What happens when you check "Convert to xx ACC"

I am looking to save some space on music and I am curious what will happen if I sync with this option checked, and what a good size option would be. I don't want my music to sound like garbage, nor do I want checking the box to convert the music in my library to ACC format.

Can anybody tell me for sure that it only converts the format of the items on the iPhone (not the actual files)? Also, what is a good compression size to go with?

Thanks,

Kris