<PAGE>
 
                                   FORM 10-Q

                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     September 30, 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
                                        -------   ------

<PAGE>
 
                         PART I - FINANCIAL INFORMATION
                         ITEM 1.  FINANCIAL STATEMENTS

             DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
                                 BALANCE SHEETS

                   September 30, 1996 and December 31, 1995
                   ----------------------------------------

                                     ASSETS
<TABLE>
<CAPTION>
                                                                    (Unaudited)
                                                                   September 30,   December 31,
                                                                        1996           1995
                                                                   --------------  -------------
INVESTMENT PROPERTIES AND EQUIPMENT:(NOTE 3)
<S>                                                                <C>             <C>
     Land                                                            $ 9,141,303    $10,027,077
     Buildings                                                        16,614,705     18,153,026
     Equipment                                                           669,778        669,778
     Accumulated depreciation                                         (5,427,753)    (5,491,806)
                                                                     -----------    -----------

       Net investment properties and equipment                        20,998,033     23,358,075
                                                                     -----------    -----------

NET INVESTMENT IN DIRECT FINANCING LEASES:(NOTE 8)                       474,894        590,527
                                                                     -----------    -----------

OTHER ASSETS:
     Cash and cash equivalents                                         2,976,900      1,005,764
     Cash restricted for real estate taxes                                   184         61,217
     Cash held in Indemnification Trust (NOTE 11)                        286,486        275,231
     Rents and other receivables (net of allowance of
       $64,687 in 1996 and $254,543 in 1995)                             210,856        459,213
     Due from current General Partner                                          0            275
     Deferred rent receivable                                            259,324        296,482
     Due from affiliated partnerships (NOTE 12)                                0         96,088
     Prepaid insurance                                                     3,424         19,631
     Unsecured notes receivable from lessees (net of allowance of
       $304,992 in 1996)                                                  89,948         50,000
                                                                     -----------    -----------
         Total other assets                                            3,827,122      2,263,901
                                                                     -----------    -----------
DUE FROM FORMER AFFILIATES: (NOTES 2 AND 12)
     Due from former general partner affiliates                        1,949,773      3,529,205
     Allowance for uncollectible amounts
        due from former affiliates                                    (1,949,773)    (2,607,104)
     Restoration cost receivable                                       3,746,234      2,823,862
     Allowance for uncollectible
       restoration receivable                                         (3,746,234)    (2,823,862)
                                                                     -----------    -----------

         Due from former affiliates, net                                       0        922,101
                                                                     -----------    -----------

         Total assets                                                $25,300,049    $27,134,604
                                                                     ===========    ===========

</TABLE>
        The accompanying notes are an integral part of these statements.

                                       2
<PAGE>
 
            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

                                BALANCE SHEETS

                   SEPTEMBER 30, 1996 AND DECEMBER 31, 1995
                   ----------------------------------------

                       LIABILITIES AND PARTNERS' CAPITAL
<TABLE>
<CAPTION>
 
                                                                   (Unaudited)
                                                                  September 30,   December 31,
                                                                       1996           1995
                                                                  --------------  -------------
<S>                                                               <C>             <C>
LIABILITIES:
   Equipment notes payable (NOTE 6)                                $          0   $     77,255
   Accounts payable and accrued expenses                                123,927        266,715
   Due to current General Partner                                         4,230            496
   Security deposits                                                    212,223        250,577
   Unearned rental income                                                48,361         18,065
   Real estate taxes payable                                             37,831         57,018
                                                                   ------------   ------------
 
      Total liabilities                                                 426,572        670,126
                                                                   ------------   ------------

CONTINGENT LIABILITIES: (NOTE 10)
 
PARTNERS' CAPITAL: (NOTES 1, 4 AND 14)
   Former general partners -
      Capital contributions                                                 200            200
      Cumulative net income                                             707,313        707,313
      Cumulative cash distributions                                  (1,547,742)    (1,547,742)
      Reallocation of former general partners'
        deficit capital to Limited Partners                             840,229        840,229
                                                                   ------------   ------------

                                                                              0              0
                                                                   ------------   ------------
   Current General Partner -
      Cumulative net income                                              74,739         47,289
      Cumulative cash distributions                                     (29,225)       (18,245)
                                                                   ------------   ------------
 
