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iOscilloscope (App Store link) is a new $.99 app that turns your iPhone into a virtual oscilloscope that can measure sound waves in real time.
iOscilloscope lets you do do several different things:

FFT allows you to view the sound waves in Fast Fourier transform mode.
Mute, mutes the sound so that there is no feedback.
Sonogram allows you [...]

Sonoma Wire Works has launched FourTrack (App Store link), a multitrack audio recorder for the iPhone and iPod touch (2nd Generation).
FourTrack works with the iPhone built-in microphone, a headset mic or an iPod touch with a third-party mic and headphones.
WiFi sync allows FourTrack recordings to be downloaded to any desktop computer with a browser. Tracks can then be loaded [...]

MilkyApps’ BeatBox Live (App Store link) is a $2.99 drum pad music application that lets you play your own drum patterns and also play over original urban/pop/rock music.
BeatBox Live includes 6 different drum kits and 12 original soundtracks. 
Kits Include:

Beatbox Drums (Vocal Beats)
808 Drums
Latin Drums
Hip-Hop Drums
Indie Drums
Euro/Dance Drums

PASY02 (App Store link) is a new synthesizer based on a physical simulation. It retails for $0.99.
Description:
You can enjoy the sound visually with PASY02. Swing the net on the screen to control the sound.?If you pull the net, it waves under tension and the sound changes.
The net tention parameter settings are configurable.?You can choose waveform [...]

Don’t watch this video on any illicit substances - it’s trippy enough already.
It’s an introduction to the “mind twisting hearing sensation” RjDj.
RjDj is an application for the iPhone that samples input to your iPhone’s earbud microphone, manipulates it in interesting ways and then sends it to the earbuds, creating a sound collage based on your [...]

A preview showing one of the new features coming in synthPond version 2.0 (a free upgrade from 1.0.x)

Smule’s Sonix Vox is a $.99 iPhone app that lets you do real-time audio processing. Sonic Vox shifts and contorts your voice while you are talking, letting you sound like Darth Vader or a chipmunk.
Features:

Alter your voice with a swipe of your finger. Want to cross over to the Dark Side? Slide your finger to the left. [...]

The above video demonstrates the $.99 SonicLife (App Store Link) application for iPhone / iPod Touch, triggering drum samples in Ableton Live with the help of OSCulator.
SonicLife is a creative, interactive controller for iPhone / iPod Touch that sends Open Sound Control messages over a Wi-Fi network using the UDP protocol.
The application runs a simple cellular [...]

Bedrum (App Store Link) is a $4.99 app that turns your iPhone into a classic drum machine.
Features:

Easy and quick to use interface
Choose between 4 different drumsets
16 step programmable pattern sequencer

Bedrum was developed by Magnus Larsson and Nick Rudolfsky.

A demo of drumming on the iPhone with DigiDrummer (App Store Link). 
DigiDrummer features:

Interface designed to work with your fingers. Makes it easy to play drums on your iPhone and
iPod Touch!
16-bit high quality samples
8 drum pads

More information is available at the DigiDrummer site.