Notes To Financial Statements

1. Business and Organization

Tel-Instrument Electronics Corp. ("Tel" or the "Company") has been in business since 1947. The Company designs, manufactures, and markets avionic test equipment for the general and commercial aviation markets and for the government/military aviation markets. The Company's instruments are used to test navigation and communications equipment installed in aircraft. The Company sells its equipment to both the domestic and international markets.

2. Summary of Significant Accounting Policies

Revenue Recognition:

Revenues are recognized at the time of shipment and provisions, when appropriate, are made where the right to return exists.

Cash and Cash Equivalents:

For purposes of the statements of cash flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at costs which approximates market value.

Concentrations of Credit Risk:

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable. The Company's customer base is primarily comprised of airlines and the U.S. Government. As of March 31, 1997, the Company believes it has no concentration of credit risk with its accounts receivable.

Inventories:

Inventories are stated at the lower of cost or market. Cost is determined on a first-in, first-out basis. In accordance with industry practice, service parts inventory is included in current assets, although parts are carried for established requirements during the serviceable lives of the products and, therefore, are not expected to be sold within one year.

TEL-INSTRUMENT ELECTRONICS CORP.

Notes To Financial Statements (Continued)

2. Summary of Significant Accounting Policies (Continued)

Office and Manufacturing Equipment:

Office and manufacturing equipment are stated at cost. Depreciation and amortization is provided on a straight-line basis over periods ranging from 3 to 10 years.

Maintenance, repairs, and renewals that do not materially add to the value of the equipment nor appreciably prolong its life are charged to expense as incurred. Upon retirement or disposition of a fixed asset, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is included in the Statements of Operations.

Research and Development Costs:

Research and development costs are expensed as incurred.

Income/(Loss) Per Common Share:

The computation of income/(loss) per common share is based on the weighted average number of shares outstanding, including dilutive common stock equivalents. Preferred stock dividends are considered when determining per share amounts. In fiscal 1995 the preferred stock dividend of $30,000 was deducted from the income before extraordinary item of $10,476, which resulted in the loss per share before extraordinary item of $.01. The convertible subordinated notes are not considered common stock equivalents for the purpose of determining per share amounts.

Accounting for Income Taxes:

Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that will be in effect when such differences are expected to reverse. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefit which is not expected to be realized. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in the period that such tax rate changes are enacted.

Stock Option Plan:

Prior to April 1, 1996, the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On April 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), which permits companies to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively SFAS 123 allows companies to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per

TEL-INSTRUMENT ELECTRONICS CORP.

Notes To Financial Statements (Continued)

2. Summary of Significant Accounting Policies (Continued)

share disclosures for employee stock option grants made in fiscal year 1996 and future years as if the fair-value-based method as defined in SFAS No. 123 has been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires that management 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 reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates include taxes, inventory and accounts receivable valuation.

Reclassification

Certain amounts have been reclassified to conform to the current year presentation.

                                                          March 31,
                                                ---------------------------
                                                  1997               1996
                                                --------           --------
     Government                                 $163,490           $147,542
     Commercial                                  139,247            211,952
                                                --------           --------
                                                $302,737           $359,494
                                                ========           ========

4.   Inventories

     Inventories consist of:

                                                          March 31,
                                                ---------------------------
                                                  1997               1996
                                                --------           --------
     Purchased parts                            $213,842           $160,327
     Work-in-process                             206,750            246,668
     Less: Reserve for obsolescence              (68,419)           (60,121)
                                                --------           --------
                                                $352,173           $346,874
                                                ========           ========

The work-in-process includes $71,943 and $147,090 for government contracts at March 31, 1997 and March 31, 1996, respectively.