                                                                         45,514         29,044
                                                                   ------------   ------------
   Limited Partners (46,280.3 interests outstanding)
      Capital contributions, net of offering costs                   39,358,468     39,358,468
      Cumulative net income                                          13,764,992     11,047,463
      Cumulative cash distributions                                 (27,455,268)   (23,130,268)
      Reallocation of former general partners' deficit capital         (840,229)      (840,229)
                                                                   ------------   ------------
 
                                                                     24,827,963     26,435,434
                                                                   ------------   ------------
 
       Total partners' capital                                       24,873,477     26,464,478
                                                                   ------------   ------------
 
       Total liabilities and partners' capital                     $ 25,300,049   $ 27,134,604
                                                                   ============   ============
</TABLE>

       The accompanying notes are an integral part of these statements.

                                       3
<PAGE>
 
            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

                             STATEMENTS OF INCOME

                                  (UNAUDITED)
                                  -----------
<TABLE>
<CAPTION>

                                                         Three Months Ended                Nine Months Ended
                                                         ------------------                -----------------
                                                            September 30,                    September 30,
                                                            -------------                    -------------
                                                         1996           1995             1996             1995
                                                         ----           ----             ----             ----
REVENUES:
<S>                                                   <C>              <C>            <C>              <C>
   Rental income (NOTE 5)                             $  857,490       $916,747       $2,472,172       $2,819,770
   Interest income on direct financing leases             14,426         29,154           48,070           80,196
   Other interest income                                  20,272          8,534           70,669           54,539
   Recovery of amount previously written off              12,925              0          657,331                0
   Other income                                           35,859          3,532           61,613           10,156
   Gain on disposal of assets                            445,772              0          929,997            1,729
                                                      ----------       --------       ----------       ----------
                                                       1,386,744        957,967        4,239,852        2,966,390
                                                      ----------       --------       ----------       ----------
EXPENSES:
   Partnership management fees                            43,098         41,714          128,512          122,699
   Disposition fees                                       46,000              0           66,550            3,000
   Disposition fees - Restoration                              0              0           20,550            3,000
   Restoration fees                                          517            210           25,155            2,341
   Selling Commissions                                         0              0                0            9,900
   Appraisal fees                                              0              0            2,268                0
   Insurance                                               7,371         12,582           29,812           36,361
   General and administrative (NOTE 9)                    26,748         15,208          102,231           78,972
   Advisory Board fees and expenses                        4,446          4,924           13,059           13,594
   Interest                                                    0         11,103            3,551           33,633
   Real estate taxes                                           0              0           (1,709)               0
   Ground lease payments (NOTE 3)                         31,124         30,936           92,996           92,890
   Expenses incurred due to default by lessee              2,269         16,956            4,737           20,672
   Professional services                                  29,157         20,727          107,224           93,880
   Professional services related to investigation          8,901        129,796          510,869          269,218
   Loss on equipment lease                                     0              0                0            7,273
   Depreciation                                          129,489        137,316          388,465          449,101
   Amortization                                              201            201              603              603
                                                      ----------       --------       ----------       ----------
                                                         329,321        421,673        1,494,873        1,237,137
                                                      ----------       --------       ----------       ----------
NET INCOME                                            $1,057,423       $536,294       $2,744,979       $1,729,253
                                                      ==========       ========       ==========       ==========

NET INCOME - CURRENT GENERAL
PARTNER                                               $   10,574       $  5,363       $   27,450       $   17,293
NET INCOME - LIMITED PARTNERS                          1,046,849        530,931        2,717,529        1,711,960
                                                      ----------       --------       ----------       ----------
                                                      $1,057,423       $536,294       $2,744,979       $1,729,253
                                                      ==========       ========       ==========       ==========

NET INCOME (LOSS) PER LIMITED
PARTNERSHIP INTEREST, based on 46,280.3  
Interests outstanding                                 $    22.62       $  11.47       $    58.72       $    36.99
                                                      ==========       ========       ==========       ==========
</TABLE>

       The accompanying notes are an integral part of these statements.

