An image processing system is arranged to provide rotation compensation and image stabilization in a video scope system such as in endoscopy and laparoscopy systems. The image processing functions may operate at real-time frame rates so that the resulting processed image is observable with no time lag. A rotation sensor is included in the system to sense the position of scope. The sensed scope rotation may be used to cause rotation of the collected image and/or an image displayed on a video monitor. The sensed rotation may be used to identify or calculate a coordinate transformation matrix that is used for processing the image data. The system may include a horizon lock mechanism that can be user-actuated to engage rotation compensation. When the horizon lock mechanism is not engaged, the output image is locked to the scope tip and rotates with rotation of the scope.