Naruto has been up to his usual mischief again. This time he's wanted for defacing the faces of the Mt Rushmore-like rock carvings of the Hokage above the village. Naruto manages to fool his pursuers by camouflaging himself by a nearby fence and almost gets away cleanly until Iruka Sensei shows up and scares the heck out of him.
After dragging Naruto back to class, Iruka wants to know why he is now playing pranks instead of attending class. After all, he's already failed the last two graduation exams. Iruka then declares that they will be having an exam on "Hengo no Jutsu" (Transformation Skill). Soon, each person takes their turn transforming themselves to look like Sensei, but Naruto tries to be difficult by transforming himself into a naked blonde girl he calls "Sexy no Jutsu." For that, Iruka Sensei keeps him after class to clean all the paint off the rock carvings. Naruto doesn't seem to care, replying that it's not like he has a home to go home to, so Iruka Sensei offers to treat him to a ramen dinner at Ichiraku Ramen if he works hard. That's enough to motivate Naruto.
At dinner, Iruka Sensei asks Naruto why he was defacing the Hokage. He answers that the Hokage are the village ninjas and the Fourth was the one who defeated the demon fox. One day he will get the Hokage name and surpass all the others. One day the villagers will recognize his strength.
The next day is the graduation exam, which consists of "Bunshin no Jutsu" (Clone Skill). Naruto steps up ready to try, knowing that is his worse skill, and on his first try, he produces a deformed clone of himself. Immediately, Iruka declares the test a failure, but Mizuki Sensei asks him to reconsider. Technically, Naruto did do the clone and he also has excellent athletic ability and stamina. Iruka sighs and replies that everyone else in the class divided themselves into at least three, but Naruto was only able to create one useless clone. Because of that, he can't pass him.
Later that night, Mizuki abruptly awakens Iruka. Naruto has taken the Scroll of Seals from Hokage-sama's place. Meanwhile, Naruto sits with the scroll looking over the technique list. The first is "Kage Bunshin" (Shadow Clone).
Iruka is the first to find Naruto, who is all proud of himself for learning the first technique that should allow him to graduate. Iruka asks where he learned about the scroll and he replies from Mizuki. Iruka immediately recognizes the trap, but he is soon attacked by Mizuki, who wants the scroll with the forbidden Ninjutsu within it for himself.
When Naruto won't hand the scroll over so quickly, Mizuki decides to tell Naruto about the rule of the village. 12 years ago a rule was created not to tell him that he is the nine tails fox demon that killed Iruka's parents and destroyed the village. That's why everyone hates him.
Suddenly, Mizuki throws a large ninja star at Naruto. Iruka warns him to duck and then immediately covers him to save his life. Naruto can't understand why anyone would do anything nice for him. Iruka replies that they are the same. Just as Naruto has no parents and does mischievous things so people acknowledge him, Iruka, too, craved attention after his parents died and sought attention any way he could get it. He knows how Naruto must feel and apologizes for never recognizing how lonely Naruto must be. Mizuki interjects that Iruka is lying, which gives Naruto reason to run away from the two.
Iruka catches up with him and asks for the scroll back, but Naruto recognizes that it isn't Iruka but Mizuki and refuses. Iruka posing as Naruto then transforms himself back into himself and defends Naruto against Mizuki's accusations. He's not the demon fox, but the Hidden Leaf Village's Uzumaki Naruto. Mizuki takes that opportunity to finish Iruka, but Naruto steps in and defends him. He does Kage Bunshin no Jutsu and soon there are many Naruto clones surrounding Mizuki. Soon he is defeated and Iruka rewards Naruto with graduation.