The film begins in a large garage structure, where Lt. Proctor (Lance Kinsey) and Commandant Mauser (Art Metrano) meet up with former cadets (now Sgts.) Chad Copeland (Scott Thomson) and Kyle Blanks (Brant van Hoffman) from Commandant Lassard's police academy. It seems one of the two police academies is getting the axe due to the state government's unwillingness to continue financing two academies, and Mauser wants Copeland and Blanks to make sure Lassard fails. The men agree to the plan, knowing this may be their only chance at revenge against Lassard for graduating them at the bottom of their class.
The following day, after the governor's (Ed Nelson) speech in which he will appoint a committee to evaluate which of the two academies should remain open, Mauser starts getting an edge by kissing up to the governor, but Sgt. Jones (Michael Winslow) quickly prevents this by discreetly humiliating Mauser in front of the governor with his noise imitations that sound like belching. Commandant Lassard (George Gaynes) gets an idea on how to win: along with now Sgt. Jones and Lt. Callahan (Leslie Easterbrook), he calls back Sgt. Mahoney (Steve Guttenberg), Sgt. Hooks (Marion Ramsey), Sgt. Hightower (Bubba Smith), and Sgt. Tackleberry (David Graf) to help train the new recruits. Among the new recruits are Sgt. Fackler's wife, Violet (Debralee Scott), whom Sgt. Fackler (Bruce Mahler) is against being trained to be a police officer; Sweetchuck (Tim Kazurinsky) and Zed (Bobcat Goldthwait), who have a history from the second movie as a meek small business owner being harassed by a gang led by Zed; Karen Adams (Shawn Weatherly), a beautiful young woman whom Mahoney is attracted to but who rejects his overtures; and Tackleberry's brother-in-law Bud Kirkland (Andrew Paris). Tomoko Nogata (Brian Tochi) is at first a recruit of Mauser's academy, but Mauser transfers him in with Lassard's academy instead in hopes of sabotaging the latters' academy further.
After a few weeks of training, Nogata is lovestruck over Callahan. Sweetchuck contemplates quitting after Zed, whom he was forced to room with, drives him crazy, but Tackleberry talks him out of it and takes him under his wing. Copeland and Blanks make the recruits do things that would make the committee think they are incompetent. The recruits fail and are teased by Mauser and Proctor. However, Mahoney gets back at them by taping Mauser's eyes closed while doing a taste test. Proctor succeeds in removing the tape, but the tape pulls off Mauser's eyebrows.
Both Lassard and Mahoney give a pep talk to each of the cadets before training resumes. Adams finally warms up to Mahoney after his pep talk and bonds with him for the rest of the film. At the policepersons' ball, Mahoney meets up with his prostitute friend from the first film (Georgina Spelvin), and has her do a favor on Proctor after the latter insults Mahoney and Adams. The prostitute tricks Proctor into removing all his clothes and then locking him out of the hotel room, and while trying to get back to his academy, Proctor accidentally enters the Blue Oyster Bar. Meanwhile, Mauser insults Lassard in front of the recruits by telling him that he is winning, so Mahoney gets him back by giving a speech at the ball and then putting the microphone in a pitcher of water. When Mauser grabs it, the microphone shocks him.
On the final day of the cadet training/evaluation competition, one recruit from each academy attends the governor's ball (Proctor misunderstands and sends in two, one of whom is portrayed by David James Elliott). Copeland and Blanks play with the computer system and send cars to the wrong locations in their attempt to help Mauser win, but they are caught by Hooks, who knocks them out cold. At the governor's party, a gang of thieves dressed as busboys start robbing the guests and take the governor hostage. Mauser's cadets promptly faint upon being threatened by the thieves, but Lassard's cadet Hedges (David Huband) manages to alert Lassard's team, prompting Mahoney and the gang to rescue the governor. Mauser's academy proves to be ineffective to react to the emergency, but Lassard's squad arrives just in time to fight off the thieves and rescue the governor.
As a result of the governor's final judgment, Mauser's academy is shut down due to them being ineffective in stopping the robbery at the party, while Lassard's stays open. The epilogue shows Lassard delivering a speech on how the academy is grateful for the "many, many" recruits. The graduating class salutes the camera as the film ends.
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