Setting up an erased iPhone

I finally got my Verizon iPhone and am giving my trusty old 3G to 6 year old nephew to use as a Touch for playing games. I erased everything via Settings on the iPhone. Now the screen shows the USB plug with instructions to connect to iTunes. When my nephew's parents plug it into iTunes on their PC, what will happen? Will there be a prompt to set it up as a new iPhone? Will the original apps be on the iPhone? The SIM card is in the iPhone but they will not be buying service, so will that be a problem when they set it up? I don't know what to tell them to expect.
Also, my nephew's sister has a Touch which is being synced on the same computer that will be used for syncing the iPhone. Will it be confusing for them to keep track of which apps are on which device? Sorry for all of the stupid questions. I don't have a Touch so haven't dealt with this. TIA for advise.

http://support.apple.com/kb/HT3406

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