A single pilot corporate jet failed to comply with the altitude restrictions on the RUUDY SID from TEB. An autopilot disconnect due to a failed AHRS system at a critical point contributed to the reporter's loss of situational awareness.

Narrative

Upon reaching Runway 24; AHRS2 (Altitude Heading Reference System) had failed for 2 seconds; then corrected itself. After departure; I flew the 240 degree heading leg of the Ruddy Two departure. I turned to WENTZ on a heading of 260 and engaged the autopilot at approximately 500 FT AGL. There was a distraction in the cabin; (spilled drink and small commotion) and then the autopilot failed; and I got a indication of a AHRS2 failure. During the autopilot failure; I did not hear the altitude alerter. Three seconds later; I called Approach and checked on with '[Flight number] 2;000 climbing' after looking down at my altimeter. The Controller immediately asked what I was climbing to and I realized that I was high; I replied back with 'descending 2;000' and the Controller asked what altitude I was assigned in a stern voice; I replied 2;000; and he asked again; I was honestly confused on which segment of the departure I was on. I was pulling the power back at this time; hand flying and attempting to re-establish situation awareness. I realized that I hadn't yet reached TASCA and that I had not only missed the 1;500 FT level off; but in the confusion; I had climbed to 2;300 FT MSL. The AHRS again correct itself and I was able to re-engage the autopilot/yaw damper. A second Controller then took over for the first Controller; and gave me a stern warning about 'blowing a SID' and the flight continued on with no further issue.