For the purpose of determining whether your home is overcrowded, all the rooms are taken into consideration, so a one bed flat with a lounge is 2 rooms. Bathroom and kitchen are not counted.
Two rooms can accommodate 3 people.
Children under 1 are ignored and children between 1 and 10 count as half.
So your flat is currently housing 4, 3 ,2.5 or 2 people depending on the ages of the children.
If your flat is deemed to be overcrowded because both children are over 10 you can apply to the council to be rehoused, but you may have to wait a long time if nothing bigger is available.
Your council may allow 'private swaps' if you can find somebody in a bigger home who wants to move to a smaller one.