They did. In fact the Post Office knew there were bugs because of course there was a bug database that tracked them, along with manual interventions to fix the ledger that SPMs were unaware of. Part of why this scandal was able to go so far is that the management of the Post Office routinely lied to the courts under oath and claimed no bugs were known, etc. They also presented expert witnesses (programmers) from Fujitsu who also claimed there were no problems and the discrepancies must be caused by fraud, whilst also knowing that it wasn't true.
Absolutely everything about this case is shocking and shows really evil behavior at every level. Evil isn't a word I ever use lightly, but Paula Vennells and her crew knew full well they were sending innocent people to prison and seem to have just doubled down at every opportunity. A good way to summarize the mundane evil of Vennells' character: when BBC One broadcast a news item about the scandal way back in 2014, she emailed the chair of the Post Office Alice Perkins to say it was just "hype and human interest" and that she was "more bored than outraged" by the whole affair. She then kept on imprisoning innocent people and lying about it.
Unfortunately one reason this case is neuralgic is that a big part of the blame lies with the toxic legacy of diversity hiring and the push for female CEOs at any cost. Something that came out recently is that the government and Post Office both knew that Vennells was completely unsuited to lead it way back in 2014 [1], with people saying she lacked knowledge had trouble working with people who challenged her, but:
The document also said it would be “more difficult” to remove Vennells due to the impending general election, which took place in 2015. “Ministers would be conscious of the political implications,” it said.
What political implications and which ministers? At the time the BBC were giving fawning bios that explicitly stressed in the headline that Vennells is a woman [2]. She was the responsibility of Jo Swinson, who was Postal Minister. Vennells was lying to Swinson too [3], so she isn't entirely to blame, but Swinson in turn is a feminist who felt it was very important to have more women in business and politics. She's written a book called "Equal Power" on gender equality, for example. Vennells was a high profile female CEO; firing her for mere incompetence was clearly not something civil servants thought Swinson would be willing to do. Instead Vennells was rewarded and made excuses for.
[1] https://www.theguardian.com/business/article/2024/jun/06/off...
[2] https://www.bbc.com/news/business-25965476
[3] https://www.mirror.co.uk/news/politics/ex-post-office-boss-p...