The two Koreas have agreed to march together under the unification flag -- a pale blue silhouette of the peninsula -- at the Games' opening ceremony on February 9, and to form a combined women's ice hockey team.
The flag shows a blue dot indicating the islands in the Sea of Japan controlled by South Korea but claimed by Tokyo.
They are known as "Dokdo" in Korean and "Takeshima" in Japanese.
"The flag is unacceptable, based on our stance on our sovereignty of Takeshima," Chief Cabinet Secretary Yoshihide Suga told reporters, adding the incident with just days until the start of the Games in Pyeongchang was "extremely regrettable."
The new spat comes a month after Japan opened a museum in Tokyo devoted to the disputed islands, drawing an immediate protest from South Korea.
The museum, run by the Japanese government, also displays documents and photographs defending Japan's claims over another set of islands disputed with China.
The controversial flag has already been waved by spectators during a women's ice hockey practice match between Sweden and the unified Korean team.
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