The Welsh Joint Education Committee, which sets exams taken by 75 per cent of candidates in Wales, as well as schools in England, has been unable to produce evidence of money spent by its European unit.
The unit was established to access European funding for research projects in Welsh schools and colleges. Since 1995, it has received pound;3.3m in grants. It was run by Mike German, who has since been elected leader of the Liberal Democrats in the Welsh Assembly, and was until recently deputy first minister in the coalition government.
In 2002, the Department for Work and Pensions was brought in to examine the unit, after the WJEC finance committee expressed misgivings. The department's audit revealed a pound;103,000 deficit, accumulated through staff expenditure on unit projects.
Derec Stockley, WJEC director of examinations, said: "The European unit had insufficient records of where money was spent. But auditors must be able to see a financial trail as evidence of spending."
This week, the DWP ordered the WJEC to pay back pound;1,391,058 of European grants by October 2005.
Mr Stockley said: "We wanted to use that money for refurbishment. But there is no point becoming embittered. We now have to concentrate on exams."
The WJEC has introduced a strict monitoring process to ensure that the situation is not repeated.
A spokesperson for Mike German said: "Mr German was head of the marketing arm of the unit. He had no responsibility for financial dealings, and was not involved in this investigation."