Neither ending is canon.The remnants of humanity are a slave race, subject to gruesome treatment by their anthropomorphic animal masters in a dystopian "Wild World", where they are bred in captivity for food, labor, and skins. The only possible human refuge was an island hideout of human rights activists in the remote Pacific, where the energy fields produced by the gyroids cross the children into animals who are then sent home. However, when gyroids cross a child, they take some portion of his sanity, crafting the child a superior animal mind at the cost of non-retarded personality and many human memories. When Tom Nook's girlfriend Penny crossed, she felt herself lose her memories of Nook, and Nook distance himself from the changed woman that she was. She took over the camp, taking its policy to new radical heights: starting with her, the animals were going to cross back to people by any means necessary, insanely feeling that would restore her memories. Taking body parts from the human child refugees, she and her followers soon regularly gathered to remove each other's parts and then go among the children to dismember the favorites: Tom alone refused to replace what he regularly lost, though he remains out of duty to the children, who Kapp'n still picks up from humans desperate to preserve their own species. That's why he keeps the kids working: dismemembered children make terrible slave labor, and Penny knows that.
The island is an extension of Silent Hill
Billy didn't cross because his favorite animal is man.
Animals turn into more gyroids.
Animals turn into humans.