A college has ordered an independent inquiry and agreed to repay Pounds 1 million in European subsidies after Government officials rejected its internal accounts.
South Devon College has replaced its system of student records after Department for Education and Employment officials said they would not satisfy European rules.
Acting principal Dr Ian Bentley is currently drawing up a recovery plan to cope with the crisis. A spokesman said he could not say whether jobs would be lost.
The problem involves European Social Fund payments to subsidise courses and travel grants to unemployed students.
College marketing manager Alex James said DFEE officials had rejected college records for the programme, saying they did not prove the work had been carried out.
He said the programmes, which cover more than one year, were carried out correctly, but staff had accepted that records were not up to scratch and had offered to repay subsidies.
Mr James said: "The projects all ran, but the DFEE came and had a look at the records that had been kept. They said they were not up to the standards they expected.
"The governors have commissioned an independent inquiry to audit and look at what happened and how our systems broke down. Since this happened we have put in new systems which have been audited by Coopers Lybrand who have declared them robust."
Mr James said the amount to be repaid, and the terms still had to be agreed with the DFEE. It is not yet known how many years' returns are affected. Governors would decide whether to publish the inquiry's conclusions.
He declined to discuss the college's recovery plan. It is expected to be approved by the end of next month. But Mr James insisted the quality of the college's work would not be affected.
It raises crucial questions for colleges, many of which are heavily dependent on European cash and other funding won through bids. Colleges already complain of the burden of Further Education Funding Council audits.