Once you have two animals (cows, sheep or horses) in an enclosed space like a pen:

1. Equip wheat.
2. Tap animal with wheat. The animal with then be surrounded in red love hearts.
3. Tap the other animal. The animal will then also be surrounded in love hearts.
4. The animals should "kiss", and then pop! A little baby animal will appear in the pen with the parents. In a couple of days, the lamb/calf/foal will grow into an adult.

Yaaay! You're practically like a parent! I should also mention that a glitch has made it possible to breed cows with sheep to create... more cows.