Daniel Stone, financial director of Bretton Hall College in Wakefield, has been suspended while an inquiry is carried out for the Higher Education Funding Council, putting pressure on the college's imminent merger with Leeds University.
Serious financial irregularities were uncovered in a "due diligence" exercise carried out by the university to establish all areas of potential risk as part of the negotiations. The problems are understood to be related to European Social Fund activities.
The two institutions have been in merger talks for 18 months. The college said auditors had identified "administrative and financial issues", which had been referred to Hefce and that an independent review was being carried out.
The merger, which had been expected to take place next year, will not go ahead until all the issues have been resolved.
Chairman of the college governors Robert Hughes said: "This suspension is not a disciplinary or punitive measure. There are ongoing investigations and clearly we cannot come to a view about the outcome of these investigations until they are completed. Daniel Stone has been temporarily suspended and remains an employee of Bretton Hall."
A working party of governors will be making recommendations to assist the board in finding a way forward.
Gordon Bell, principal and chief executive of Bretton Hall, said: "Whatever the outcome of the merger talks, students enrolling on existing courses will be able to complete their studies as described at the time of enrolment.
"The college is cooperating fully with all investigations and we remain confident that a successful merger is the best possible way forward for Bretton Hall in continuing to make its distinctive contribution to the arts and education."
A Hefce spokesperson refused to comment on the investigation, but said the council took a strong interest in any merger because of the financial and educational issues at stake.
Leeds said it was working with government officials and Hefce to resolve all the issues and remained convinced of the overwhelming academic arguments in favour of the merger.