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So I answered the questions in the application as below. These questions were asked after filling out all the information from their passports including their birthplace which is Japan.
Q: ARE YOU NOW, A CITIZEN OR NATIONAL OF ANY OTHER COUNTRY?
A: Yes
(Both of my children have dual(Japanese/Canadian) citizenship)
Q:COUNTRY OF CITIZENSHIP / NATIONALITY
A: CANADA (CAN)
Q: HOW DID YOU ACQUIRE CITIZENSHIP / NATIONALITY FROM THIS COUNTRY?
A: Through parents
Now, other choices were "By birth", "Naturalized" and "Other".
Also, I noticed in the little help window that pops up when you click on a little question mark it said "Please indicate whether you acquired citizenship/nationality by birth, through parents, as a national of another country (born in the territory or possession of another country) or by other means."
Q: HAVE YOU EVER BEEN A CITIZEN OR NATIONAL OF ANY OTHER COUNTRY?
A: No
And about 20 minutes after I finished paying for the applications I checked the status and the result was "Authorization Approved".
For me "By birth" is suggestive of "jus soli" and "Through parents" is suggestive of "jus sanguinis". Japan is strictly operated by jus sanguinis with only a few exceptions, yet for Canada it's operated by the rules of both jus soli and jus sanguinis. Since our children were born in Japan obviously they are not Canadian by jus soli. So I've come to the conclusion I should choose "Through parents" with a help of phoog's answer. Thank you.