest                                                                3,551       42,893       113,687
     Real estate taxes                                                        (880)      30,203       128,382
     Ground lease payments (NOTE 3)                                        123,921      123,825       123,710
     Expenses incurred due to default by lessee                              7,220       24,748         9,424
     Professional services                                                 141,073      133,189       145,670
     Professional services related to Investigation                        526,210      417,433       216,474
     Loss on equipment lease                                                95,246       72,264             0
     Depreciation                                                          511,650      584,352       663,296
     Amortization                                                              804          804        14,570
     Provision for uncollectible rents and other receivables                     0      111,762        47,883
     Write down of properties to net realizable value                      126,052      254,881       170,127
                                                                        ----------   ----------   -----------
                                                                         2,039,341    2,150,393     2,032,649
                                                                        ----------   ----------   -----------

NET INCOME                                                              $3,277,512   $1,782,105    $2,158,283
                                                                        ==========   ==========   ===========

NET INCOME - CURRENT GENERAL PARTNER                                        32,775       17,821        21,583

NET INCOME  - LIMITED PARTNERS                                           3,244,737    1,764,284     2,136,700
                                                                        ----------   ----------   -----------
                                                                        $3,277,512   $1,782,105    $2,158,283
                                                                        ==========   ==========   ===========
NET INCOME PER LIMITED PARTNERSHIP                                 
  INTEREST, based on 46,280.3 Interests outstanding                         $70.11       $38.12        $46.17
                                                                        ==========   ==========   ===========
</TABLE>

        The accompanying notes are an integral part of these statements.

                                      18
<PAGE>
 
            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

                        STATEMENTS OF PARTNERS' CAPITAL

             FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
             ----------------------------------------------------

<TABLE>
<CAPTION>
                                             Current General Partner                              Limited Partners                 
                                    ------------------------------------- -------------------------------------------------------- 
                                                                                                                                   
                                                                              Capital                                              
                                    Cumulative    Cumulative               Contributions,                Cumulative                
                                       Net           Cash                      Net of      Cumulative       Cash                   
                                      Income    Distributions     Total    Offering Costs  Net Income   Distribution  Reallocation 
                                    ----------  --------------  ---------  --------------  -----------  ------------  ------------  
<S>                                 <C>         <C>             <C>        <C>             <C>          <C>            <C>         
BALANCE AT DECEMBER 31, 1993           $ 7,885       $ (4,206)  $  3,679      $39,358,468  $ 7,146,479  $(16,521,804)  $(840,229) 
  Cash Distributions                                                                                                       
    ($68.68 per limited                                                                                                    
     partnership                                
      interest)                                        (8,959)    (8,959)                                 (3,178,464) 
  Net Income                            21,583                    21,583                     2,136,700                            
                                        -------       --------   --------      -----------  -----------  ------------   ---------  
BALANCE AT DECEMBER 31, 1994           $29,468       $(13,165)  $ 16,303      $39,358,468  $ 9,283,179  $(19,700,268)  $(840,229) 
Cash Distributions                                                                                                                 
  ($74.11 per limited                                                                                                              
   partnership interest)                               (5,080)    (5,080)                                 (3,430,000)             
Net Income                              17,821                    17,821                     1,764,284                            
                                        -------       --------   --------      -----------  -----------  ------------   ---------  
BALANCE AT DECEMBER 31, 1995           $47,289       $(18,245)  $ 29,044      $39,358,468  $11,047,463  $(23,130,268)  $(840,229) 
  Cash Distributions                                                                                                               
    ($147.47 per limited                                                                                                           
     partnership                                                                                                                   
        interest)                                     (13,110)   (13,110)                                 (6,825,000)             
  Net Income                            32,775                    32,775                     3,244,737                            
                                        -------       --------   --------      -----------  -----------  ------------   ---------  
BALANCE AT DECEMBER 31, 1996           $80,064       $(31,355)  $ 48,709      $39,358,468  $14,292,200  $(29,955,268)  $(840,229) 
                                        =======       ========   ========      ===========  ===========  ============   =========   

<CAPTION> 
                                            Total       
                                            -----       
<S>                                     <C>              
BALANCE AT DECEMBER 31,  1993           $29,142,914  

  Cash Distributions                     
    ($68.68 per limited                  
     partnership                         
      interest)                          (3,178,464)                          
  Net Income                              2,136,700                       
                                        -----------                       
BALANCE AT DECEMBER 31, 1994            $28,101,150                       
Cash Distributions                                                        
  ($74.11 per limited                                                     
   partnership interest)                 (3,430,000)                      
Net Income                                1,764,284                       
                                        -----------                       
BALANCE AT DECEMBER 31, 1995            $26,435,434                       
  Cash Distributions                                                      
    ($147.47 per limited                                                  
     partnership                                                          
        interest)                       (6,825,000)                       
  Net Income                              3,244,737                       
                                        -----------                       
BALANCE AT DECEMBER 31, 1996            $22,855,171                       
                                        ===========                        
</TABLE> 

       The accompanying notes are an integral part of these statements.
       

                                       19
<PAGE>
 
            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
                           STATEMENTS OF CASH FLOWS
                          
             FOR THE YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
             -----------------------------------------------------

<TABLE>
<CAPTION>
                                                                               1996          1995          1994
                                                                           ------------  -----------   -----------
<S>                                                                        <C>           <C>           <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
     Net income                                                             $ 3,277,512   $ 1,782,105   $  2,158,283
     Adjustments to reconcile net income to net
       cash provided by operating activities -
               Depreciation and amortization                                    512,454       585,156        677,866
               Recovery of amount previously written off                       (863,643)            0              0
               Provision for uncollectible rents and other receivables                0       111,762         47,883
               Property write downs to net realizable value                     126,052       254,881        170,127
               Net (gain) on disposal of assets                                (929,997)       (1,729)       (44,662)
               Loss on equipment leases                                          95,246        72,264              0
               Interest applied to Indemnification Trust account                (14,406)      (21,673)        (3,558)
               (Increase) Decrease in rents and other receivables               203,837      (296,921)      (138,155)
               (Deposits) Withdrawals for payment of real estate taxes          
                  and CD                                                        (49,408)      240,477        129,358
               (Increase) Decrease in prepaids                                   (2,631)       21,020         45,406
               (Increase) Decrease in deferred rent receivable                   37,156        13,747        (10,308)
               Increase (Decrease) in due to current General Partner             32,611          (814)       (18,072)
               Increase (Decrease) in accounts payable and other               (199,126)       82,558         (6,034)
               (Decrease) in security deposits                                  (38,355)     (254,136)       (12,552)
               (Decrease) in interest payable                                         0             0         (5,193)
               Increase (Decrease) in real estate taxes payable                  62,113       (54,558)       (53,143)
               Increase (Decrease) in unearned rental income                     39,674        (7,056)        (7,056)
                                                                            -----------   -----------   ------------

                       Net cash from operating activities                     2,289,089     2,527,083      2,944,302
                                                                            -----------   -----------   ------------

CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
     Principal payments received on direct financing leases                     229,294       603,956        309,936
     Proceeds from sale of investment properties                              2,990,000       300,000        220,000
     Deposit to Indemnification Trust cash account                                    0             0       (150,000)
     Recoveries from former affiliates                                        1,785,744        65,400        224,272
     Payments from affiliated partnerships                                       96,088        29,068        325,868
     Issuance of unsecured notes                                                (36,288)            0              0
     Principal receipts from unsecured notes                                          0             0         15,240
                                                                            -----------   -----------   ------------

                       Net cash from investing activities                     5,064,838       998,424        945,316
                                                                            -----------   -----------   ------------

CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
     Cash distributions to Limited Partners                                  (6,825,000)   (3,430,000)    (3,178,464)
     Cash distributions to current General Partner                              (13,110)       (5,080)        (8,959)
     Principal payments on mortgage notes                                             0             0       (493,764)
     Payments of equipment notes                                                (77,255)     (433,764)      (222,665)
                                                                            -----------   -----------   ------------

                       Net cash (used in) financing activities               (6,915,365)   (3,868,844)    (3,903,852)
                                                                            -----------   -----------   ------------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                            438,562      (343,337)       (14,234)

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                                1,005,764     1,349,101      1,363,335
                                                                            -----------   -----------   ------------

CASH AND CASH EQUIVALENTS AT END OF YEAR                                    $ 1,444,326   $ 1,005,764   $  1,349,101
                                                                            ===========   ===========   ============

SUPPLEMENTAL DISCLOSURE--cash paid for interest                                 $ 3,551      $ 30,203      $ 118,880
                                                                                 ======       =======       ========
</TABLE>

       The accompanying notes are an integral part of these statements.

