The two accused - Omar Al-Kutobi, 24, from Iraq and Mohammad Kiad, 25, from Kuwait - were arrested in a raid carried out by the New South Wales Police at a house in the western Sydney suburb of Fairfield yesterday, following a tip-off that they were planning an attack.
They have been charged with preparing to commit a terrorist act, which carries a maximum punishment of life in prison.
Police seized a machete, a hunting knife and a homemade flag associated with Islamic state along with a video of a man talking about carrying out an attack.
Deputy Commissioner Cath Burn said the men appeared to be planning to harm or kill someone by "using one of the items recovered (in the raids), potentially a knife".
Police believed the attack was going to occur yesterday.
She said the video showed one of the two arrested men making threats. "One of the men indicated an attack as going to be carried out," she said.
Asked whether they were planning a beheading, Burn replied, "We don't really know what act they were going to commit."
The lawyer of the two accused didn't apply for their bail and it was formally refused during a brief court hearing today. Neither man appeared in the courtroom.
Meanwhile, Prime Minister Abbott predicted that the threat of terrorism attacks like the one allegedly foiled in Sydney yesterday would get "worse before it gets better".
Speaking to the Federal Parliament in Canberra today, Abbott said, "This was an imminent attack in Australia inspired by the Da'esh (IS) death cult."

Latest News from World News Desk