The Ofsted report also says pupils at Grindon Hall in Sunderland aren't being taught how to develop appropriate levels of respect or tolerance for those from other faiths, cultures or communities.
"Prejudice-based bullying, while reported on, is not tackled effectively enough. Discrimination through racist or homophobic language persists," said the report.
"Leaders have not instigated a review of the curriculum to ensure it takes account of pupils' lack of awareness about e-safety and aspects of sex and relationships education," it added.
The report also detailed "derogatory language relating to race or sexual orientation persists" because, it said, the curriculum failed to teach pupils about equality, diversity and the need to be tolerant and respectful towards those who are different to themselves.
Last week the school complained to Ofsted after inspectors asked ten-year-olds at the Christian school if they knew what lesbians 'did' to check they were being taught about British values.
Grindon Hall's Principal Chris Gray says the report was "playing politics with the new regulations on 'British values'."
In a statement he said: "It is now well known that the manner in which inspectors questioned our pupils in November was hostile, inappropriate and raises serious safeguarding issues.
"Despite raising these concerns more than a month ago we have yet to receive any response from Ofsted. To issue a report that grades the best performing secondary state-funded school in Sunderland (latest published GCSE results) as the worst defies all common sense and logic."
A Department for Education spokesperson said: "This school has been troubled for some time and Ofsted have been monitoring it carefully. This report shows that problems persist and there are continued concerns about leadership, the quality of learning and safeguarding.
"Underperformance at any school is unacceptable and one of the many strengths of the free school programme is that we can identify and intervene quickly wherever we find failure. We will look at the report in detail once it is officially published by Ofsted and will respond in due course."
In November the Government said schools in England must promote respect and tolerance in pupils for all faiths, races and cultures, says new government guidance on British values.
The guidance follows calls by ministers for schools to actively promote British values after concerns about an Islamist takeover in some Birmingham schools.
The advice is aimed at head teachers and governors at maintained schools.
