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.