5.   Office and Manufacturing Equipment

                                                          March 31,
                                                ---------------------------
                                                  1997               1996
                                                --------           --------
     Leasehold Improvements                    $  39,657          $  36,999
     Machinery and equipment                     487,672            471,083
     Sales equipment                              70,663             68,021
     Less:  Accumulated depreciation            (552,500)          (534,278)
                                               ---------          ---------
                                               $  45,492          $  41,825
                                               =========          =========

                                                     March 31,
                                           ---------------------------
                                             1997               1996
                                           --------           --------

Deferred salary and wages and interest    $169,955            $468,980
Accrued vacation pay                        53,157             101,621
Accrued salary, and payroll taxes           24,851              19,752
Accrued profit sharing                      94,469                --
                                          --------            --------
                                          $342,432            $590,353
                                          ========            ========

Through March 31, 1994, the Company maintained a salary and wage deferral plan which was applicable for all employees. The deferrals were scaled in proportion to an employee's salary level. Interest is accrued on the amount of deferred salary and wages. Such deferred amounts have been recognized as expense in the period incurred. The Company's managers also deferred salary for portions of the fiscal years ending March 31, 1997 and March 31, 1996.

Other accrued expenses of $325,556 and $351,099 at March 31, 1997 and 1996, respectively, consist primarily of professional service costs for legal, accounting and consulting services and of product related costs, such as warranty.

TEL-INSTRUMENT ELECTRONICS CORP.

Notes To Financial Statements (Continued)

7. Redeemable Preferred Stock

In July 1996, a group of the Company's employees and creditors (the "Group") agreed to purchase the Company's outstanding redeemable preferred stock (the "Preferred Stock") from the preferred stockholder. The Group purchased the Preferred Stock from the preferred stockholder for $111,700 and exchanged the Preferred Stock for unregistered shares, legended, of the Company's common stock and common stock purchase warrants (the warrants). The Company had been previously obligated to the Group for certain incurred liabilities and these funds were used by the Group to purchase the Preferred Stock. The Company's Board of Directors approved the exchange of the Preferred Stock and accrued dividends for 178,720 newly issued unregistered shares, legended, of common stock and warrants to purchase an additional 35,744 shares of common stock. The warrants are exercisable at a price of $0.75 per share until March 31, 1997, $1.50 until March 31, 1998 and $2.25 until March 31, 1999. At March 31, 1997, 32,291 have been exercised.

The issuance of 178,720 common shares was recorded based upon the estimated market value of the stock at the time of the transaction. The difference between the market value and par value was credited to additional paid-in capital. The redemption of the Preferred Stock in exchange for common stock resulted in a difference of $494,943 between the carrying value of the Preferred Stock ($606,643) and the market value ($111,700) of the Company's common stock and such difference was recorded as an increase to additional paid-in capital. Based upon the application of an option pricing model and in accordance with SFAS No. 123, the warrants were estimated to have a fair value of $6,434 which amount was recorded in connection with this transaction. The exchange of the Preferred Stock and accrued dividends for unregistered shares, legended, of common stock and warrants was recorded as a non-cash financing transaction.

Current:
   Federal                                    $     --

   State and Local                                  --
                                              ----------
   Total Current Benefit                      $     --
                                              ==========

Deferred:
   Federal                                    $ (299,000)

   State and Local                               (41,200)
                                              ----------
   Total Deferred Benefit                     $ (340,200)
                                              ==========

The  components of the Company's  deferred taxes at March 31, 1997 and 1996
are as follows

                                                March 31,    March 31,
                                                   1997        1996
                                                ---------    ---------
Net operating loss carryforwards              $1,222,000    $1,446,900
Asset reserves                                    53,000        50,400
Deferred wages and accrued interest              206,000       218,800
Provision for estimated expenses                  70,000        78,500
                                              ----------    ----------
Deferred tax asset                             1,551,000     1,794,600

Less, valuation allowance                      1,210,800     1,794,600
                                              ----------    ----------
Amount recognized in financial
  statements                                  $ (340,200)    $     --
                                              ==========    ==========

As of March 31, 1997, the Company has Federal tax net operating loss carryforwards of approximately $3,521,000 which begin to expire in 1998. As of March 31, 1997 and 1996, the Company reduced the valuation allowance to reflect the deferred tax assets utilized to offset income tax expense. In addition, during 1997, the Company, in accordance with FASB 109, reduced the valuation allowance to recognize in the financial statements a deferred tax asset of $340,200 at March 31, 1997. The recognized deferred tax asset is based upon the expected utilization of net operating loss carryfowards as the Company believes it is more likely than not it will realize a portion of its net operating losses before they expire. The remaining valuation allowance consists of the estimated amount of deferred tax assets which may not be realized due to the expiration of net operating losses. The foregoing amounts are management's estimates and the actual results could

TEL-INSTRUMENT ELECTRONICS CORP.

