AirAsia said the Airbus A320, carrying 151 people, suffered a "technical issue", with Australian media reporting the aircraft, en route to Indonesia, had dropped from 32,000 feet (10,000 metres) to 10,000 feet 25 minutes after take-off.
Video circulating online shows distressed passengers wearing oxygen masks with an alarm blaring and cabin crew calling for people to assume the brace position.
"I picked up my phone and sent a text message to my family, just hoping that they would get it," one tearful passenger named Leah told Channel Nine television.
Another holidaymaker said not knowing what was going on heightened fears.
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"We didn't know what was happening because all the voice recordings on the plane were in every language but English," she said.
AirAsia apologised for the scare on yesterday's Perth to Bali flight, blaming a "technical issue" without elaborating on the cause.
"The safety of passengers and crew is our priority," the budget airline said in a statement.
"AirAsia apologises to passengers for any inconvenience caused."
Several flights have been forced back to Australia in recent months, including an AirAsia Gold Coast to Kuala Lumpur service in July that the carrier said was involved in a suspected bird strike.
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