If I stop audio with audio.stop() I hear an ugly scratch sound from the iPad2 speakers. Same thing happens with headphones as well. I don't hear it with older builds so something must have changed in the Corona audio system.

The weird thing is I hear the scratch only in iPad2 not in iPad. Also, I can't hear the scratch in the simulator. Does anyone have similar issue? This is keeping me from releasing my game.

I forgot to mention that this problem doesn't exists on my iPad1 which has an old iOS. My iPad2 has iOS5 so maybe that's the problem...

Simple workaround is to fade out before stopping.

I'm not aware of this specific problem, however there are some really bad bugs in iOS 5.0. This could be another one or a side effect of one of the others.

Since you don't have this problem on your other device, this is an Apple regression bug. Please file a bug with Apple at https://bugreport.apple.com/ and let them know about it. Please include as much detail as possible in your bug report and also include an iOS binary that reproduces the problem (i.e. build for device and attach it to your bug report).

Since I haven't seen this, I might also suggest re-encoding your files to something else to see if it makes a difference, say a 22050Hz and or 44100Hz wav file as an example.