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Although ringtones are readily available for purchase through Apple’s iTunes store, it is also possible to create ringtones using any unprotected audio file. The license protection can be removed by burning the audio file to a CD and the re-extracting it, though this may or may not be legal depending on your country of residence as this would technically be considered bypassing license protection. iTunes files cannot be made into ringtones without defeating the license unless they are downloaded as ringtones.
The first step is to acquire the audio file and be sure it does not contain license protection. Load the iTunes application and drag the file over to iTunes, which we will use to convert the audio file into a media format that the iPhone can use.
After selecting the file, select “Convert Selection to AAC” from the “Advanced” menu. AAC is an acronym for Advanced Audio Coding and is the format that the Apple iPhone uses for its ringtones, though the file extension is not .aac.
Once the AAC file is created, select Show in Finder in the File menu, which will display the file , and change the file extension to .m4r from .m4a. The system will ask to confirm the change of file extensions. Select the .m4r button to complete the conversion of the file to an AAC audio file.
Drag the new .m4r file back to iTunes, which will automatically place it in the ~/Music/iTunes/iTunes Music/Ringtones folder. This is where the iPhone looks for new ringtones from the iTunes application.
Connect the iPhone, select the “Ringtone” tab, and select the newly created ringtone which should be listed along with any other ringtones that have been created or downloaded.
Sync the iPhone with iTunes, and the newly created ringtone should be available for use. If not, you may need to crop the file down to thirty seconds or less before converting it to a ringtone format. This needs to be done before converting to an AAC file in order to be effective, and it is advisable to delete any files but the original before restarting this process.. Also, every version of iTunes is a little bit different, so some of these steps may not be completely, literally accurate, though the methodology is sound.
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Source: http://ezinearticles.com/?iPhone-Ringtone-Format—How-to-Create-Ringtones-For-the-iPhone&id=2999269