Two schools of thought on this. 1) Is that the items are scaled to suit the character's size which should result in their damage scaling down by one dice size typically. (ie a 1d8 becomes a 1d6).   2) Is that the characters have to treat them as something like a bastard sword or a pavis shield in terms of how they use them.

The third option which I think more of us use is as long the game is fun, who cares. Utlimately it will be up to the CK and thier players in how to deal with it. ;) 

The PH says the dwarf and halfling are small generally.  the CKG shows that many dwarves can be medium size by the PH definition of size at the beginning of the race section.  So a taller and heavier dwarf is likely medium and able to use "full sized stuff" with no real issues, might need letting out in the shoulders and hemming, but Medium creature.,  But most would say the halfing is much smaller.  longer or larger weapons would need to be 2 handed as these PCs are likley "small".  Scale everything to them.  Many folks like to give the small races a bonus to their AC since they are harder to hit, at least with ranged attacks.

These are all my two cents... in the end "who cares, have fun" is fine too.