When Esteban's body first comes towards them, washing up from the sea, the children playing by the water think it is an enemy ship. Then, as it comes closer and is obviously not a ship, they believe it to be a whale. In other words, they initially engage with it imaginatively, projecting oversized desires onto the simple corpse. This foreshadows the way the adults will also engage imaginatively with this new object that comes floating into their lives.

After the body washes onto the shore, the children play with it. We learn that they bury Esteban in the sand and dig him up again. In doing so, they are enacting a drama of death and resurrection, foreshadowing the way Esteban will bring rebirth to the village.

Esteban, who at this point is covered in mud and a crust of vegetation, does not frighten or horrify the children. They welcome him and incorporate him into their life, much as the adults soon will.

The answer to your question can be found at the very beginning of the story, in the first paragraph:

THE FIRST CHILDREN who saw the dark and slinky bulge approaching through the sea let themselves think it was an enemy ship. Then they saw it had no flags or masts and they thought it was a whale. But when it washed up on the beach, they removed the clumps of seaweed, the jellyfish tentacles, and the remains of fish and flotsam, and only then did they see that it was a drowned man.

The children, due to their natural innocence and because of the remoteness of the area in which they live, seldom have visitors coming to their village. According to the story, everybody knows each other, and this has been the case for ever. This is basically the gist of the story: the isolation of these people bind them together as a family, more so than a community. The entrance of this drowned man that washed up on the shore was, therefore, a huge deal for the villagers.

The woman embraced the man, the kids had been playing with him for a few hours not finding anything creepy about him, and the men of the town felt amazed by him. Therefore, the entrance of this handsome man was a welcome diversion from the repetitive life of these villagers, who took him in as one of their own.

How do the children react when esteban's body washes ashore in "The Handsomest Drowned Man in the World"?  

Gabriel Garcia Marquez's short story "The Handsomest Drowned Man in the World" begins when the body of a man washes at the shore of a fishing village where people were pretty much only used to seeing each other and never received visitors.

The village's children, who are playing at the time that the body appears, ignore it completely and actually made him a part of the game. At first they pretended that the bulging body was an enemy ship. Then, they approached it and took off it the jellyfish and weeds. It was then when they realized that this was a drowned man. However, they were not at all worried.

They had been playing with him all afternoon burying him in the sand and digging him up again

It was only when the villagers saw what the children were doing that the word spread around the village and the story of the soon-to-be-named "Esteban" begins.