Jamie Murphy, 18, was detained at the Sky Garden nightclub at Kuta beach in the early hours of Tuesday morning.
His lawyer claimed forensic tests proved a white powder, allegedly found on Mr Murphy, was not an illegal substance.
News Corp Australia reported police now believed the powder was paracetamol.
"He's doing fine. The test results were negative," lawyer Desi Widyantari told reporters outside Kuta police station.
The Perth tourist was also expected to undergo blood and urine tests.
Police are yet to make any comment on the tests or Ms Widyantari's claims.
'It's not mine'
Mr Murphy denied any wrongdoing in a video taken immediately after he was detained.
"It's not mine, I haven't taken it, what are you doing, it's not mine," he said in footage aired by Australia's Nine News.
The footage showed a small bag containing a powder-like substance on the floor beside a mobile phone and a hotel key.
Thousands of young Australians are in Bali to celebrate their high school graduation in a tradition known as "schoolies".
It is understood that Mr Murphy graduated last year and arrived in Bali with two friends on Sunday.
Teen's parents fly to Bali
The teenager's parents, Brendan and Anna Murphy, left Perth Airport on Wednesday morning to join their son.
Asked by reporters if they had anything to say, Brendan Murphy said: "Just that we love our son."
Gerry Maio, president of the Bayswater City Soccer Club where the teenager plays, said the Mr Murphy's mother was upset by what happened.
"She was in tears as any mother would be," he told ABC radio.
"He was a very promising athlete in our sport. I haven't even seen him with a bottle of beer in his hand."
Foreign Minister Julie Bishop told the Nine Network consular officials made contact with Mr Murphy and were preparing to visit him on Wednesday.
"It is a warning to all those who are going overseas on schoolies weeks, and to their parents and friends, that we are subject to the laws of another country when we visit those countries," she said.
Indonesia has some of the world's toughest drug laws.
Queensland woman Schapelle Corby was convicted in 2005 of trying to smuggle marijuana into Bali.
Her case attracted intense interest in Australia, with prolonged public debate over her guilt or innocence, before she was released from prison in 2014.
Australians Andrew Chan and Myuran Sukumaran were executed in Indonesia last year for drug offences.
They were among a group of Australians dubbed the Bali Nine who travelled to Indonesia in 2005 hoping to bring 8.3kg (18lb) of heroin back to Australia.
Australia briefly withdrew its ambassador from Indonesia after the execution.