Quoted: If the gas port is already drilled in the barrel you are going to use then forget changing the extension.  It is just too much work to do it right.  Your smith is willing to do it because he is preparing to charge you WAY more than a new barrel to do the job.

He is also offering to do it because he has never DONE it before and does not realize what a pain it is.
I have done a few of these and a big box of extensions is the best advice I can give you.
You really want to avoid having to set the barrel back nearly a full turn as you will be shortening the distance to the front sight base which will effect handguard and gas tube fit.
You can fix this by setting the barrel nut back as well, but you are chasing your tail at this point...

Quoted: What is involved in setting the headspace on a brand new barrel? I guess that the extension is torqued until the headspace is good, then pinned, and the gas hole drilled to match the pin. I also assume that if the extension needs it, some material (.001 or so) might be removed from the forward end.

You don't "set" headspace with the extension, you do it while reaming.
Ok, here's how it works:
The dimension from the torque shoulder of the extension to the bolt face is 0.750" and this dimension is relatively reliable +0.002" and minus 0.0005" or so.
I have a special micrometer that measures from the torque shoulder on the barrel to the back of a headspace gauge.
When chambering, I simply chamber to the depth I need to get proper headspace with the particular barrel extension and bolt I will be using.
I have another fixture that allows me to measure flange depth of a bolt/extension pair, that's why I know the 0.750" dimension is relatively trustworthy.
Now the extension gets torqued into place and the headspace checked.
If it's within spec (amost always is), they I pin the extension into place.
If not, corrections are made by either facing the barrel's torque shoulder or running the reamer in deeper as required adn then I pin the extension into place.
The gas port is drilled last and uses the index pin as the TDC reference.

In a mass production environment, barrels are profiled, threaded and chambered all on CNC machines with only minor inspection throughout the run.
The extensions get installed later, but the barrels are made to tight enough specs that they are not likely to have to adjust headspace as they assemble the extensions to the barrels.