Bali's deputy police chief has confirmed to Fairfax Media that he believes there is "a terrorist group targeting the 10-year memorial of the Bali bombing".
He said that local authorities would "prioritise" the event.
The threat, revealed this morning, comes before the arrival in Bali of Australian Prime Minister Julia Gillard and other dignitaries, including Indonesian President Susilo Bambang Yudhoyono and former Australian prime minister John Howard.
"There will be security involving the people, the event, the activities, and places," Deputy Police Chief, Brigadier-General Ketut Untung Yoga Ana told Fairfax.
The deputy chief said the Indonesian army, TNI, would be involved in the defence effort, as would police, including the local villagers.
He would not name any particular VIP as a target of the potential attack, nor the identity of the terrorist group believed to be involved, and declined to answer other questions.
"From the information we have gathered, there is an indication of a certain movement of [suspected terrorists] that plan to target VIPs who will attend the event," Brigadier-General Yoga Ana said, AAP reported.
"We have prepared to face such a threat and we are still following the people involved.
"We are confident we can secure the event."
The comments directly contradict statements made earlier today by Bali's governor, I Made Pastika, a former police chief who helped catch and prosecute the original Bali bombers.
Mr Pastika said the threat was no higher than usual. Asked if Australia's travel advice that a high threat of terrorism existed in Indonesia was reasonable, the governor said: "No."
However, Mr Pastika said that, on an island such as Bali, with so many entry points, it would "never ever" be able to be declared "clean", even by the best security forces in the world.
More than 1500 police and military will be deployed at sites around Bali.
These include the main commemoration site at Jimbaran and the bombing site in Kuta, where thousands of people are expected to turn out for a memorial ceremony on Friday afternoon.
Ms Gillard is to attend a commemoration ceremony at Jimbaran on Friday morning, with Mr Yudhoyono and Mr Howard.
The Jimbaran event will also be attended by hundreds of survivors from the 2002 bombing, as well as family and friends of those killed in the attacks in Kuta that left 202 people dead, including 88 Australians.
The Australian government said it was aware of reports of a terrorist threat and was expected to comment later today.
- with AAP