.ICO [You can use a plugin for Photoshop, or use GIMP] or .BMP @ 32x32 pixels...
I believe the lower left or top left corner pixel is used for transparency, so just to let you know that is how the transparency works, but I prefer solid icons makes things easier haha
And yes, you would use the Properties tab, Application section and click the little three dot box that appears when you click inside the space next to where it says Icon, if you need further help finding this in recent DBP releases in the so called vanilla IDE, just ask away...
Maybe let us know which IDE you are using too... default or something like Indigo...
Seasons Greetings and Happy New Year folks!