Seoul says the country is on its highest non-wartime alert and F16 fighter jets have been scrambled to the location.
At least South Korean 14 soldiers were reportedly hurt, including four seriously, and around 60 to 70 houses were ablaze after the shelling.
The rounds landed on Yeonpyeong island and also went into the sea near the countries' disputed western border.
South Korea says its troops then returned fire.
South Korean President Lee Myung-bak has held an emergency meeting following the incident.
He said he was trying to prevent the exchange of artillery fire from escalating into a greater conflict.
YTN television reported that Seoul had warned of a stronger response if the North continued with provocations.
China has expressed concern over the exchange of fire and urged the two sides to work toward peace and stability on the Korean peninsula.
Between 1,200 and 1,300 people reportedly live on the island. TV pictures showed smoke rising from the location.
Sky's Holly Williams said: "We do see skirmishes from time to time in the Yellow Sea, which lies off the western coast of the Korea peninsula, but this is different.
"Civilians are involved. It is bigger in scale than the skirmishes we normally see."
She added: "Normally when this sort of aggression takes place started by the North we tend to assume it is something to do with dictator Kim Jong-il's own position domestically.
"Perhaps he is having to shore up his own position. We know he has been ill in recent years and perhaps also weakened politically. There will be speculation this is more of the same."
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At least South Korean 14 soldiers were reportedly hurt, including four seriously, and around 60 to 70 houses were ablaze after the shelling.
The rounds landed on Yeonpyeong island and also went into the sea near the countries' disputed western border.
South Korea says its troops then returned fire.
South Korean President Lee Myung-bak has held an emergency meeting following the incident.
He said he was trying to prevent the exchange of artillery fire from escalating into a greater conflict.
YTN television reported that Seoul had warned of a stronger response if the North continued with provocations.
China has expressed concern over the exchange of fire and urged the two sides to work toward peace and stability on the Korean peninsula.
Between 1,200 and 1,300 people reportedly live on the island. TV pictures showed smoke rising from the location.
Sky's Holly Williams said: "We do see skirmishes from time to time in the Yellow Sea, which lies off the western coast of the Korea peninsula, but this is different.
"Civilians are involved. It is bigger in scale than the skirmishes we normally see."
She added: "Normally when this sort of aggression takes place started by the North we tend to assume it is something to do with dictator Kim Jong-il's own position domestically.
"Perhaps he is having to shore up his own position. We know he has been ill in recent years and perhaps also weakened politically. There will be speculation this is more of the same."
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