South Korea has claimed the North has used 70% of wages earned by workers at a jointly-run industrial complex for its weapons programme and luxury goods for the elite.
Last week, Seoul suspended its operations at Kaesong following the North's recent rocket and nuclear tests to cut off the money supply.
The North has called the shutdown "a declaration of war".
Kaesong was one of the last points of co-operation between the two Koreas.
The North reacted to the shutdown by expelling all South Koreans from the complex and freezing the assets of South Korean firms. It has also vowed to cut key communication hotlines with the South.
The privately-run manufacturing zone saw thousands of North Koreans working for South Korean businesses, making clothing, textiles, car parts and semi-conductors.
Workers 'only given tickets'
On Sunday, the South's unification ministry said in a statement the wages, in US dollars, had been paid to the government instead of directly to the workers.
"Any foreign currency earned in North Korea is transferred to the Workers' Party, where the money is used to develop nuclear weapons or missiles, or to purchase luxury goods," said Hong Yong-pyo, the unification minister, in a televised interview, referring to Pyongyang's ruling communist party.
He added that 70% of the money was kept by Pyongyang while workers were given tickets to buy food and essential items, and local currency. The government cited "multiple channels" as its sources for these claims but did not divulge how it had arrived at the percentage.
The South estimates about 616bn Korean won (£350m, $508m) had been paid to the North over the years.
Mr Hong was quoted by Yonhap news agency as saying that the South did not suspend operations earlier at Kaesong because "the international community recognised its significance", and it shut it down this time because "North Korea was only going to intensify its weapons development, and we needed to make a decisive move to alleviate our people's security concerns".
On 7 February, North Korea conducted a long-range rocket launch. It came after the country's fourth nuclear test in January.
What is Kaesong?
- Joint industrial complex located inside North Korea just across from the demilitarised zone
- Launched in 2004 - it is a source of badly-needed cash for the North
- 124 companies operate there from industries including clothing, textiles, car parts and semiconductors
- South Korean firms pay about $100m (£69m) a year in wages. About 54,000 North Koreans work there
- Last shut down in April 2013 - for four months - after US-South Korean military drills angered North Korea