                                       20
<PAGE>
 
           SUPPLEMENTAL INFORMATION TO THE STATEMENTS OF CASH FLOWS
           --------------------------------------------------------

The following significant noncash transactions occurred during the three years
affecting the Partnership's financial statements:


     1.   During 1996, the Partnership was deeded land with a value of $88,424
          in exchange for a note receivable from a tenant.

     2.   During 1996, equipment was transferred to the Partnership with an
          estimated value of $37,600 in exchange for delinquent rent from a
          tenant.

     3.   During 1996, security deposits totaling $67,932 were applied as
          equipment lease payments for a tenant.

     4.   During 1996, the Partnership incurred leasing commissions totaling
          $53,520 which were unpaid at year-end.

       The accompanying notes are an integral part of these statements.

                                       21
<PAGE>
 
            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

                         NOTES TO FINANCIAL STATEMENTS

                       DECEMBER 31, 1996, 1995 AND 1994


1.   ORGANIZATION AND BASIS OF ACCOUNTING:
     -------------------------------------

DiVall Insured Income Properties 2 Limited Partnership (the "Partnership") was
formed on November 18, 1987, pursuant to the Uniform Limited Partnership Act of
the State of Wisconsin.  The initial capital which was contributed during 1987,
consisted of $300, representing aggregate capital contributions of $200 by the
former general partners and $100 by the Initial Limited Partner.  The minimum
offering requirements were met and escrowed subscription funds were released to
the Partnership as of April 7, 1988.  On January 23, 1989, the former general
partners exercised their option to increase the offering from 25,000 interests
to 50,000 interests and to extend the offering period to a date no later than
August 22, 1989.  On June 30, 1989, the general partners exercised their option
to extend the offering period to a date no later than February 22, 1990.  The
offering closed on February 22, 1990, at which point 46,280.3 interests had been
sold, resulting in total offering proceeds, net of underwriting compensation and
other offering costs, of $39,358,468.

The Partnership is currently engaged in the business of owning and operating its
investment portfolio (the "Properties") of commercial real estate and recovering
the assets misappropriated by the former general partners and their affiliates.
The Properties are leased on a triple net basis to, and operated by, franchisors
or franchisees of national, regional, and local retail chains under long-term
leases.  The lessees consist primarily of fast-food, family style, and
casual/theme restaurants, but also include an auto tag agency, a video rental
store and a child care center.  At December 31, 1996, the Partnership owned 36
properties with specialty leasehold improvements in 15 of these properties.

Rental revenue from investment properties is recognized on the straight-line
basis over the life of the respective lease.  Revenue from direct financing
leases is recognized at level rates of return over the term of the lease.

Depreciation of the properties is provided on a straight-line basis over 31.5
years, which is the estimated useful lives of the buildings and improvements.
Equipment is depreciated on a straight-line basis over the estimated useful
lives of 5 to 7 years.

Deferred charges represent leasing commissions paid when properties are leased
to tenants other than the original tenant.  Leasing commissions are capitalized
and amortized over the life of the lease.

Real estate taxes on the Partnership's investment properties are the
responsibility of the tenant.  However, when a tenant fails to make the required
tax payments or when a property becomes vacant, the Partnership makes the
appropriate payment to avoid possible foreclosure of the property.  Taxes are
accrued in the period in which the liability is incurred.

Cash and cash equivalents include cash on deposit with financial institutions
and highly liquid temporary investments with initial maturities of 90 days or
less.

                                       22
<PAGE>
 
The preparation of 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 revenues and expenses during the reporting period.
Actual results could differ from those estimates.

During 1996, the Partnership adopted Statement of Financial Accounting Standards
No.121 ("SFAS 121"), Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of, which requires that all long-lived assets
be reviewed for impairment in value whenever changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.  The adoption of
SFAS 121 had no impact on the Partnership's financial statements in 1996.

The Partnership will be dissolved on November 30, 2010, or earlier upon the
prior occurrence of any of the following events:  (a) the disposition of all
properties of the Partnership; (b) the written determination by the General
Partner that the Partnership's assets may constitute "plan assets" for purposes
of ERISA; (c) the agreement of Limited Partners owning a majority of the
outstanding interests to dissolve the Partnership; or (d) the dissolution,
bankruptcy, death, withdrawal, or incapacity of the last remaining General
Partner, unless an additional General Partner is elected previously by a
majority of the Limited Partners.

No provision for Federal income taxes has been made, as any liability for such
taxes would be that of the individual partners rather than the Partnership.  At
December 31, 1996, the tax basis of the Partnership's assets exceeded the
amounts reported in the accompanying financial statements by approximately
$8,300,000.

The following represents a reconciliation of net income as stated on the
Partnership statements of income to net income for tax reporting purposes:

<TABLE>
<CAPTION>
                                                    1996         1995         1994
                                                 -----------  -----------  -----------
<S>                                              <C>          <C>          <C>
Net income, per statements of income             $3,277,512   $1,782,105   $2,158,283
 
Book to tax depreciation difference                 (35,161)      (6,450)      17,262
Book over tax gain from asset disposition           (98,501)     (82,904)           0
Straight line rent adjustment                        37,156       13,747      (10,308)
Affiliate receivable basis adjustment                     0            0      (19,136)
Bad debt reserve/expense                           (488,777)     111,762       63,733
Real estate tax expense                             (65,881)      16,804      (94,368)
Minimum rent receivable                                   0            0     (188,176)
Book valuation adjustment of real property          126,052      254,881      128,127
Book valuation adjustment of equipment leases             0       50,820            0
Other, net                                          215,779       (6,437)      22,539
                                                 ----------   ----------   ----------
   Net income for tax reporting
    purposes                                     $2,968,179   $2,134,328   $2,077,956
                                                 ==========   ==========   ==========
</TABLE>

                                       23
<PAGE>
 
2.   REGULATORY INVESTIGATION:
     -------------------------

A preliminary investigation during 1992 by the Office of Commissioner of
Securities for the State of Wisconsin and the Securities and Exchange Commission
(the "Investigation") revealed that during at least the four years ended
December 31, 1992, the former general partners of the Partnership, Gary J.
DiVall ("DiVall") and Paul E. Magnuson ("Magnuson") had transferred substantial
cash assets of the Partnership and two affiliated publicly registered
partnerships, DiVall Insured Income Fund Limited Partnership ("DiVall 1") and
DiVall Income Properties 3 Limited Partnership ("DiVall 3") (collectively the
"Partnerships") to various other entities previously sponsored by or otherwise
affiliated with DiVall and Magnuson.  The unauthorized transfers were in
violation of the respective Partnership Agreements and resulted, in part, from
material weaknesses in the internal control system of the Partnerships.  The
aggregate amount of the misappropriations, related costs, and 9% interest
accrued since January 1, 1993, is approximately $14,000,000, of which
approximately $5,641,000 has been attributed to the Partnership and is reflected
as due from former affiliates on the balance sheet at December 31, 1996.  The 9%
interest accrued as of December 31, 1996, amounted to approximately $1,918,000
and is not reflected in the accompanying income statement.  As of December 31,
1995, approximately $6,353,000 was reflected as due from former affiliates based
on estimated overall misappropriation and related costs of $15,700,000.

Subsequent to discovery, and in response to the regulatory inquiries, a third-
party Permanent Manager, The Provo Group, Inc. ("TPG"), was appointed (effective
February 8, 1993) to assume responsibility for daily operations and assets of
the Partnerships as well as to develop and execute a plan of restoration for the
Partnerships.  Effective May 26, 1993, the Limited Partners, by written consent
of a majority of interests, elected the Permanent Manager, TPG, as General
Partner.  TPG terminated the former general partners by accepting their tendered
resignations.

