It's a 3 year old and they're in their own yard. I think the cop should have left them alone entirely or just warned them.
If it was an older kid or if they were urinating in a commercial area or the sidewalk or something, then that would be different.
I don't think the parents should have let the child drop his pants in the front yard, because some little girls don't know yet that boys and girls are different down there and if they had happened to see it, even while in a car driving by, or something like that, it might have been a bit of a shock for them and raised some uncomfortable questions. Also it's important for kids to learn modesty and self control and while it might not be that big of a deal for a 3 year old to do this, an older child doing the same thing would be vulgar.