It simply means that, if you wanna add a custom sound effect to your dialogue, and you name the sound file sound.wav, for example, you have to enter the name of the file without the extension (which is the .wav part). So if you write sound.wav it won't work, it has to be just sound.
The audio file must go [mod folder]\Audio\Sounds for sound effects, or [mod folder]\Audio\Music for dialogue background music.
I'm actually not sure about that last one, but you could probably try adding an image file to [mod folder]\Textures\CG , use the Set CG function and see if it works. Let me know if it does, by the way ;)