In 1993, the current General Partner estimated an aggregate recovery of $3
million for the Partnerships.  At that time, an allowance was established
against amounts due from former general partners and their affiliates reflecting
the estimated $3 million receivable.  This net receivable was allocated among
the Partnerships based on each Partnership's pro rata share of the total
misappropriation.  Through December 31, 1996, $5,160,000 of recoveries have been
received which exceeded the original estimate of $3 million.  As a result, the
Partnership has recognized $864,000 as income, which represents its share of the
excess recovery.  The current General Partner continues to pursue recoveries of
the misappropriated funds, however no further significant recoveries are
anticipated.

3.   INVESTMENT PROPERTIES:
     ----------------------

As of December 31, 1996, the Partnership owned 33 fully constructed fast-food
restaurants, an auto tag agency, a video store, and a preschool.  The properties
are composed of the following:  ten (10) Wendy's restaurants, eight (8) Hardee's
restaurants, seven (7) Denny's restaurants, one (1) Applebee's restaurant, one
(1) Popeye's Famous Fried Chicken restaurant, one (1) Country Kitchen
restaurant, one (1) Hooter's restaurant, one (1) Kentucky Fried Chicken
restaurant, one (1) Hostetler's restaurant, one (1) Miami Subs restaurant, one
(1) Village Inn restaurant, one (1) Hallandale Tag Agency, one (1) Blockbuster
Video store, and one (1) Sunrise Preschool.  The 36 properties are located in a
total of thirteen (13) states.

From time to time, the Partnership experiences interruptions in rental receipts
due to tenant delinquencies and vacancies.  At December 31, 1996, two of the
Partnership's properties were unoccupied.  During 1995, the tenant of the
Country Kitchen restaurant in Cedar Rapids, Iowa, vacated the property and
stopped making rent 

                                       24
<PAGE>
 
payments. Management is marketing the property for sale or lease. During 1996,
the tenant of the Hardee's restaurant in Delavan, Wisconsin, vacated the
property and paid a lease termination fee of $37,500. The property is currently
under contract for sale to the former tenant.

The total cost of the investment properties and specialty leasehold improvements
includes the original purchase price plus acquisition fees and other capitalized
costs paid to an affiliate of the former general partners.

According to the Partnership Agreement, the former general partners were to
commit 80% of the original offering proceeds to investment in properties.  Upon
the close of the offering, approximately 75% of the original proceeds was
invested in the Partnership's properties.

The Current General Partner receives a fee for managing the Partnership equal to
4% of the gross receipts, with a maximum reimbursement for office rent and
related office overhead of $25,000 between the three affiiliated Partnerships.
Effective March 1, 1996, the minimum management fee and the maximum
reimbursement for office rent and overhead increased by 2.8% representing the
allowable annual Consumer Price Index adjustment per the Permanent Manager
Agreement ("PMA").  For purposes of computing the 4% overall fee, gross receipts
includes amounts recovered in connection with the misappropriation of assets by
the former general partners and their affiliates.  TPG has received fees from
the Partnership totaling $44,995 to date on the amounts recovered, which has
been offset against the 4% minimum fee.

The tenant of the Partnership's eight (8) Hardee's restaurants has experienced
sales difficulties over the past three years.  Effective December 31, 1995,
management entered into a one-year lease modification with the tenant for 1996
resulting in a $200,000 decrease in base rent for the year and agreed to
capitalize delinquent rents totaling $112,000 into a five-year note earning 10%
interest.  During the Fourth Quarter of 1996, management terminated six (6) of
the leases and entered into new leases on five (5) of the properties with
Hardee's Food Systems, Inc.  In connection with the transaction, the capitalized
rent was received.  The new leases resulted in annual rents which are $255,000
lower than the former tenant's contract rent and $106,000 lower than the 1996
adjusted rents.  In connection with the transaction, the original tenant
terminated their equipment leases in three of the properties and the equipment
was sold to the new tenant for $80,000, resulting in a loss to the Partnership
of $95,000.  Additionally, purchase options were granted on three of the
properties. Those properties were written down to the option price at December
31, 1996.

The Partnership owns four (4) restaurants located on parcels of land where it
has entered into long-term ground leases.  Two (2) of these leases are paid by
the tenant and two (2) are paid by the Partnership.  The leases paid by the
Partnership are considered operating leases and the lease payments are expensed
in the periods to which they apply.  The lease terms require aggregate minimum
annual payments of approximately $124,000 and expire in the years ranging from
1998 to 2003.

The tenant operating a Denny's restaurant on Camelback Road in Phoenix, Arizona,
has not formally exercised its option to extend its lease which expired on
January 30, 1993, but continues to operate the restaurant and pay rent.
Management is currently negotiating a possible new lease or sale of the property
to the tenant.

                                       25
<PAGE>
 
Several of the Partnership's property leases contained purchase option
provisions with stated purchase prices in excess of the original cost of the
properties.  The Partnership's lease with an Arby's restaurant in Champaign,
Illinois, contained a purchase option with an option price of $300,000.  The
Partnership acquired the property at a cost of $389,757.  During the Fourth
Quarter of 1994, the tenant notified the Partnership of its intent to exercise
the purchase option.  The property was written down to $300,000, the option
price, at December 31, 1994.  The sale closed during the Second Quarter of 1995.
The current General Partner is not aware of any additional unfavorable purchase
options in relation to original cost.  Apple South, Inc. the tenant of two
Applebee's restaurants, notified Management of its intent to exercise an option
in its lease to purchase those properties.  One sale closed in January 1996,
resulting in an approximate gain of $484,000.  The other sale took place during
September 1996 and resulted in an approximate gain of $446,000.

4.   PARTNERSHIP AGREEMENT:
     ----------------------

The Partnership Agreement, prior to an amendment effective May 26, 1993,
provided that, for financial reporting and income tax purposes, net profits or
losses from operations were allocated 90% to the Limited Partners and 10% to the
general partners.  The Partnership Agreement also provided for quarterly cash
distributions from Net Cash Receipts, as defined, within 60 days after the last
day of the first full calendar quarter following the date of release of the
subscription funds from escrow, and each calendar quarter thereafter, in which
such funds were available for distribution with respect to such quarter.  Such
distributions were to be made 90% to Limited Partners and 10% to the former
general partners, provided, however, that quarterly distributions were to be
cumulative and were not to be made to the former general partners unless and
until each Limited Partner had received a distribution from Net Cash Receipts in
an amount equal to 10% per annum, cumulative simple return on his or her
Adjusted Original Capital, as defined, from the Return Calculation Date, as
defined.

Net Proceeds, as originally defined, were to be distributed as follows:  (a) to
the Limited Partners, an amount equal to 100% of their Adjusted Original
Capital; (b) then, to the Limited Partners, an amount necessary to provide each
Limited Partner a Liquidation Preference equal to a 13.5% per annum, cumulative
simple return on Adjusted Original Capital from the Return Calculation date
including in the calculation of such return all prior distributions of Net Cash
Receipts and any prior distributions of Net Proceeds under this clause; and (c)
then, to Limited Partners, 90% and to the General Partners, 10%, of the
remaining Net Proceeds available for distribution.

On May 26, 1993, pursuant to the results of a solicitation of written consents
from the Limited Partners, the Partnership Agreement was amended to replace the
former general partners and amend various sections of the agreement.  The former
general partners were replaced as General Partner by The Provo Group, Inc., an
Illinois corporation.  Under the terms of the amendment, net profits or losses
from operations are allocated 99% to the Limited Partners and 1% to the current
General Partner.  The amendment also provided for distributions from Net Cash
Receipts to be made 99% to Limited Partners and 1% to the current General
Partner provided, that quarterly distributions will be cumulative and will not
be made to the current General Partner unless and until each Limited Partner has
received a distribution from Net Cash Receipts in an amount equal to 10% per
annum, cumulative simple return on his or her Adjusted Original Capital, as
defined, from the Return Calculation Date, as defined, except to the extent
needed by the General Partner to pay its federal and state income taxes on the
income allocated to them attributable to such year.  Distributions paid to the
General Partner are based on the estimated tax liability resulting from
allocated income.  Subsequent to the filing of the General Partner's income tax
returns, a true-up with actual distributions is made.