                                       4
<PAGE>
 
             DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

                            STATEMENTS OF CASH FLOWS

                                  (UNAUDITED)
                                  -----------

<TABLE>
<CAPTION>


                                                                     Nine Months Ended September 30,
                                                                     --------------------------------
                                                                        1996                     1995
                                                                     -----------             -----------
<S>                                                                  <C>                     <C>
CASH FLOWS FROM OPERATING ACTIVITIES:                                                      
   Net income                                                        $ 2,744,979             $ 1,729,253
   Adjustments to reconcile net income to net                                              
     cash provided by operating activities -                                               
      Depreciation and amortization                                      389,068                 449,704
      Recovery of amounts previously written off                        (657,331)                      0
      Net (gain) on disposal of assets                                  (929,997)                 (1,729)
      Loss on equipment lease                                                  0                   7,273
      Interest applied to Indemnification Trust account                  (11,255)                (14,298)
      (Increase) Decrease in rents and other receivables                 248,630                (251,050)
      (Deposits)withdrawals for payment of real estate taxes              61,033                 (13,270)
      Decrease in prepaids                                                16,207                  17,962
      Decrease in deferred rent receivable                                37,158                  12,523
      Increase in due to current General Partner                           3,734                   3,840
      (Decrease) in accounts payable and other                          (142,788)                (11,659)
      (Decrease) in security deposits                                    (38,354)                   (200)
      (Decrease) in real estate taxes payable                            (19,187)                (56,612)
      Increase/(Decrease) in unearned rental income                       30,296                  (7,056)
                                                                     -----------             -----------
                                                                                           
        Net cash from operating activities                             1,732,193               1,864,681
                                                                     -----------             -----------
                                                                                           
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:                                            
                                                                                           
   Principal payments received on direct financing leases                115,030                 293,925
   Proceeds from sale of investment properties                         2,901,576                 300,000
   Recoveries from former affiliates                                   1,579,432                  58,525
   Increase in unsecured notes from lesses                               (39,948)                      0
   Payments from affiliated partnerships                                  96,088                  26,013
                                                                     -----------             -----------
                                                                                           
        Net cash from investing activities                             4,652,178                 678,463
                                                                     -----------             -----------
                                                                                           
CASH FLOWS (USED IN) FINANCING ACTIVITIES:                                                 
                                                                                           
   Cash distributions to Limited Partners                             (4,325,000)             (2,780,000)
   Cash distributions to current General Partner                         (10,980)                 (6,632)
   Payments of equipment notes                                           (77,255)               (181,789)
                                                                     -----------             -----------
                                                                                           
        Net cash (used in) financing activities                       (4,413,235)             (2,968,421)
                                                                     -----------             -----------
                                                                                           
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                   1,971,136                (425,277)
                                                                                           
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                       1,005,764               1,349,101
                                                                     -----------             -----------
                                                                                           
CASH AND CASH EQUIVALENTS AT END OF PERIOD                           $ 2,976,900             $   923,824
                                                                     ===========             ===========
                                                                                           
SUPPLEMENTAL DISCLOSURE--cash paid for interest                      $     3,551             $    33,633
                                                                     ===========             ===========

</TABLE>

       The accompanying notes are an integral part of these statements.

                                       5
<PAGE>
 
            DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

                         NOTES TO FINANCIAL STATEMENTS



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 a video rental store and a child care
center. At September 30, 1996, the Partnership owned 36 properties with
specialty leasehold improvements in 16 of these properties.

Deferred organization costs are amortized over a 60-month period. Deferred costs
on proposed acquisitions are capitalized as a cost of the properties upon
acquisition.

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.

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.

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.

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 in interest of the Limited Partners.

                                       6
<PAGE>
 
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, 1995, the tax basis of the Partnership's assets exceeded the
amounts reported in the accompanying financial statements by approximately
$8,700,000.

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 in excess of $14,000,000, of which
approximately $5,696,000 has been attributed to the Partnership and is reflected
as due from former affiliates on the balance sheet at September 30, 1996.  The
9% interest accrued as of September 30, 1996, amounted to approximately
$1,790,000 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.  Permanent Manager Agreement ("PMA") savings, representing cost
savings to the Partnerships as a result of the implementation of the PMA, are
not credited against the due from former affiliates account on the financial
statements of 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 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.