Notes to Financial Statements (Continued)

8. Income Taxes (Continued)

differ from those estimates. Future profitability in this competitive industry depends on the continually obtaining and fulfilling new profitable contracts and modifying products. The inability to obtain new profitable contracts or the failure of the Company's engineering development efforts could reduce estimates of future profitability in the near term, which could affect the Company's ability to utilize the deferred tax asset on the balance sheet or its loss carryfowards.

A reconciliation of the income tax expense at the statutory Federal tax rate of 34% to the income tax expense recognized in the financial statements is as follows:

                                                 1997             1996
                                                 ----             ----
Income tax expense - statutory rate           $ 150,000        $ 32,500
Income tax expenses - state and
  local, net of federal benefit                  27,200
Reduction of federal valuation allowance       (542,600)        (32,500)
Other                                            25,200            --
                                              ---------        --------
Income tax benefit recognized
  in financial statements                     $(340,200)        $   --
                                              =========        ========

9. Related Party Transactions

At March 31, 1996 the $100,000 non-current note payable - related party was payable to the Company's Chairman/President, bore interest at 10% and was payable on demand no earlier than April 1, 1997. At March 31, 1996 accrued interest thereon of $72,500 was included in accrued expenses - related parties.

On March 31, 1997, the Company's Chairman/President renegotiated the term of the non-current note payable-related party. This note, along with $250,000 of other accrued expenses due to the Company's Chairman/President, were converted into seven $50,000 convertible subordinated notes (the "Notes") totaling $350,000. The Notes become due beginning March 31, 1999 with the last note due March 31, 2005. The Notes bear interest at a rate of 10% per annum, payable semi-annually on the last day of September and March of each year. The Company is required to prepay the outstanding balance of the Notes and any accrued interest thereon, if the Company sells all or substantially all of its assets. The Notes can be converted into newly issued common shares of the Company at the conversion price of $1.50 per share until March 31, 1998, and thereafter at $2.50 per share. The conversion prices shall be adjusted for any stock dividends, stock issuances or capital reorganizations. The Notes may be redeemed by the Company prior to maturity upon giving written notice of not less than 30 days or more than 60 days at a redemption price equal to 120% of the principal if redeemed two years or more

TEL-INSTRUMENT ELECTRONICS CORP.

Notes To Financial Statements (Continued)

9. Related Party Transactions (Continued)

prior to the maturity date or 110% of the principal if redeemed more than one year, but less than two years prior to the maturity date.

Accrued payroll, vacation pay and deferred wages and related interest includes, $114,555 and $374,343 at March 31, 1997 and 1996, respectively, which is due to officers of the Company.

Accrued expenses-related parties consists of interest and expenses due to an officer of the Company of approximately $16,000 and $82,000 at March 31, 1997 and 1996, respectively. In addition, accrued expenses-related parties includes interest and professional fee of approximately $54,000 due to an officer/stockholder of the Company at March 31, 1997 and 1996.

Tel has obtained professional services from an officer/stockholder with the related fees amounting to approximately $35,600, $21,000 and $12,000 which are included in selling, general and administrative expenses for the years ended March 31, 1997, 1996 and 1995, respectively.

The Company's $30,000 convertible subordinated note-related party matured on March 31, 1997. The Company renegotiated such note and satisfied $15,000 of this obligation and extended the maturity date of the remaining $15,000 until March 31, 1999. This note accrues interest semi-annually at a rate of 7%. The subordinate note is for past professional fees and services converted into a note payable due to an officer/stockholder of the Company. The notes are convertible to common stock at the option of the holder at $1.50 per share, at any time prior to maturity.

