The project was a co-production between US-based Sesame Workshop, and Rafi Peer Puppet Workshop, based in Lahore.
The decision to terminate the funding came after Pakistani newspapers reported that Rafi Peer was allegedly using the money given by the US to pay off old debts, and rewarded lucrative contracts to sources.
The State Department said it cut off money and began an investigation after receiving credible accusations of fraud and abuse.
"We did receive via that hotline what we believe were credible allegations of fraud and abuse by the Rafi Peer Theater Workshop, which is the theater workshop that manages the Sesame Street program in Pakistan. So we did launch an investigation into the allegations," State Department spokesman Mark Toner told reporters.
"We`ve also sent the theater workshop a letter that terminates the project agreement."
The initial agreement between United States Agency for International Development (USAID) and the Rafi Peer Theater Workshop was for USD 20 million, of which USD 6.7 million has been spent as of the last fiscal quarter ending March 31.
"There is an investigation underway looking at these allegations. No one`s questioning obviously the value and positive impact of this kind of programming for children, but this is about allegations of corruption," Toner said.
Noting that there is an investigation underway, adding the US will wait for the results of that investigation.
"We deemed that the allegations were serious enough that we wanted to suspend or cut off the program until we were able to complete this investigation," he said.
"We do acknowledge the programming is beneficial, but we had what we believe were credible allegations, so rather than continue to throw good money after bad, we thought it was prudent to cut off this program," Toner said.
The US, he said, strongly support the goal of the Sesame Street and the Sesame Workshop worldwide.
"These are valuable programmes teaching kids worldwide values as well as math, reading skills, et cetera. This is simply two very different cases but in the latest case, in Pakistan, concerns that US taxpayer money was being misused," he argued.
Meanwhile, Sesame Workshop in a statement said that it was surprised and dismayed to learn about the recent serious allegations made against Rafi Peer.
"Beyond what we have read in the press, we do not know the specific details of these allegations. We trust that the facts will be fairly and fully assessed, and we will wait for the full report," it said.
"When Rafi Peer Theatre Workshop was selected by USAID in 2010 to work on Sim Sim Hamara, a multi-platform childrens educational media program, Sesame Workshop was selected and funded independently by USAID as one of the sub-award recipients on the project," it added.
"We are grateful for USAIDs initial investment which has allowed Sesame Workshop to provide its expertise in children`s media to help Rafi Peer reach three million children, many of whom otherwise would not have access to any early childhood education.
"It is our hope that the achievements of Sim Sim Hamara, and the gains we have made in the lives of children in Pakistan, will carry on," it said in a statement.