The Australian Defence Force is refusing to disclose any details of the incident, confirming only that an incident occurred and that no Australian soldiers were killed or wounded.
But reliable Afghan sources have told SBS that the incident took place in the Shahid-E Hasas district of Uruzgan province, north-west of Tarin Kowt.
Afghan police are understood to have been on an operation near the village of Diwanbala in the Chah Chineh area of the district when they came under fire from suspected insurgents.
As they did not have a security detail of Afghan soldiers with them, they are understood to have called for coalition forces' support.
It is not clear what support was sent or exactly what happened next. But in the ensuing contact, two children are understood to have been killed.
The ADF and the International Security Assistance Force are investigating the incident and Prime Minister Julia Gillard and Defence Minister Stephen Smith have been briefed.
The Afghan Police have long protested in Uruzgan Province that they are not adequately protected when out on patrol.
Their vehicles are not armoured and they regularly come under attack because they are seen as a soft target.
For this reason, there has been tension between the Afghan Police and the 4th Brigade of the Afghan National Army, which is stationed in Uruzgan Province. While both police and soldiers have, in the past, expressed concerns about their safety once foreign forces leave, it's the police who are most vulnerable.
This incident may only serve to reinforce those concerns.