The Northampton-based company said it had uncovered the issues at Sandcity, its O'Neill boardwear subsidiary, while looking at a possible merger of the business with its Freespirit operation.

Sandcity's managing director, Darren Spurling, who is also a main board director of Blacks, has been suspended.

Blacks said Sandcity's performance in the two years to February 2008 had been overstated by around £2 million in total. Profits for both last year and the current will be £1 million below market hopes.

A company spokesman said: "There is no evidence so far of any fraud at all. The investigation is continuing."

The accounting issues are the latest blow for its boardwear brands, which struggled in Christmas trading. Sales at O'Neill and Freespirit dived by more than 10% over the festive period despite like-for-like sales up almost 3% across the group.

Blacks Leisure's shares fell more than 11% following the update.

It said: "Whilst this internal review was being conducted some discrepancies in the Sandcity management accounts began to emerge.

"Following the identification of this potential issue, the group's auditors, BDO Stoy Hayward, were asked to assist in establishing the nature and extent of the problem."

The Northampton-based company, which also owns the Millets chain, added that Mr Spurling's suspension "was necessary in the circumstances".

Blacks is also beginning consultation with Sandcity's staff over the closure of the subsidiary's headquarters in Washington, Tyne & Wear, which will put 59 jobs under threat.

Despite the Sandcity problems, the firm said that the medium term prospects for the business were "healthy", adding that trading was in line with expectations.

It added: "It is important to stress that the recovery plan for the group is unaffected by these developments."

In January the group, which has around 450 stores, outlined plans to reduce costs by £3 million this year, although it warned sales growth would be "hard to deliver" in challenging retail conditions.