B.A.
First off, I can totally sympathize, as similar incidents have happened in our family. Though reading the responses to this inquiry, I am more than surprised. I am not sure if some of the parents thinking suspension/excessive counceling/and child services getting involved have 7 year old children. 7 year olds are VERY curious...they start exploring their own bodies (whether parents want them to or not), and start getting quite curious about the bodies of the children of the opposite sex. Do they look the same? Do they feel the same? Etc.
What this little boy did was indeed not appropriate, Yet it is extremely common for kids of this age to play "doctor". I don't know many parents that have had kids this age that have not experienced this to some degree. It was wonderful that your daughter came to you and told you. It was great how the boys parents responded to this as well. As far as the school, they realize that this curiosity is normal and natural, though the boy does need to learn what is appropriate and what is not.
Unless there are other signs that the boy is being abused, I doubt that is the case. Sounds like curiosity to me, and nothing more. If a huge deal is made about this, if these kids are shown that this was so horrible, so terrible that the boy gets kicked out of school, or athorities get involved, both the kids could be in a way traumatized with their first innocent experience with sexuality and the opposite sex. (Trust me, I know that most parents do not like to think of their small children as sexual beings, but that does not change the fact that they are...at least in the very early stages of becoming so.)
If there are other signs that the boy is being abused, then yes, definetly pursue it...but if it is just a matter of wondering if girls have the same thing he does under his jeans, then I think appropriate action has taken place, and pushing for harsher action may sexualy traumatize him for life. (Kids learn more in the early years of life, which stays with them forever, than they do the rest of their lives combined).
I have been in the same situation you are, so I do understand how you feel. When it happened to my daughter, I talked with health care professionals. Including a good freind who is a child psychologist. That is why I know what I do. If you are having such a hard time with this, perhaps you should do the same. Find out for yourself just how innocent this was...how natural and normal.