10. Convertible Subordinated Notes

The Company's $35,000 convertible subordinated note matured and was discharged on March 31, 1997.

During the year ended March 31, 1995, a convertible subordinated note with a face value of $35,000 was redeemed for $23,000. The gain on this transaction of $12,000 has been recognized as an extraordinary item - extinguishment of debt. As part of the redemption transaction the subordinated noteholders adjusted the interest due and accrued by $6,942. This income has been reflected within the operating statement line item interest expense-related parties.

11. Leases

The Company rents its office space and manufacturing facility under a lease agreement expiring in August, 1998. Minimum lease payments are $55,824 in 1997 and $20,934 in

TEL-INSTRUMENT ELECTRONICS CORP.

Notes To Financial Statements (Continued)

11. Leases (Continued)

1998. Under terms of the lease, the Company pays all real estate taxes and utility costs for the premises.

Total rent expense, including real estate taxes, was approximately $80,000, $84,000, and $85,000 for the years ended March 31, 1997,1996 and 1995, respectively.

12. Significant Customer Concentrations

No distributor or end user customer accounted for more than 10% of commercial sales for the year ended March 31, 1997. Sales to a major commercial distributor accounted for 14% and 12% of total commercial revenue for the years ended March 31, 1996 and 1995, respectively. Sales to another commercial distributor accounted for 12% of total commercial revenue for the year ended March 31, 1996. Foreign commercial sales were 14%, 27% and 17% of total commercial sales for the years ended March 31, 1997, 1996 and 1995, respectively.

Government sales to the USAF were 46% and 37% of total government sales, respectively, for the years ended March 31, 1997 and 1996. Government sales to the CDF and US Army for the fiscal year ended March 31, 1996 were 30% and 18% of total government sales, respectively. Government sales to the CDF and US Coast Guard for the fiscal year ended March 31, 1995 were 54% and 23% of total government sales, respectively.

13. Stock Option Plan

The Company has a stock option plan that provides for the granting of options to employees and directors. Activity during 1997, 1996 and 1995 is summarized below (in number of options):

                                        1997        1996        1995
                                      -------     -------     -------
Held at beginning of year             107,886      54,153      57,653
Granted                                 6,933      53,733        --
Exercised                               1,667        --          --
Canceled or expired                    19,933        --        (3,500)
                                      -------     -------     -------
Held at end of year                    93,219     107,886      54,153
                                      =======     =======     =======

TEL-INSTRUMENT ELECTRONICS CORP.

Notes To Financial Statements (Continued)

13. Stock Option Plan (Continued)

For the years ended March 31, 1997, 1996 and 1995 the Company had 59,130, 38,100 and 21,600 of options outstanding and exercisable.

As of March 31, 1997, the Company had 93,219 options outstanding of which 86,286 are exercisable at $0.375 per share with a weighted average remaining contractual life of 2.4 years and 6,933 are exercisable at $0.72 per share with a weighted average remaining contractual life of 4.2 years.

The per share weighted-average fair value of stock options granted during 1997 and 1996 were $0.64 and $0.33, respectively on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: expected dividend yield of 0.0%, risk-free interest rate of 5%, volatility factor of 135%, and an expected life of 5 years. The Company applies Accounting Principles Board Opinion No. 25 in accounting for its stock options and, accordingly, no compensation expense has been recognized for its stock options in the financial statements. Had the Company determined compensation cost based on the fair market value at the grant date for its stock options under SFAS No. 123, the Company's net income would not have been materially affected. The pro forma amounts are indicated below:

                                             1997            1996
                                           -------         -------
Net income - as reported                  $781,284        $ 95,679
Net income - pro forma                     775,526          92,524

Earnings per share - as reported          $   0.41            0.04
Earnings per share - pro forma                0.41            0.04

In accordance with SFAS No. 123, pro forma net income and earnings per share data reflect only options granted in 1996 and 1997. Therefore, the full impact of calculating compensation expense for stock options under SFAS No. 123 is not reflected in the pro forma amounts presented above since compensation expense for options granted prior to April 1, 1995 was not considered.