Both, after syncing. I've gone through the process several times.
I'll just mention one more thing: When I edited the song down to a 30-second clip, I did not get a discrete file in the directory. The only change was that the song was shorter; not even the nominal length changed (i.e., the length of the song in the directory was unchanged). I continued with the process, converting it to AAC, changing the suffix to .m4r, etc. Then, when I dragged the song to the desktop in preparation to put it into the "Add Automatically" folder, the length of the clip reverted back to the original. I know what you're thinking, but there is no way I picked the wrong file. I feel the fact I was not able to generate a separate, shorter version of the song has something to do with the problem.