                                       26
<PAGE>
 
The provisions regarding distribution of Net Proceeds, as defined, were also
amended to provide that Net Proceeds are to be distributed as follows:  (a) to
the Limited Partners, an amount equal to 100% of their Adjusted Original
Capital; (b) then, to the Limited Partners, an amount necessary to provide each
Limited Partner a Liquidation Preference equal to a 13.5% per annum, cumulative
simple return on Adjusted Original Capital from the Return Calculation Date
including in the calculation of such return on all prior distributions of Net
Cash Receipts and any prior distributions of Net Proceeds under this clause,
except to the extent needed by the General Partner to pay its federal and state
income tax on the income allocated to its attributable to such year; and (c)
then, to Limited Partners, 99%, and to the General Partner, 1%, of remaining Net
Proceeds available for distribution.

Additionally, per the amendment of the Partnership Agreement dated May 26, 1993,
the total compensation paid to all persons for the sale of the investment
properties shall be limited to a competitive real estate commission, not to
exceed 6% of the contract price for the sale of the property.  The General
Partner may receive up to one-half of the competitive real estate commission,
not to exceed 3%, provided that the General Partner provides a substantial
amount of services in the sales effort.  It is further provided that a portion
of the amount of such fees payable to the General Partner is subordinated to its
success in recovering the funds misappropriated by the former general partners.
(See Note 8.)

5.   LEASES:
     -------

Lease terms for the majority of the investment properties are 20 years from
their inception.  The leases generally provide for minimum rents and additional
rents based upon percentages of gross sales in excess of specified breakpoints.
The lessee is responsible for occupancy costs such as maintenance, insurance,
real estate taxes, and utilities.  Accordingly, these amounts are not reflected
in the statements of income except in circumstances where, in management's
opinion, the Partnership will be required to pay such costs to preserve its
assets (i.e., payment of past-due real estate taxes).  Management has determined
that the leases are properly classified as operating leases; therefore, rental
income is reported when earned and the cost of the property, excluding the cost
of the land, is depreciated over its estimated useful life.

Aggregate minimum lease payments to be received under the leases for the
Partnership's properties are as follows:

<TABLE>
          <S>                           <C>
          Year ending
          December 31,
          1997                          $ 2,908,582
          1998                            2,810,316
          1999                            2,804,916
          2000                            2,801,584
          2001                            2,692,654
          Thereafter                     20,617,293
                                        -----------
                                        $34,635,345
                                        ===========
</TABLE>

Percentage rentals included in rental income in 1996, 1995, and 1994 were
$578,747, $719,407, and $708,706, respectively.  The decrease in percentage
rental income is a result of the sale of various properties subject to
percentage rent.

Ten (10) of the properties are leased to Wensouth Orlando, a franchisee of
Wendy's restaurants.  Wensouth base rents accounted for 26% of total base rents
for 1996.

                                       27
<PAGE>
 
Five (5) of the properties are leased to Hardee's Food Systems, Inc., the
corporate owner of Hardee's restaurants.  Base rents for those leases account
for 12% of total base rents.

6.   TRANSACTIONS WITH CURRENT GENERAL PARTNER:
     ------------------------------------------

Amounts incurred to the current General Partner for the years ended December 31,
1996, 1995, and 1994, are as follows:

<TABLE>
<CAPTION>
                                        Incurred            Incurred            Incurred
                                   for the year ended  for the year ended  for the year ended
     Current General Partner       December 31, 1996   December 31, 1995   December 31, 1994
---------------------------------  ------------------  ------------------  ------------------
<S>                                <C>                 <C>                 <C>
Management fees                              $202,587            $164,350            $171,256
Disposition fees                               66,750               3,000               3,300
Restoration fees                               33,408               2,616               8,971
Overhead allowance                             14,301              13,914              13,546
Leasing Commissions                            53,620                   0                   0
Reimbursement for out-of-pocket                21,781              19,148              14,268
 expenses
Cash distribution                              13,110               5,080               8,959
                                             --------            --------            --------
                                             $405,557            $208,108            $220,300
                                             ========            ========            ========
</TABLE>

7.   NET INVESTMENT IN DIRECT FINANCING LEASES:
     ------------------------------------------

The net investment in direct financing leases which includes the Partnership's
specialty leasehold improvement leases, is comprised of the following as of
December 31, 1996:

<TABLE>
<S>                                                              <C>
              Minimum lease payments receivable                  $104,156
              Estimated residual values of leased                   
                   property (non-recourse)                         22,364
              Less-Unearned income                                (17,694)
                                                                 --------
 
                   Net investment in direct
                     financing leases                            $108,826
                                                                 ========
</TABLE> 
 
At December 31, 1996, future minimum lease payments for each of the three
succeeding fiscal years are as follows:
 
<TABLE> 
                     <S>                                         <C> 
                     Year ending
                     December 31,                     
                     1997                                        $ 60,960
                     1998                                          37,860
                     1999                                          27,700
                                                                 --------
                                                                 $126,520
                                                                 ========
</TABLE>

During 1995, it was determined that the residual values of the equipment leases
were overstated.  Accordingly, they were written down to their estimated net
realizable values as of December 31, 1995.  The total amount of the write-down
was approximately $72,000.

                                       28
<PAGE>
 
During 1996, Terratron, Inc., the tenant of eight (8) Hardee's restaurants (3 of
which had equipment leases), terminated their equipment leases and purchased the
equipment from the Partnership, resulting in a net loss of $95,000.

8.   CONTINGENT LIABILITIES:
     -----------------------

According to the Partnership Agreement, as amended, the current General Partner
may receive a disposition fee not to exceed 3% of the contract price of the sale
of investment properties.  Fifty percent (50%) of all such disposition fees
earned by the current General Partner is to be escrowed until the aggregate
amount of recovery of the funds misappropriated from the Partnerships by the
former general partners is greater than $4,500,000. Upon reaching such recovery
level, full disposition fees will thereafter be payable and fifty percent (50%)
of the previously escrowed amounts will be paid to the current General Partner.
At such time as the recovery exceeds $6,000,000 in the aggregate, the remaining
escrowed disposition fees shall be paid to the current General Partner.  If such
levels of recovery are not achieved, the current General Partner will contribute
the amounts escrowed towards the recovery.  In lieu of an escrow, 50% of all
such disposition fees have been paid directly to the restoration account and
then distributed among the three Partnerships.  Fifty percent (50%) of the total
amount paid to the recovery was refunded to the current General Partner during
1996 after exceeding the recovery level of $4,500,000.  The remaining amount
allocated to the Partnership may be owed to the current General Partner if the
$6,000,000 recovery level is met.  As of December 31, 1996, the Partnership may
owe the current General Partner $16,296, which is currently reflected as a
recovery, if the $6,000,000 recovery level is achieved.

9.   PMA INDEMNIFICATION TRUST:
     --------------------------

The Permanent Manager Agreement ("PMA") provides that the Permanent Manager will
be indemnified from any claims or expenses arising out of or relating to the
Permanent Manager serving in such capacity or as substitute general partner, so
long as such claims do not arise from fraudulent or criminal misconduct by the
Permanent Manager. The PMA provides that the Partnership fund this
indemnification obligation by establishing a reserve of up to $250,000 of
Partnership assets which would not be subject to the claims of the Partnership's
creditors. An Indemnification Trust ("Trust") serving such purposes has been
established at United Missouri Bank, N.A. The Trust has been fully funded with
Partnership assets as of December 31, 1996. Funds are invested in U.S. Treasury
securities. In addition, $39,637 of earnings have been credited to the Trust as
of December 31, 1996. The rights of the Permanent Manager to the Trust shall be
terminated upon the earliest to occur of the following events: (i) the written
release by the Permanent Manager of any and all interest in the Trust; (ii) the
expiration of the longest statute of limitations relating to a potential claim
which might be brought against the Permanent Manager and which is subject to
indemnification; or (iii) a determination by a court of competent jurisdiction
that the Permanent Manager shall have no liability to any person with respect to
a claim which is subject to indemnification under the PMA. At such time as the
indemnity provisions expire or the full indemnity is paid, any funds remaining
in the Trust will revert back to the general funds of the Partnership.

