I don't have young children, but since no one else has responded, I'll
put my USD 0.02 in.
From everything I've heard, young children have a much easier
time with it than older people. They're used to the idea that
the world has lots of mysterious things -- Santa Claus,
the Easter Bunny, where babies come from, etc. The idea
that someone who everybody thought was a man was really
a woman isn't any more mysterious.
Typical explanations are, "we thought she was a man, but it turns
out they made a mistake and she is really a woman." Or something
like that.
Jazz Jennings describes how when she was little, her
friends didn't have any problem with the fact that she,
a girl, happened to have a penis. Weirder things had
happened, after all. In every other respect (and in all
the respects that count at that age), she was a girl.
It was always the adults that had a problem. (It
became more of an issue for other kids when she was older.)