The current General Partner is vigorously pursuing recovery of the
misappropriated funds from the various sources and initially estimated an
aggregate recovery of $3 million for the Partnerships, of which approximately
$1.2 million was allocated to the Partnerships.  As such, an allowance has been
established against amounts due from former general partner affiliates
reflecting the current General Partner's best estimate of probable loss from
misappropriated amounts. This allowance has been allocated among the
Partnerships based on each Partnership's pro rata share of the total
misappropriation.  The amount of the allowance recorded by the Partnership was
reduced by approximately $657,000 during the first nine months of 1996 as a
result of recoveries received in excess of the original estimate.  Pending the
outcome of resolution of all sources of potential recovery, it is not possible
to determine the amount that will ultimately be recovered.

As mentioned above, material weaknesses were identified in the Partnership's
internal control structure.  The internal control structure was not adequate to
assure that all transactions of the Partnership were properly recorded and
reflected in the books and records and financial statements of the Partnership.
Significant transactions affecting the Partnership were apparently initiated by
DiVall and Magnuson during at least the four years ended December 31, 1992,
which initially either were not recorded on the books and records of the
Partnership or were improperly recorded and characterized.  Such transactions
included unsupported disbursements or improper disbursements under the terms of
the Partnership Agreement and the encumbrance of the Partnership assets.  All
such transactions identified during the Regulatory Investigation and concurrent
reviews have been reflected in the Partnership's financial statements as of
September 30, 1996.  Because of the significance of the weaknesses in the
internal control structure, there could be no certainty that all improper and
unsupported transactions were identified and recorded and reflected in the
Partnership's financial statements as of December 31, 1992.  Accordingly, the
Partnership's auditors were unable to render an opinion on the financial
statements for the year ended December 31, 1992.  Financial statements for prior
periods, including 1991 and certain prior years, and quarterly reports as of
September 30, 1992, and certain prior quarters, do not properly reflect such
transactions,

                                       7
<PAGE>
 
but have not been restated due to the impracticality and uncertainty in
attempting to make such restatements. Correspondingly, management has elected to
record currently certain immaterial errors discovered during 1993, which relate
to prior periods, to assure effective disclosure of amounts which have otherwise
been deemed immaterial in relation to partners' capital.

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

As of September 30, 1996, the Partnership owned 33 fully constructed fast-food
restaurants, a 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 fourteen (14) states.

From time to time, the Partnership experiences interruptions in rental receipts
due to tenant delinquencies and vacancies. At September 30, 1996, one of the
Partnership's properties was unoccupied. During 1995, the tenant of the Country
Kitchen restaurant in Cedar Rapids, Iowa, vacated the property and stopped
making rent payments. Management is pursuing a potential sale or lease of the
property and is pursuing collection of the past due rents.

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
full investment of the net proceeds of the offering, approximately 75% of the
original proceeds was invested in the Partnership's properties.

The Partnership's investment properties had been managed by an affiliate of the
former general partners pursuant to a management agreement which provided for a
fee equal to 1% of gross receipts amounting to approximately $8,000 through
February 28, 1993. In addition, the former general partner affiliate was
entitled to receive reimbursements of general and administrative costs, either
direct or indirect, amounting to approximately $49,000 during 1993. As a result
of the Investigation, the Partnership engaged a third party as Interim Manager
in October 1992. The Interim Manager received approximately $53,000 during 1993,
for management services. Subsequent to the appointment of the Permanent Manager,
effective February 8, 1993, these services were being provided by the Permanent
Manager for an overall fee equal to 4% of gross receipts, with a maximum
reimbursement for office rent and related office overhead of $25,000 between the
three affiliated Partnerships as provided in the Permanent Manager Agreement
("PMA"). On May 26, 1993, the Permanent Manager, TPG, replaced the former
general partner as the new General Partner as provided for in an amendment to
the Partnership Agreement dated May 26, 1993. Pursuant to amendments to the
Partnership Agreement, TPG continues to provide management services for the same
fee structure as provided in the PMA mentioned above. The minimum management fee
and the maximum reimbursement for office rent and overhead have increased
annually by the allowable annual Consumer Price Index adjustment per the 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 $36,742 to date on the amounts recovered, which has been
offset against the 4% minimum fee.

