The auditor-general's scathing report released on Monday found the department's administration of the Community Health and Hospitals Program was "ineffective and fell short of ethical requirements".
The $1.25 billion program was announced in December 2018, five months before the 2019 federal election, with a further $747 million committed for associated projects.
Funding was provided in the form of grants to Primary Health Networks and state and territory governments, in a bid to ease pressure on community services and hospitals.
"Health's administration of CHHP grants was not appropriate, involving deliberate breaches of the relevant legal requirements and the principles underpinning them," the report said.
The audit found the governance of the funding arrangements was "not effective".
Only two of 63 national partnership agreement projects assessed by the health department were found to be "highly suitable".
Seven of 108 grants awarded had no grant opportunity guidelines.
"Executive oversight, risk and fraud management were deficient," the report found.
"Projects funded under grant agreements with Primary Health Networks and non-government organisations were designed, assessed, established and managed in a manner that was largely inconsistent with the commonwealth grants rules and guidelines."
Among the report's four recommendations were ensuring advice to government is consistent with the commonwealth's grant rules and guidelines, and that grant assessments support a value-for-money recommendation.
The Department of Health and Aged Care has accepted all four recommendations.
In response to the report, the department wrote that it had started implementing "improvements".
"Throughout the administration of the program the department has considered carefully its stewardship obligations and has acted with honesty, impartiality and transparency," the department said.
"The findings will support the ongoing review and improvement of the department's advice to governments."
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