10.  RESTORATION TRUST ACCOUNT; EXPENSE ALLOCATIONS;
     AND RELATED INTER-PARTNERSHIP RECEIVABLES:
     ------------------------------------------

Restoration costs represent expenses incurred by the Partnership associated with
the misappropriated assets by the former general partners and their affiliates.
These costs are allocated among the Partnerships based on each partnership's
respective share of the entire misappropriation, as currently quantified.  The
amount of 

                                       29
<PAGE>
 
misappropriation for each partnership is adjusted annually to reflect new
discoveries and more accurate quantification of amounts based on the continuing
Investigation. Such adjustments may result in periodic adjustments to prior
allocations of recovery costs to reflect updated information. Consequently,
previous payments for restoration expenses may not be consistent with modified
allocations. Based on modified allocations adjusted as of December 31, 1993, the
Partnership was owed $192,358 from DiVall 3 for amounts paid on its behalf.
During 1994, the Partnership made an additional adjustment increasing the amount
due from DiVall 3 by $9,785. As of December 31, 1996, the Partnership has been
repaid all amounts owed from DiVall 3 for restoration costs.

When recoveries are realized by the Partnerships, the amounts received are
distributed to each respective partnership on the same basis as the restoration
costs are currently being allocated. Additionally, any available recovery funds
have been utilized first to satisfy amounts due other partnerships for amounts
advanced under prior allocation methods. As of December 31, 1996, the
Partnerships recovered a total of $5,120,365 from the former general partners
and their affiliates, accountants and attorneys. Of this amount, the Partnership
received its pro-rata share in the amount of $2,070,924. Additionally, $40,347,
representing 50% of all previously escrowed disposition fees earned by the
General Partner have been paid to the recovery. Of that amount, $16,296 was
allocated to the Partnership and is contingently payable to the General Partner
upon achievement of certain recovery levels as described in Note 8.

The PMA contemplated that the Permanent Manager could establish a separate and
distinct Restoration Trust Fund which would hold all recoveries until a final
independent adjudication by a court of competent jurisdiction or vote of the
Limited Partners ratified the allocation of proceeds to each respective
partnership. Management has concluded that a fair and reasonable interim
accounting for recovery proceeds can be accomplished at the partnership level in
a manner similar to restoration costs which are paid directly by the
Partnerships. Management reserves the right to cause the final allocation of
such costs and recoveries to be determined either by a vote of the Limited
Partners or a court of competent jurisdiction. Potential sources of recoveries
include third party litigation, promissory notes, land contracts, and personal
assets of the former general partners and their affiliates.

On March 24, 1994, an affiliated partnership, DiVall 1, filed a complaint in the
United States District Court for the Western District of Missouri against
Boatmen's First National Bank of Kansas City ("Boatmen's) seeking a declaratory
judgment that Boatmen's has no right or interest in a promissory note executed
in the name of DiVall 1 by the former general partners (the "Note") secured by
mortgages on five DiVall 1 properties, and further seeking an injunction against
foreclosure proceedings instituted against a DiVall 1 property located in
Dallas, Texas under a first deed of trust and security agreement given to secure
the Note (the "Foreclosure"). The former general partners borrowed $600,000
during or before 1991 from Metro North State Bank (now Boatmen's). The proceeds
of the Note were not received by DiVall 1. As of December 31, 1996, DiVall 1 had
not paid debt service on the Note. DiVall 1 received a notice of default on the
Note in October 1993, and the Foreclosure Action was filed in February, 1994. As
of December 31, 1996, interest in the amount of $226,000 had accrued but was
unpaid on the Note. Interest is accrued at the face rate of the note. If DiVall
1 loses the case against Boatmen's, additional interest totaling approximately
$246,000, representing the default rate of interest may be due. Boatmen's has
agreed to stay its foreclosure proceedings pending the outcome of the
litigation. Boatmen's answered the complaint and filed a motion for summary
judgment to which DiVall 1 responded. The District Court granted Boatmen's
motion for summary judgement. DiVall 1 appealed and the Eighth Circuit Court of
Appeals reversed the District Court's ruling. The case was sent back to the
District Court for further discovery and trial. Trial of the case is scheduled
to

                                       30
<PAGE>
 
begin on June 23, 1997. Pursuant to the Restoration Trust Account procedures
described above, all of the Partnerships are sharing the expenses of this
litigation and any recoveries resulting effectively from the partial or full
cancellation of the alleged indebtedness will be allocated among the three
Partnerships on the same basis as the restoration costs are currently being
allocated.

11.  LITIGATION:
     -----------

On March 16, 1993, the Partnership, along with DiVall 1 and DiVall 3, initiated
a lawsuit against Ernst & Young LLP ("E & Y"), a certified public accounting
firm, in the Circuit Court of Dane County, Wisconsin in connection with the
audits of the Partnerships performed by E & Y for the years 1989, 1990, and
1991. The Partnerships requested the payment of damages in the amount of
$9,000,000, plus interest, attorneys fees and costs, and whatever additional
relief the court deemed just and proper. The Partnerships hired legal counsel
under a contingent fee arrangement to prosecute all of the Partnerships' claims.
E & Y filed an Answer denying that it was negligent.

E & Y also filed third-party claims alleging fraud and negligence on the part of
the Partnerships' former law firm, Quarles & Brady. The Partnerships also filed
claims against Magnuson, DiVall, DiVall Real Estate Investment Corporation,
David Shea, and Quarles & Brady.

The trial of the case was scheduled to take place in Iowa County, Wisconsin,
beginning March 20, 1996. Shortly before trial the Partnerships reached a
resolution of their claims against Quarles & Brady. A resolution of the claims
against Ernst & Young was reached after opening statements. As a result of these
settlements, net proceeds to the Partnership, after the payment of contingent
legal fees and related costs, totaled approximately $900,000.

As part of the Permanent Manager Agreement, DiVall, Magnuson, and entities owned
by them, granted the Partnership a security interest in certain promissory notes
and mortgages from other DiVall related entities (the "Private Partnerships").
In the aggregate, the face amount of these notes were equal to a minimum of
$8,264,932. In addition, DiVall, Magnuson, and related entities owned by them,
granted the Partnership a security interest in their general partner interests
in the Private Partnerships. The foregoing security interests were to secure the
repayment of the funds which were diverted by DiVall and Magnuson from the
Partnership. The Partnership shares such security interests with DiVall 1 and
DiVall 3. These promissory notes and mortgages are not recorded on the balance
sheets of the Partnerships, but are recorded as recoveries on a cash basis upon
settlement.

On July 23, 1993, nineteen (19) of the Private Partnerships sought the
protection of the Bankruptcy Court in the Eastern District of Wisconsin. Seven
(7) of these bankruptcies were voluntary and twelve (12) of these bankruptcies
were involuntary. Several of the Private Partnerships seeking bankruptcy owe
promissory notes to DiVall, Magnuson, or entities owned by them, in which the
Partnership has a security interest. These cases were subsequently transferred
to the Western District Bankruptcy Court located in Madison, Wisconsin.

The Partnership's experience in those bankruptcy cases that have concluded,
either through the approval of Plans of Reorganization, dismissal of the
bankruptcies, settlements or a combination of the foregoing, is that (i) the
value of the obligations of the Private Partnerships assigned to the Partnership
has been at a significant discount to their face amounts, and (ii) the General
Partner interests in such Private Partnerships often have little economic value.
The Partnership's recoveries in these bankruptcies have been on a steeply
discounted basis.

Plans of reorganization have been filed in the bankruptcies, and settlement
agreements in all of the Private Partnerships have been reached. Settlements in
the bankruptcies have resulted in cash payments to the Partnerships of a total
of $720,000 and notes secured by subordinated mortgages in the aggregate amount
of $625,000. The Partnerships subsequently sold the secured notes for a total of
$175,000.

                                       31
<PAGE>
 
12.  FORMER GENERAL PARTNERS' CAPITAL ACCOUNTS:
     ------------------------------------------

The capital account balance of the former general partners as of May 26, 1993,
the date of their removal as general partners pursuant to the results of a
solicitation of written consents from the Limited Partners, was a deficit of
$840,229. At December 31, 1993, the former general partners' deficit capital
account balance in the amount of $840,229 was reallocated to the Limited
Partners.

