The Department for Work & Pensions wrote to Lambeth LBC after it overpaid the council by£30m following an audit three years ago, and the cash was to be repaid in instalments of£3.1m.
But the letter was filed and forgotten until recently appointed finance director Jane West went through the books.
The council did not realise the government had been taking the instalments for the last three years, and calculated the extra cash into this year's budget.
Around£4m of the deficit had been earmarked to bail out the council's beleaguered housing benefit service. The service was taken back in-house from Capita after a Benefit Fraud Inspectorate report revealed a massive backlog of claims, failure to monitor the quality of case assessments and poor management of information.
Capita said the housing benefit service was far worse than had been described when the contract was put out to tender, and the council had understated the backlog of work and number of staff required to deliver the service.
A council spokesman said the budget would still balance and the cash would be found for the housing benefit service.
He said: 'Council tax collection has been much better than expected so the books balance at the end of the day.
'When we received the letter, officers said it wasn't very clear about what the government intended to do. But it should have been more closely monitored and in future every account will be carefully reviewed each quarter.'