South Korea said it had returned fire and scrambled fighter jets in response to the attack from the north, and said bombardment of civilian areas violated the 1953 armistice halting the Korean War.
The two sides technically remain at war because a peace treaty was never negotiated.
The skirmish came amid high tension over North Korea's claim that it has a new uranium enrichment facility and just six weeks after North Korean leader Kim Jong Il unveiled his youngest son Kim Jong Un as his heir apparent.
The United States, which has tens of thousands of troops stationed in South Korea, condemned the attack and called on North Korea to "halt its belligerent action."
The North's artillery struck the small South Korean-held island of Yeonpyeong, which houses military installations and a small civilian population and which has been the focus of two previous deadly battles between the Koreas.
One South Korean marine was killed, three were seriously wounded and 10 slightly wounded. Islanders were escaping to about 20 shelters while sporadic shelling continued.
The firing came amid South Korean military drills in the area. North Korea's military had sent a message to South Korea's armed forces early today to demand that the drills stop, but the South continued them, a military official said.
During the drills, South Korean marines on the island shot artillery toward southern waters, away from North Korea, the official said.
South Korean military official Lee Hong-ki said the North's premeditated bombardments struck civilian areas and were "inhumane atrocities." There are about 30 small islands around the Yeonpyeong, and tension runs high in the area because of its proximity to North Korea. Yeonpyeong is known for its crab fishing.
After the North's barrages, South Korea responded by firing self-propelled howitzers.
Lee Chun-ok, a 54-year-old islander, said she was watching TV when she heard sounds of artillery and a wall and door in her home suddenly collapsed.
"I though I would die," she said from the port city of Incheon, west of Seoul, where she was evacuated. "I was really, really terrified, and I'm still terrified."
Relations between the divided Koreas sank to their lowest point in years after the sinking in March of a South Korean warship near the tense Korean sea border, which killed 46 sailors. Seoul blamed a North Korean torpedo, while Pyongyang has denied any responsibility.
President Lee Myung-bak ordered officials to "sternly respond" to North Korea's action but also called on officials to make sure that the "situation would not escalate," according to a presidential official.
China, which is the North's economic and political benefactor while maintaining robust commercial ties with the South, called for calm.
In a message to North Korea's armed forces, South Korea's military urged the North to stop provocations and warned of strong measures unless the North stopped, a Joint Chiefs of Staff official said.
The countries' western maritime boundary has long been a flash point between the two Koreas. The North does not recognise the border that was unilaterally drawn by the United Nations at the close of the 1950-53 Korean War.
North and South Korea have fought three skirmishes near the maritime border in recent years, most recently in November 2009. That battle left one North Korean officer dead and three others wounded.
Two deadly clashes have previously erupted around Yeonpyeong. In June 2002 one South Korean warship sank, killing six sailors. In a 1999 clash, South Korea said several sailors were wounded, and that up to 30 North Koreans died.
In a sign of North Korea's anger over the South Korean drills, North Korea's state news agency said that South Korea was readying war games with the United States for aggressive purposes against North Korea.