The Partnership currently maintains rent insurance policies with terms expiring
in 1996 for 10 of the 36 leased properties. Terms of the rent insurance policies
call for the Partnership to be paid 80% of gross rent due in the event of
nonpayment and vacancy of the property. Under the terms of the original offering
document, rent insurance was originally intended to be obtained on all leased
properties unless the tenant had financial net worth in excess of $5,000,000.
The Partnership did not have sufficient documentation at September 30, 1996 to
substantiate whether the uninsured properties had tenants with adequate net
worth at the time the leases were initiated.

                                       8
<PAGE>
 
The tenant of the Partnership's eight (8) Hardee's restaurants has experienced
sales difficulties over the past two years. 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 September 1996,
management began negotiating new leases with Hardee's Food Systems, Inc.,
whereby all payments due from Terratron for 1996 under their modified lease
terms would be received. Management anticipates execution of these leases during
the Fourth Quarter of 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.

Several of the Partnership's property leases contain purchase option provisions
with stated purchase prices in excess of the original cost of the properties.
The current General Partner is not aware of any 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 these two properties.  One sale closed in January 1996,
resulting in a gain of $484,000.  The other sale closed on September 30, 1996 at
a gain of approximately $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.

Under the terms of the Partnership Agreement, the General Partners were
obligated to create and contribute to an escrow fund an amount equal to 25% of
Net Cash Receipts distributed to the General Partners.  At December 31, 1993,
the General Partner had contributed $1,641 to the fund.  The fund was to be used
to repurchase interests of Limited Partners that exhibited hardship, at the
determination of the General Partner, and for distributions to the Limited
Partners upon final dissolution of the Partnership to permit the Limited
Partners to receive an amount equal to their Liquidation Preference of 13.5% per
annum.  During 1994, it was determined that the amounts being funded to the
escrow fund were immaterial, and the fund was eliminated.  Amounts paid to the
fund were returned to the Partnership.

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

                                       9
<PAGE>
 
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.

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 10.)

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>
<CAPTION> 
          <S>                           <C> 
          Year ending
          December 31,
          1996                          $ 3,048,076
          1997                            3,221,602
          1998                            3,123,336
          1999                            3,156,936
          2000                            3,153,604
          Thereafter                     26,571,560
                                        -----------
                                        $42,275,114
                                        ===========
</TABLE>

Eight (8) of the Partnership's properties are leased to Terratron, Inc., a
franchisee of Hardee's restaurants and ten (10) of the properties are leased to
Wensouth, a franchisee of Wendy's restaurants.  Terratron base rents accounted
for 22% of total base rents for 1995, and Wensouth accounted for 25% of base
rents for 1995.  Due to sales difficulties experienced by Terratron, a one (1)-
year lease modification was entered into, reducing 1996 base rents 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 at December 31,
1995.  During September 1996, management began negotiating new leases with
Hardee's Food Systems, Inc., whereby all payments due from Terratron for 1996
under their modified lease terms would be received.  Management anticipates
execution of these leases during the Fourth Quarter of 1996.

                                      10
<PAGE>
 
6.   EQUIPMENT NOTE PAYABLE:
     -----------------------

In August 1992, the Partnership executed a note payable in the amount of
$190,000 with Norwest Equipment Finance, Inc., for equipment placed in the
Denny's restaurant located in Twin Falls, Idaho. The note was payable in monthly
installments of $4,018, including interest at 9.8% through September 1997 and
was secured by the equipment under a direct financing lease with an initial cost
of $190,000. The note was repaid in full during April 1996.


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

Amounts paid to the current General Partner for the nine-month periods ended
September 30, 1996 and 1995 are as follows.

<TABLE>
<CAPTION>
                                              Incurred as of        Incurred as of
Current General Partner                     September 30, 1996    September 30, 1995
-----------------------                     ------------------    ------------------
<S>                                         <C>                   <C>
Management fees                                  $128,512              $122,699
Disposition fees                                   66,550                 3,000
Restoration fees                                   25,155                 2,341
Overhead allowance                                 10,710                10,420
Reimbursement for out-of-pocket expenses           15,322                13,762
Cash distribution                                  10,980                 6,632
                                                 --------              --------
                                                 $257,229              $158,854
                                                 ========              ========
</TABLE>


8.  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
September 30, 1996:

