Normally when a disk image is mounted, it shows up on the desktop with a plain white icon that looks like a hard drive. With this option checked, DropDMG will customize the icon in one of two modes:
If the top level of the image contains an application, DropDMG will badge the application’s icon onto the white drive icon. Or, if the disk image contains a single file, DropDMG will badge that file’s icon onto the drive. DropDMG renders an optimized version of the badged icon for each size up to 512×512.
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DropDMG ignores the Custom volume icon option when creating a disk image by converting.