Monsoon, the fashion chain that pioneered ethical shopping, has used suppliers in India who employ child labour and pay workers below the minimum wage, the Observer has discovered.

In embarrassing revelations thrown up by the company's own investigations, the standard-bearer for ethical fashion on the British high street has acknowledged that children have been discovered working in its supply chain; women working from home may have been paid less than the legal minimum wage; some workers are regularly required to work excessive overtime; and conditions in suppliers' factories sometimes break both local laws and the industry's own ethical code. Monsoon insists that it works hard to stamp out such abuses.

The company is owned by Peter Simon, who is reported to be worth £250m. Simon opened his first Monsoon store in London in 1973 and the first Accessorize followed in 1984. The company now has about 1,000 stores in 54 countries, including 400 in the UK (160 Monsoon and 240 Accessorize). It opened its first US stores this year and plans to open another 100 by 2015.

Internal documents obtained by the Observer highlight the scale of the problems over issues ranging from child labour to failure to pay the minimum wage, excessive working hours and harsh or inhumane treatment of staff.

Monsoon's most recent ethical audit of its own operations also suggests that, in common with other retailers operating in Asia, it is struggling to tackle the problem of child labour. The report notes: "Subcontractors monitored thus far have exposed a number of serious breaches. The use of child labour is a major concern... Poor wages, health and safety and excessive working hours are also rife." Monsoon claims this was included as a background comment, rather than a description of its own supply chain.

The revelations, the latest in a series involving British firms which outsource their production to Asia, will cause deep concern to a company that prides itself on its ethical credentials. Monsoon's slogan is "Living our values and ethics since 1973" and its website notes: "We know our responsibility extends beyond your wardrobe."

A report last year by Ethical Consumer magazine ranked the company as the most ethical on the UK high street, one place above Marks & Spencer. An Observer investigation earlier this year found that staff in the factories of an M&S supplier in India were being paid as little as 26p an hour and forced to work excessive overtime.

Monsoon is also a leading light in the Ethical Trading Initiative (ETI), the industry's own ethical code which it signed up to in 1999, and it sponsors the Estethica show at British Fashion Week.

It has hired a series of star models – including Sophie Ellis-Bextor, Heidi Klum, Sophie Dahl, Mischa Barton and Lily Cole – to promote its wares. In 2007 it was reported to have paid Liz Hurley £1m to model its clothes. The model Jodie Kidd is the patron of its Monsoon Trust charity and has appeared in a video urging customers to donate cash to aid projects in southern Asia.

In an interview, Monsoon's global ethical trading manager, Derek Jackson, said child labour was rife in India and challenged the Indian government over the issue. "I'm not trying to abrogate our responsibility but...," he said. "The problem is when our back is turned. We don't encourage child labour. Of course, we are aware it is a possibility. We try to manage it to prevent it happening."

According to company sources, five children were found working in a subcontractor's factory in Shakoor Ki Dandi in Delhi in the summer of 2009, making notebooks, pencil boxes and other stationery items for Monsoon. The children were younger than nine years old. The company said it believed they had been trafficked. They were later reunited with their families in Bihar state. The subcontractor was fired, but Monsoon continues to work with the supplier involved.

The second case confirmed by the company was uncovered in a supplier's factory in Shenzhen, China. The company claims that only one 15-year-old girl was found working, although its own reports refer to a number of children, all of whom later left the factory for "personal reasons".

A company insider said staff in India reported that they had found children on several visits to suppliers. One member of staff is understood to have found a number of children engaged in the manufacture of scarves in Amritsar. Another found a number of young workers aged between 12 and 16 at a factory in Uttar Pradesh in May 2009. On another visit by Monsoon staff to the factory of a prospective supplier in Faridabad, which manufactured children's items, two children were found on the roof. A company source suggested the children had been working and had been hidden on the roof by factory management when they saw Monsoon's inspection team arriving. Monsoon said that no deal had been done with the supplier and that it subsequently walked away.

Asked what happened when children were found working for suppliers, Jackson said: "We have policies to sequester the kids, we involve an NGO, and the kids are basically put into a care home and we identify where they come from and then we repatriate them to the family."

The latest report notes that 64 suppliers were breaking rules on paying the minimum wage. These cases include women working from home for a supplier who, Jackson said, was paid enough by Monsoon to cover the minimum wage, but that money was being siphoned off by intermediaries, whom he described as parasites, leaving workers with less than they should have received.

But he added that, while the women were still not receiving the minimum wage, they were at least doing better than when Monsoon first started working with them, when they received just six rupees (8p) an hour. "The big challenge for us is to get those home workers up to a minimum wage, and we have made significant progress over the past two years to achieve that," he said.

Peter Simon told the Observer: "Ethical trading has been at the heart of Monsoon since it was founded in 1973. No British retailer does more to improve the living and working standards of many, many thousands of workers in the developing world than we do, and this is recognised by NGOs everywhere. We tirelessly monitor and work alongside our suppliers, and even their suppliers. Where we find an issue, we deal with it. We're proud of our campaigning work in this area and will continue to expand it."

In a separate statement, Monsoon said: "We accept that a number of homeworkers in India are not being paid minimum wages, yet significant improvements have been made."

Its ETI reports for both of the last two years record an increase in serious breaches of the code by its suppliers, a trend which Monsoon attributes to more robust monitoring. In its audit, signed off in February this year, the company revealed that only 6% of its suppliers fully complied with the ETI code, which sets out basic standards of ethical behaviour, including paying the legal minimum wage and not employing children. Nineteen per cent of its supply chain was listed as high risk; suppliers had systemic problems, were guilty of major breaches of the code, or simply refused to co-operate. The remaining 75% were listed as middle risk, providing Monsoon with incomplete or out-of-date information, committing major breaches of the code or "showing a preponderance of non-compliance", or showing no evidence of commitment to ethical practices.

A company insider accused Monsoon of caring more about profits than workers' wellbeing. He said the firm's management had made matters worse by demanding suppliers cut their prices to help the company through a rocky financial patch two years ago. "All the management wanted was to cut down the prices. It is highly unfair to ask the suppliers to pay better wages if Monsoon Accessorize is itself not wanting to pay fair prices for a product," he said.

Cole and Ellis-Bextor have both spoken out in the past on the issue of child labour. "As a mother, it is inconceivable to me that some of the world's poorest children should be exploited for the sake of the clothes we wear in the west," said Ellis-Bextor last year. Cole, meanwhile, has modelled a T-shirt with the slogan "Save the Future" to fight child labour in the fashion industry.

Despite the serious problems exposed by its own findings, Monsoon insists it has a "long-lasting and passionate commitment to ethical trade".

It also points out that it is the only manufacturer to make public some of its own investigations into its suppliers and it insists it is right to try to work with those suppliers to improve conditions for workers, rather than sacking them. However, it says, it has parted company with five suppliers in the past three years.

"We have never claimed to be perfect, but ethical values have been at the heart of the business since 1973," it said in a statement. "We are a craft-orientated business and take pride in the fact that some of our product is still hand-made by craftspeople in homes and villages. Much of our signature embellishment work is made in this way, including intricate work that cannot be undertaken by machinery. This sets us apart from fast fashion retailers and allows us to support traditional crafts in disadvantaged communities in India and other parts of Asia."