<TABLE>
<S>                                                            <C>
Minimum lease payments receivable                              $540,470
Estimated residual values of leased property (non-recourse)      22,364
Acquisition fees, net                                               201
Less-Unearned income                                            (88,141)
                                                               --------
    Net investment in direct financing leases                  $474,894
                                                               ========
</TABLE> 

At September 30, 1996, future minimum lease payments for each of the four
succeeding fiscal years are as follows:

<TABLE>
<CAPTION>
                    Year ending
                    December 31,
                    <S>                           <C> 
                    1996                          $ 57,557
                    1997                           196,139
                    1998                           177,791
                    1999                           131,347
                                                  --------
                                                  $562,834
                                                  ========
</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.


                                       11

<PAGE>
 
9.   GENERAL AND ADMINISTRATIVE EXPENSES:
     ------------------------------------

For the periods ended September 30, 1996 and 1995, general and administrative
expenses incurred by the Partnership were as follows:

<TABLE>
<CAPTION>
                                 Three Months Ended         Nine months Ended
                                    September 30,             September 30,
                                --------------------      ---------------------
                                  1996         1995         1996          1995
                                -------      -------      --------      -------
<S>                             <C>          <C>          <C>           <C>
Communication costs             $15,715      $ 9,659      $ 57,756      $44,888
Other administration                952         (407)        4,493        3,156
Travel costs                      1,483          365         3,407        2,266
Overhead allowance                3,592        3,494        10,710       10,420
Registration/filing fees          3,056        2,097        10,420        7,039
Income taxes                      1,950            0        15,445       11,203
                                -------      -------      --------      -------
                                $26,748      $15,208      $102,231      $78,972
                                =======      =======      ========      =======
</TABLE>


10.  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
March 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 September 30, 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.


11.  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 September 30, 1996. Funds are invested in U.S. Treasury
securities. In addition, $36,486 of earnings have been credited to the Trust as
of September 30, 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.


                                       12

<PAGE>
 
12.  RESTORATION TRUST ACCOUNT; EXPENSE ALLOCATIONS;
     AND RELATED INTER-PARTNERSHIP RECEIVABLES:
     ------------------------------------------

Restoration costs represent expenses incurred by the Partnership in relation to
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 misappropriation for each partnership is adjusted annually to reflect
new discoveries and more accurate quantification of amounts based on the
continuing investigation. Such adjustments will 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. Such amounts are reflected on the balance sheet as due from
affiliated partnerships. During 1994, the Partnership made an additional
adjustment increasing the amount due from DiVall 3 by $9,785. These amounts have
been fully repaid by DiVall 3 as of September 30, 1996.

Recoveries realized by the Partnerships are being distributed to each respective
partnership on the same basis as the restoration costs are currently being
allocated. Any available recovery funds have been utilized first to satisfy
amounts due other partnerships for amounts advanced under prior allocation
methods. As of September 30, 1996, the Partnerships recovered a total of
approximately $4,609,000 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 $1,865,000. Additionally, $40,347, representing 50% of
all previously escrowed disposition fees earned by the General Partner, is
reflected as a recovery. Of that amount, $16,296 was allocated to the
Partnership and is contingently payable to the General Partner upon achievement
of the final recovery level as described in Note 10.

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 September 30, 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 September 30, 1996, interest in the amount of $213,000 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
$232,000, 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

                                      13
<PAGE>
 
and trial. 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.

13.  LITIGATION:
     -----------

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, to date, been on a
steeply discounted basis. Management anticipates that the recoveries in the
remaining unresolved bankruptcies are likely to also be on a deeply discounted
basis.

Plans of reorganization have been filed in some of the bankruptcies, and
settlement agreements in many of the Private Partnerships have been reached.
Settlements in eighteen (18) of the bankruptcies to date have resulted in cash
payments to the Partnerships of a total of $580,000 and notes secured by
subordinated mortgages in the aggregate amount of $625,000. Two of the
settlement notes have subsequently been sold for a total of $50,000, and an
option has been granted to purchase the remaining note for $125,000. The
Partnership is continuing to vigorously defend its interests in the remaining
bankruptcies.

14.  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.