13.  SUBSEQUENT EVENTS:
     ------------------

On February 15, 1997, the Partnership made distributions to the Limited Partners
of $1,000,000 amounting to $21.61 per limited partnership interest.


ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE

Not applicable.

                                   PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The General Partner of the Partnership is The Provo Group, Inc., an Illinois
corporation ("TPG") with its principal office at 101 West 11th Street, Suite
1110, Kansas City, Missouri 64105. TPG was elected General Partner by vote of
the Limited Partners effective on May 26, 1993. TPG had been managing the
Partnership since February 8, 1993, under the terms of the Permanent Manager
Agreement ("PMA"), which remains in effect. TPG also serves as the corporate
general partner for DiVall 1 and DiVall 3. See Items 1 and 13 hereof for
additional information about the PMA and the election of TPG as General Partner.

The executive officers and director of the General Partner who control the
affairs of the Partnership are as follows:

     BRUCE A. PROVO, AGE 46 - PRESIDENT, FOUNDER AND DIRECTOR.
     Mr. Provo has been involved in the management of real estate 
     and other asset portfolios since 1979. Since he founded the 
     company in 1985, Mr. Provo has been President of TPG. From 
     1982 to 1986, Mr. Provo served as President and Chief Operating 
     Officer of the North Kansas City Development Company ("NKCDC"), 
     North Kansas City, Missouri. NKCDC was founded in 1903 and the 
     assets of the company were sold in December, 1985 for 
     $102,500,000. NKCDC owned commercial and industrial properties, 
     including an office park and a retail district, as well as 
     apartment complexes, motels, recreational facilities, fast food 
     restaurants, and other properties. NKCDC's holdings consisted 
     of over 100 separate properties and constituted approximately 
     20% of the privately held real property in North Kansas City, 
     Missouri (a four square mile municipality). Following the sale 
     of the company's real estate, Mr. Provo served as the President, 
     Chief Executive Officer and Liquidating Trustee of NKCDC from 
     1986 to 1991.

                                       32
<PAGE>
 
     Mr. Provo graduated from the Miami University, Oxford, Ohio in 
     1972 with a B.S. in Accounting. He became a Certified Public 
     Accountant in 1974 and was a manager in the banking and 
     financial services division of Arthur Andersen LLP prior to 
     joining Rubloff Development Corporation in 1979. From 1979 
     through 1985, Mr. Provo served as Vice President - Finance and 
     then as President of Rubloff Development Corporation. Mr. 
     Provo has previously served on the Board of Directors of the 
     National Realty committee, a legislative "watchdog" organization 
     for the commercial real estate industry headquartered in 
     Washington, DC.

     KRISTIN J. ATKINSON, AGE 34 - VICE PRESIDENT - FINANCE AND 
     ADMINISTRATION. Ms. Atkinson joined The Provo Group, Inc. in 
     September 1994 to provide management expertise in the areas 
     of financial controls and management accounting services for 
     four limited partnerships managed by TPG. Prior to joining TPG, 
     Ms. Atkinson was Manager of Financial Reporting for Farm &
     Home Savings Association, a $4 billion savings and loan 
     association, for nine years where she was responsible for 
     supervision of the preparation of internal and external 
     financial documentation, including regulatory filings for the 
     savings association and its parent company.  Ms. Atkinson 
     graduated Magna Cum Laude with a B.S. in Accounting from 
     Missouri Southern State College in Joplin, Missouri and worked 
     as an accountant for James P. Arthus and Company for one year 
     before joining Farm & Home Savings Association.

     BRENDA BLOESCH, AGE 35 - DIRECTOR OF INVESTOR RELATIONS.  Ms. 
     Bloesch joined The Provo Group, Inc. in March 1993, to 
     oversee and provide various levels of client support for more 
     than 8,000 broker dealers, registered representatives, 
     custodians and investors. Primarily responsible for all 
     communications regarding four limited partnerships managed by 
     TPG, Ms. Bloesch is also involved with database management 
     and partnership compliance issues. Prior to joining TPG, Ms. 
     Bloesch was Manager of Investment Services at DiVall Real 
     Estate Investment Corporation ("DREIC") for four years and 
     Publisher Services Manager at NewsNet, Inc. for five years. 
     Her role at DREIC allowed Ms. Bloesch to obtain extensive 
     knowledge of limited partnerships and gain familiarity with 
     the broker and investor communities. Ms. Bloesch is a graduate 
     of Lock Haven University in Lock Haven, Pennsylvania, where 
     she received her B.A. in Journalism and Media Studies.

The Advisory Board, although its members are not "Directors" or "Executive
Officers" of the Partnership, provides advisory oversight to management of the
Partnership and consists of:

     D. TODD WITTHOEFT - VICE PRESIDENT OF NELSON WITTHOEFT FINANCIAL.
     Mr.Witthoeft has been an investment broker for over ten (10) 
     years and was one of the original founders of Calton and 
     Associates.  Mr. Witthoeft serves as part of the firm's due 
     diligence committee which reviews the structure of public and 
     private limited partnerships prior to offering to clients. Mr. 
     Witthoeft has over 400 clients and has taught personal financial 
     planning courses.  Mr. Witthoeft holds the following securities
     licenses:  Options Principal, Licensed Life Insurance Agent - 
     series 4; General Securities Representative - series 7; 
     General Securities Principal - series 24; and State Agent - 
     series 63.

     GERHARD ZOLLER - ADVISOR.  Mr. Zoller is currently involved in 
     special training projects at J.H. indorff & Son, Inc., a leading 
     construction firm in Wisconsin.  Mr. Zoller has worked for his 
     company for 27 years and served as both President and then 
     Chairman of the Board in more recent years.  Prior business 
     background and experience include positions as Project Manager, 
     Estimator and Chief Executive.  Mr. Zoller has also been
     actively managing personal investments for over 25 years 
     including several real estate limited partnerships.  Mr. Zoller 
     is a Limited Partner in DiVall 1.

                                       33
<PAGE>
 
     RICHARD W. OTTE - EDITORIAL WRITER. Mr. Otte is in his sixth
     year as an Editorial Board Member and editorial writer for The
     Volusion, a DeLand, Florida, subsidiary of the News-Journal
     Corporation in Daytona Beach, Florida. Mr. Otte retired in 1988
     after 34 years with the Dispatch Printing Co., serving his last
     eight years as Managing Editor of the Columbus Dispatch and as a
     member of its Operating Committee. He previously was the
     executive sports editor of the newspaper in Ohio's capital city.
     Mr. Otte's 49 years in professional journalism also include news
     reporting, editing and sports assignments with the Daytona
     Journal Herald and Springfield News-Sun. Mr. Otte is a Limited
     Partner in DiVall 2.

     ALBERT H. ESCHEN - OPTOMETRIST. Dr. Eschen has been an
     optometrist for 46 years and is also employed by New York City's
     Department of Health. Prior business experience include
     partnerships or personal investments in Crown Nursing Home;
     Coronet Nursing Home; and Sands Hotel & Casino. Dr. Eschen is
     currently a member of the American Optometry Association and is
     a member of the Board of Directors Illinois College Alumni
     Association. Dr. Eschen was past-President of the Brooklyn
     Optometric Society and was the first optometrist to be appointed
     to New York City's Department of Health. Dr. Eschen is a Limited
     Partner in DiVall 3.

ITEM 11.  EXECUTIVE COMPENSATION

The Partnership has not paid any "executive compensation" to the corporate
General Partner or to the directors and officers of the General Partner.  The
General Partner's participation in the income of the Partnership is set forth in
the Agreement of Limited Partnership and amendments thereto, which are filed as
Exhibits 3.1, 3.2, 3.3, 3.4 and 3.5 hereto.  The current General Partner
received management fees and expense reimbursements during the year.

See Item 13, below, and Note 6 to the financial statements in Item 8 hereof for
further discussion of payments by the Partnership to the General Partner and the
former general partners.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

(a)  As of December 31, 1996, no one person or group is known by the Partnership
to own beneficially more than 5% of the outstanding interests of the
Partnership.

