The Foreign Office was forced to issue a public apology to the Vatican while Sir Peter Ricketts, the permanent under-secretary, contacted Cardinal Keith O'Brien, the head of the Catholic Church in Scotland, to apologise personally for any offence caused by the document.
The memo joked the Holy Father could open an abortion clinic, launch a range of condoms or sing a charity duet with the Queen. The document also suggested Benedict XVI could show his hard line on the sensitive issue of child abuse allegations against Roman Catholic priests by "sacking dodgy bishops" and launching a helpline for abused children.
And last night a senior Vatican source said the incident could threaten the papal visit in September, saying: "It's possible the trip could be cancelled as this matter is hugely offensive."
The Pope is due to start his UK visit in Scotland, meeting the Queen at the Palace of Holyroodhouse in Edinburgh before leading an open-air Mass in Glasgow's Bellahouston Park.
The Catholic Church in Scotland questioned whether sufficiently stern action had been taken over the memo and said there appeared to be "a lack of respect and serious engagement on the Foreign Office's part" towards the papal visit. A senior Catholic source in Scotland said: "There is serious and deep concern that not only was this document created and so widely disseminated, but that it took so long before alarm bells were rung.
"There will be those who begin to ask two questions: was moving the person who created this document sideways sufficient; and, secondly, does this question the lead role that the Foreign Office have in the planning for this visit?"
The source said that many were "very worried" about the "role and conduct" of the Foreign Office.
"It is felt that there appears to be a lack of respect and serious engagement on the Foreign Office's part. If there was a visit from Barack Obama then you wouldn't imagine a memo circulating with gratuitously offensive racist suggestions in it; that's just not imaginable. And in the event of anything like that happening, you can imagine the Foreign Office taking really hard and severe action."
The individual responsible has been transferred to other duties.
A spokesman for Cardinal O'Brien said: "The cardinal has received and accepted an apology from the head of the diplomatic service and Foreign Office Permanent Under-Secretary, Sir Peter Ricketts."
The document, entitled The Ideal Visit Would See…, was distributed to officials in Whitehall and Downing Street a month ago in preparation for the papal visit to the UK in September. It arrived with a covering note that said the paper was the result of a brainstorming session and accepted that some of the ideas were "far-fetched".
However, many of the proposals appeared to be aimed specifically at mocking Catholic teachings and its current difficulties as regards child abuse.
Apologising for what it described as a "foolish" document, the Foreign Office said the individual responsible had been transferred to other duties.
Foreign Secretary David Miliband was said to have been "appalled" at the paper's contents, while Britain's ambassador to the Vatican, Francis Campbell, met officials of the Holy See to apologise on behalf of the government.
The controversy has been greeted in the Vatican with similarly grave concern. Publicly, it has expressed disquiet while trying to play down the incident's impact. But Vatican officials have accused the Foreign Office of giving "serious offence" to the Pope and, in doing so, endangering the visit.
One senior Vatican source said: "This could have very severe repercussions and is embarrassing for the British government. One has to question whether the action taken is enough.
"It is disgusting and Britain's ambassador to the Holy See has been in to see the secretary of state and explain what happened and this will all be relayed to the Pope. It's even possible the trip could be cancelled as this matter is hugely offensive."
Another Vatican official said: "Britain's ambassador to the Holy See has put in a lot of hard work over the last few years to secure this trip and it is now under threat. Is this really how a head of state invited to Britain should be treated?"
During a Scottish political debate broadcast on Sky yesterday, the Secretary of State for Scotland, Jim Murphy, who is responsible for the Pope's visit, moved to distance himself from the memo's suggestions, which he described as "despicable".
"These are vile, they are insulting, they are an embarrassment, and, on behalf of the whole of the United Kingdom, I want to apologise to His Holiness the Pope."
First Minister Alex Salmond also castigated the memo as "incredibly offensive", and "juvenile". His surname was spelt "Salmon" in the memo.
Liz Leydon, editor of the Scottish Catholic Observer, said that the document appeared to have been a "poor attempt at humour". She added: "With so much time and energy going into the Papal visit by the Church and the government, the document is an unfortunate gaffe.
"It may have been the result of inexperience, or even a poor attempt at humour, but I doubt it was intended to cause offence. Hopefully, lessons have been learned from this and we can all move on in eager anticipation of the arrival of Pope Benedict XVI in Scotland on 16 September."