15.  SUBSEQUENT EVENTS:
     ------------------

On November 15, 1996, the Partnership made distributions to the Limited Partners
for the Third Quarter of 1996 of $2,500,000 amounting to approximately $54.02
per limited partnership interest.

                                      14
<PAGE>
 
ITEM 2.  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
September 30, 1996, were originally purchased at a price, including acquisition
costs, of approximately $27,000,000.

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

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, resulting in a gain of approximately $484,000. The
sale of the Florida property took place in the Third Quarter of 1996 at a gain
of approximately $446,000.

Terratron, Inc., the lessee of eight (8) Hardee's restaurants has experienced
sales difficulties over the past two years. Management entered into a one year
lease modification with the tenant which reduces 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 at December 31,
1995. During September 1996, management began negotiating new leases with
Hardee's Food Systems, Inc., whereby all payments due from Terratron for 1996
under their modified lease terms would be received. Management anticipates
execution of these leases during the Fourth Quarter of 1996.

The net investment in direct financing leases, which includes the Partnership's
specialty leasehold improvement leases, amounted to $475,000 at September 30,
1996, compared to $591,000 at December 31, 1995. The decrease of $116,000 was a
result of principal payments received.

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

Cash and cash equivalents, including cash restricted for real estate taxes was
approximately $2,977,000 at September 30, 1996, compared to $1,067,000 at
December 31, 1995. The Partnership designated cash of $2,500,000 to fund the
Third Quarter 1996 distributions to Limited Partners, $290,000 for the payment
of accounts payable and accrued expenses, and the remainder represents reserves
deemed necessary to allow the Partnership to operate normally. 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 an additional $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 11 to the financial statements.

                                      15
<PAGE>
 
DUE FROM AFFILIATED PARTNERSHIPS, DUE FROM FORMER AFFILIATES, ALLOWANCE FOR
---------------------------------------------------------------------------
UNCOLLECTIBLE AMOUNTS DUE FROM FORMER AFFILIATES AND DEFERRED INCOME
--------------------------------------------------------------------

Due from former affiliates represented misappropriated assets due from the
former general partners and their affiliates in the amount of $1,950,000 at
September 30, 1996. The receivable decreased from December 31, 1995 due to
$1,567,000 of recoveries received from the former general partners and their
affiliates, including the settlement received in the litigation against the
Partnerships' 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
$3,746,000 at September 30, 1996, and includes $1,790,000 of cumulative accrued
interest.

The current General Partner is vigorously pursuing recovery of the
misappropriated funds from the various sources and initially estimated an
aggregate recovery of $3 million for the Partnerships, of which approximately
$1.2 million was allocated to the Partnership. As such, an allowance was
established against amounts due from the former general partners and their
affiliates reflecting the current General Partner's original estimate of
probable loss from misappropriated amounts. This allowance was allocated among
the Partnerships based on each Partnership's pro rata share of the total
misappropriation. The amount of the allowance recorded by the Partnership was
reduced by approximately $657,000 during the first nine months of 1996 as a
result of recoveries received in excess of the original estimates.

The restoration costs are allocated among the Partnerships based on each
Partnership's respective share of the misappropriation as discussed in Note 12
of the financial statements. 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 repay
amounts owed to the Partnership. At December 31, 1995, the remaining amount due
from DiVall 3 for restoration costs was $74,000. The total amount due was repaid
by DiVall 3 during March 1996 from recoveries received.

As a result of the misappropriation and material weaknesses in the internal
control structure of the Partnership prior to February 8, 1993, there can be no
assurance that all transactions recorded by the Partnership prior to February 8,
1993, were appropriate transactions of the Partnership and properly reflected in
the accompanying financial statements of the Partnership or that all
transactions of the Partnership prior to February 8, 1993, including improper
and unsupported transactions, have been identified and reflected in the
accompanying financial statements of the Partnership as of September 30, 1996.

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

Accounts payable and accrued expenses at September 30, 1996, in the amount of
$124,000, primarily represented the accrual of legal and auditing fees. The
decrease from December 31, 1995, is a result of the payment of out-of-pocket
costs associated with the litigation against the Partnerships' former
accountants and attorneys.

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

                                      16
<PAGE>
 
PARTNERS' CAPITAL
-----------------

Net income for the quarter 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. The former general partners'
deficit capital account balance was reallocated to the Limited Partners at
December 31, 1993. Refer to Note 14 to the financial statements for additional
information regarding the reallocation.