(b)  As of December 31, 1996, neither the General Partner nor any of their
affiliates owned any Limited Partner Interests in the Partnership.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The compensation to be paid to TPG is governed by the Partnership Agreement, as
amended by vote of the Limited Partners to reflect the terms of the PMA. TPG's
compensation includes a base fee equal to 4% of the Partnership's gross
collected receipts, subject to a minimum of $159,000 per year. For this purpose,
"gross collected receipts" means all cash revenues arising from operations and
reserves of the Partnerships, including any proceeds recovered with respect to
the obligations of the former general partners. The portion of such fee
resulting from recoveries from former general partners is designated as
restoration fees. TPG is also entitled to reimbursement for office rent and
utilities not to exceed $13,250 per year. TPG is entitled to reimbursement of
reasonable direct costs and expenses, such as travel, lodging, overnight
delivery and postage, but has no right to be reimbursed for administrative
expenses such as payroll, payroll taxes, insurance, retirement and other
benefits, base phone and fax charges, office furniture and equipment, copier
rent, and the like. Between the three Partnerships, TPG is entitled to an
aggregate minimum base management 

                                       34
<PAGE>
 
fee of $300,000 per year and reimbursement for office rent in the maximum amount
of $25,000 per year. The Partnership shall only be responsible for its allocable
share of such minimum and maximum amounts as indicated above ($159,000 minimum
base fee and $13,250 maximum rent reimbursement). TPG is entitled to an annual
increase in the minimum base management fee and maximum office overhead
reimbursement in an amount not to exceed the percentage increase in the Consumer
Price Index ("CPI") for the immediately preceding calendar year. Effective March
1, 1996, the minimum management fee and the maximum reimbursement for office
rent and overhead increased by 2.8% representing the allowable annual CPI
adjustments. Additionally, TPG is allowed up to one-half of the Competitive Real
Estate Commission, not to exceed 3% upon the disposition of assets. The payment
of a portion of such fees is subordinated to TPG's success at recovering the
funds misappropriated by the former general partners.

The PMA has an expiration date of December 31, 2002, but may be terminated
earlier (a) by a vote at any time by a majority in interest of the Limited
Partners, (b) upon the dissolution and winding up of the Partnership, (c) upon
the entry of an order of a court finding that the Permanent Manager has engaged
in fraud or other like misconduct or has shown itself to be incompetent in
carrying out its duties under the Partnership Agreement, or (d) upon sixty (60)
days written notice from the Permanent Manager to the Limited Partners of the
Partnership. Upon termination of the PMA, other than by the voluntary action of
TPG, TPG shall be paid a termination fee of one month's Base Fee allocable to
the Partnership, subject to a minimum of $13,250. In the event that TPG is
terminated by action of a substitute general partner, TPG shall also receive, as
part of this termination fee, 4% of any proceeds recovered with respect to the
obligations of the former general partners, whenever such proceeds are
collected.

Under the PMA, TPG shall be indemnified by the Partnership, DiVall and Magnuson,
and their controlled affiliates, and shall be held harmless from all claims of
any party to the Partnership Agreement and from any third party including,
without limitation, the Limited Partners of the Partnership, for any and all
liabilities, damages, costs and expenses, including reasonable attorneys' fees,
arising from or related to claims relating to or arising from the PMA or its
status as Permanent Manager. The indemnification does not extend to claims
arising from fraud or criminal misconduct of TPG as established by court
findings. To the extent possible, the Partnership is to provide TPG with
appropriate errors and omissions, officers liability or similar insurance
coverage, at no cost to TPG. In addition, TPG is granted the right to establish
and segregate Partnership assets in an amount, not to exceed $250,000, solely
for the purpose of funding such indemnification obligations (the
"Indemnification Trust"). Once a determination has been made that no such claims
can or will be made against TPG, the balance of the Indemnification Trust will
become unrestricted cash of the Partnership. At December 31, 1996 the
Partnership had fully funded the Indemnification Trust.

The following fees and reimbursements from the Partnership were incurred to
management in 1996:

<TABLE>
<CAPTION>
          The Provo Group, Inc.
          ---------------------
          <S>                                        <C>
          Management Fees                            $202,587
          Disposition Fees                             66,750
          Restoration Fees                             33,408
          Leasing Commissions                          53,620
          Office Overhead Allowance                    14,301
          Direct Cost Reimbursements                   21,781
                                                     --------
 
          1996 Total                                 $392,447
                                                     ========
</TABLE>

                                       35
<PAGE>
 
                                    PART IV


ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)  1.   Financial Statements

          The following financial statements of DiVall Insured Income Properties
          2 Limited Partnership are included in Part II, Item 8:

          Report of Independent Public Accountants
 
          Balance Sheets, December 31, 1996 and 1995

          Statements of Income for the Years Ended December 31, 1996, 1995, and
          1994

          Statements of Partners' Capital for the Years Ended December 31, 1996,
          1995, and 1994

          Statements of Cash Flows for the Years Ended December 31, 1996, 1995,
          and 1994

          Notes to Financial Statements

     2.   Financial Statement Schedules

          Schedule III - Real Estate and Accumulated Depreciation
 
     All other schedules for which provision is made in the applicable
     accounting regulation of the Securities and Exchange Commission are not
     required under the related instruction or are inapplicable and, therefore,
     have been omitted.

     3.   Listing of Exhibits
 
          3.1    Agreement of Limited Partnership dated as of November 18, 1987,
                 amended as of November 25, 1987, and February 20, 1988, filed
                 as Exhibit 3A to Amendment No. 1 to the Partnership's
                 Registration Statement on Form S-11 as filed on February 22,
                 1988, and incorporated herein by reference.

          3.2    Amendments to Amended Agreement of Limited Partnership dated as
                 of June 21, 1988, included as part of Supplement dated August
                 15, 1988, filed under Rule 424(b)(3), incorporated herein by
                 reference.

          3.3.   Amendment to Amended Agreement of Limited Partnership dated as
                 of February 8, 1993, filed as Exhibit 3.3 to the Partnership's
                 10-K for the year ended December 31, 1992, and incorporated
                 herein by reference.

          3.4    Amendment to Amended Agreement of Limited Partnership dated as
                 of May 26, 1993, filed as Exhibit 3.4 to the Partnership's 10-K
                 for the year ended December 31, 1993, and incorporated herein
                 by reference.

                                       36
<PAGE>
 
          3.5    Amendment to Amended Agreement of Limited Partnership dated as
                 of June 30, 1994, filed as Exhibit 3.5 to the Partnership's 10-
                 K for the year ended December 31, 1994 and incorporated herein
                 by reference.

          10.0   Permanent Manager Agreement filed as an exhibit to the Current
                 Report on Form 8-K dated January 22, 1993, incorporated herein
                 by reference.

          28.0   Correspondence to the Limited Partners dated February 15, 1997
                 regarding the Fourth Quarter 1996 distribution.

(b)  Reports on Form 8-K:

     The Registrant filed no reports on Form 8-K during the fourth quarter of
     fiscal year 1996.

                                       37
<PAGE>
 
            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
            SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
                               DECEMBER 31, 1996
<TABLE>
<CAPTION>
                                             
                                                                                           Gross amount at which 
                                         Initial cost to Partnership                     carried at end of year (A)
                                         ---------------------------              -----------------------------------------

                                                                         Costs
                                                          Building    capitalized
                                                            and        subsequent                Building and
         Property            Encumbrances     Land      Improvements       to          Land      Improvements     Total
                                                                      acquisitions
---------------------------------------------------------------------------------------------------------------------------
<S>                          <C>            <C>         <C>           <C>            <C>         <C>            <C>
Palm Gardens, Florida (1)    $          -   $  495,237   $   248,388  $   -          $  325,487   $   163,258   $   488,745
Hallandale, Florida (2)                 -      502,578       289,610             -      198,084       147,937       346,021
Oconomowoc, Wisconsin (3)               -      290,400       512,350             -      290,400       428,695       719,095
Phoenix, Arizona                        -      444,224       421,676             -      444,224       421,676       865,900
Phoenix, Arizona                        -            -       295,750             -            -       295,750       295,750
N. Richland Hills, Texas                -      762,580       584,139             -      662,580       584,139     1,246,719
Sandy City, Utah                        -            -       355,847             -            -       355,847       355,847
South Milwaukee, Wisconsin              -      274,749       454,064        79,219      274,749       533,283       808,032
Phoenix, Arizona                        -      482,383       490,343             -      482,383       490,343       972,726
West Jordan, Utah                       -      274,203       343,704             -      274,203       343,704       617,907
Cedar Rapids, Iowa                      -      108,125       552,031             -      108,125       552,031       660,156
Santa Fe, New Mexico                    -            -       451,230             -            -       451,230       451,230
Augusta, Georgia                        -      215,416       434,178             -      215,416       434,178       649,594
Charleston, South Carolina              -      273,619       323,162             -      273,619       323,162       596,781
Park Forest, Illinois                   -      187,900       393,038             -      187,900       393,038       580,938
Aiken, South Carolina                   -      402,549       373,795             -      402,549       373,795       776,344
Augusta, Georgia                        -      332,154       396,659             -      332,154       396,659       728,813
Mt. Pleasant, South Carolina            -      286,060       294,878             -      286,060       294,878       580,938
Charleston, South Carolina              -      273,625       254,500             -      273,625       254,500       528,125
Aiken, South Carolina                   -      178,521       455,229             -      178,521       455,229       633,750
Des Moines, Iowa                        -      164,096       448,529       287,991      164,096       680,902       844,998
Daytona Beach, Florida                  -      291,356       738,488             -      291,356       738,488     1,029,844
Hartford, Wisconsin                     -      201,603       484,960             -      201,603       484,960       686,563
Delavan, Wisconsin (4)                  -      245,718       472,532             -      245,718       390,135       635,853
Milwaukee, Wisconsin                    -      409,143       600,902             -      409,143       600,902     1,010,045
North Augusta, Georgia                  -      250,859       409,297             -      250,859       409,297       660,156
Charleston, South Carolina              -      286,068       294,870             -      286,068       294,870       580,938
Martinez, Georgia                       -      266,175       367,575             -      266,175       367,575       633,750
Grand Forks, North Dakota               -      172,701       566,674             -      172,701       566,674       739,375
Phoenix, Arizona                        -            -       725,000             -            -       500,000       500,000
Phoenix, Arizona                        -      241,371       843,132             -      241,371       843,132     1,084,503
New Smyrna Beach, Florida               -      403,771       622,059             -      403,771       622,059     1,025,830
Ogden, Utah                             -      194,350       452,075             -      194,350       452,075       646,425
Fond du Lac, Wisconsin                  -      297,418       552,349             -      297,418       552,349       849,767
Twin Falls, Idaho                       -      155,269       483,763        60,000      155,269       543,763       699,032
Columbus, Ohio                          -      351,325       708,141             -      351,326       708,140     1,059,466
                           ------------------------------------------------------------------------------------------------
                                       $0   $9,873,899   $16,926,321      $427,210   $9,141,303   $16,448,654   $25,589,957
                           ================================================================================================

<CAPTION>
                                                                                   Life on which
                                                                                  depreciation in
                                                                                in latest statement
                                                                                   of operations
                                                                                    is computed
                             Accumulated           Date of          Date              (years)
                            depreciation        construction      aquired
------------------------------------------------------------------------------------------------------
<S>                         <C>                 <C>              <C>            <C>
Palm Gardens, Florida (1)   $   91,982               -            3/11/88              31.5
Hallandale, Florida (2)         99,399               -            3/11/88              31.5
Oconomowoc, Wisconsin (3)      169,095               -             5/9/88              31.5
Phoenix, Arizona               160,579               -            6/15/88              31.5
Phoenix, Arizona               112,625               -            6/15/88              31.5
N. Richland Hills, Texas       188,281               -            7/15/88              31.5
Sandy City, Utah               115,953               -            7/22/88              31.5
South Milwaukee, Wisconsin     169,666              1986           8/1/88              31.5
Phoenix, Arizona               156,154               -            8/15/88              31.5
West Jordan, Utah              108,128               -            8/22/88              31.5
Cedar Rapids, Iowa             173,667               -             9/9/88              31.5
Santa Fe, New Mexico           119,294               -           10/10/88              31.5
Augusta, Georgia               129,873               -           12/22/88              31.5
Charleston, South Carolina      96,665               -           12/22/88              31.5
Park Forest, Illinois          117,567               -           12/22/88              31.5
Aiken, South Carolina          110,363               -            2/21/89              31.5
Augusta, Georgia               117,114               -            2/21/89              31.5
Mt. Pleasant, South Carolina    87,063               -            2/21/89              31.5
Charleston, South Carolina      75,141               -            2/21/89              31.5
Aiken, South Carolina          134,406               -            3/14/89              31.5
Des Moines, Iowa               193,120              1989           8/1/89              31.5
Daytona Beach, Florida         223,757               -             4/4/89              31.5
Hartford, Wisconsin            137,546               -            4/28/89              31.5
Delavan, Wisconsin (4)         135,853               -             4/1/89              31.5
Milwaukee, Wisconsin           170,416               -             8/2/89              31.5
North Augusta, Georgia         103,365               -           12/29/89              31.5
Charleston, South Carolina      74,467               -           12/29/89              31.5
Martinez, Georgia               92,828               -           12/29/89              31.5
Grand Forks, North Dakota      143,109               -           12/28/89              31.5
Phoenix, Arizona               131,947               -             1/1/90              31.5
Phoenix, Arizona               212,927               -             1/1/90              31.5
New Smyrna Beach, Florida      157,096               -             1/5/90              31.5
Ogden, Utah                    141,864               -            1/31/90              31.5
Fond du Lac, Wisconsin         139,491               -             1/5/90              31.5
Twin Falls, Idaho              125,409               -            3/21/90              31.5
Columbus, Ohio                 165,044               -             6/1/90              31.5
                            -------------
                            $4,881,162
                            =============
</TABLE>

(1)  This property was written down to its estimated net realizable value of
     $400,000 at December 31, 1995. 

(2)  This property was written down to its estimated net realizable value of
     $250,000 at December 31, 1994. 

(3) This property was written down to its estimated net realizable value of
     $550,000 at December 31, 1996.

(4) This property was written down to its estimated net realizable value of
     $500,000 at December 31, 1996.

                                       38
<PAGE>
 
            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

            SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION

                               DECEMBER 31, 1996

<TABLE>
<CAPTION>
                                 YEAR ENDED     YEAR ENDED                                         YEAR ENDED     YEAR ENDED 
                                DECEMBER 31,   DECEMBER 31,                                       DECEMBER 31,   DECEMBER 31,
INVESTMENT IN REAL ESTATE           1996           1995              ACCUMULATED DEPRECIATION         1996           1995    
------------------------------  -------------  -------------         ---------------------------- ------------   ------------
<S>                             <C>            <C>                   <C>                          <C>            <C>         
Balance at beginning of year     $28,180,103    $28,790,395          Balance at beginning of year   $4,822,028     $4,336,437

Deletions:                                                           Additions charged to costs                                 
                                                                     and expenses                      511,650        542,731

Due to disposition                (2,424,094)      (355,411)         Deletion due to real estate                                
                                                                     disposition                      (452,516)       (57,140)
Due to property write-downs         (126,052)      (254,881)                                                                 
                                     -------        -------                                            -------         ------
                                                                                                                             
Balance at end of year           $25,629,957    $28,180,103          Balance at end of year         $4,881,162     $4,822,028
                                 ===========    ===========                                         ==========     ========== 
</TABLE> 

                                       39
<PAGE>
 
                                  SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP


By:  The Provo Group, Inc., General Partner


By:    /s/ Bruce A. Provo
       -----------------------------
       Bruce A. Provo, President


Date:  March 28, 1997


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.


By:    The Provo Group, Inc., General Partner



By:      /s/ Bruce A. Provo
         ---------------------------
         Bruce A. Provo, President


Date:    March 28, 1997



By:    /s/ Kristin J. Atkinson
       -----------------------------
       Kristin J. Atkinson
       Vice President - Finance and Administration


Date:  March 28, 1997

                                       40