Cash distributions paid to the Limited Partners and to the General Partner
during 1996 of $4,325,000 and $10,980, respectively, have also been in
accordance with the amended Partnership Agreement. The Third Quarter 1996
distribution of $2,500,000 was paid to the Limited Partners on November 15,
1996.

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

Management believes that the financial results of the quarter 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 Partnership's 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 three years.

The Partnership reported net income for the quarter ended September 30, 1996, in
the amount of $1,057,000 compared to net income for the quarter ended September
30,1995, of $536,000. For the nine months ended September 30, 1996 and 1995, net
income totaled $2,745,000 and $1,729,000, respectively. Results for all periods
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 and tenant defaults, as well as gains
recorded during 1996 on the sales of two Applebee's properties. The costs
associated with the misappropriation increased significantly during the First
Quarter of 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. These costs decreased during the
remainder of 1996 due to the settlement of the litigation.

REVENUES
--------

Total revenues were $1,387,000 and $958,000, for the quarters ended September
30, 1996 and 1995, respectively, and were $4,240,000 and $2,966,000 for the nine
months ended September 30, 1996 and 1995, respectively. 1996 revenue included a
recovery of amounts due from the former general partners which had been
previously written off and a gain on the sale of two Applebee's properties.

Total revenues should approximate $3,000,000 annually or $750,000 quarterly
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. The decrease in
estimated recurring revenues from 1995 to 1996 is a result of property sales as
well as the one (1) year lease modification entered into with Terratron, the
tenant of eight (8) Hardee's restaurants.

EXPENSES
--------

For the quarters ended September 30, 1996 and 1995, cash expenses amounted to
approximately 14% and 30%, of total revenues, respectively. For both the nine
months ended September 30, 1996 and 1995, cash expenses totaled 26%. Total
expenses, including non-cash items, amounted to approximately 24% and 44%, of
total

                                      17
<PAGE>
 
revenues for the quarters ended September 30, 1996 and 1995, respectively, and
were 35% and 42% for the nine months ended September 30, 1996 and 1995,
respectively. Items negatively impacting expenses include expenses incurred
primarily in relation to the misappropriation of assets by the former general
partners and their affiliates.

For the nine months ended September 30, 1996 and 1995, expenses incurred in
relation to the misappropriated assets amounted to $511,000 and $269,000,
respectively. Future expenses incurred in relation to the misappropriation
should have a minimal impact on the Partnership.

As noted above, management believes the Partnership's operations have yet to
stabilize to what could be considered normal, due to the negative impact of the
costs related to the recovery of the misappropriated assets.

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. 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.

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.

                          PART II - OTHER INFORMATION

Item 2.  Legal Proceedings

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, to
date, been on a steeply discounted basis. Management anticipates that the
recoveries in the remaining unresolved bankruptcies are likely to also be on a
deeply discounted basis.

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<PAGE>
 
Plans of reorganization have been filed in some of the bankruptcies, and
settlement agreements in many of the Private Partnerships have been reached.
Settlements in eighteen (18) of the bankruptcies to date have resulted in cash
payments to the Partnerships of a total of $580,000 and notes secured by
subordinated mortgages in the aggregate amount of $625,000. Two of the
settlement notes have subsequently been sold for a total of $50,000, and an
option has been granted to purchase the remaining note for $125,000. The
Partnership is continuing to vigorously defend its interests in the remaining
bankruptcies.

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.

The Partnership is also pursuing collection actions against former tenants of
the Partnership and/or guarantors of former tenants of the Partnership arising
from defaults on their leases. Although the Partnership believes its claims are
valid, it is currently unknown whether the Partnerships will receive favorable
verdicts or whether any such verdicts will ultimately prove collectible.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)  Listing of Exhibits:

     28.0  Correspondence to the Limited Partners dated November 15, 1996,
           regarding the Third Quarter 1996 distribution.

(b)  Reports on Form 8-K:

     The Registrant filed no reports on Form 10-K during the third quarter of
     fiscal year 1996.

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<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:  November 13, 1996


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:  November 13, 1996



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


Date:  November 13, 1996

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