Yep - all files that are listed in the AppCache are cached by the browser, no matter if they're HTML files, JavaScript, or audio files. As long as they're explictly mentioned in the CACHE section, they'll be available offline.
For a good AppCache tutorial, check out http://www.html5rocks.com/en/tutorials/appcache/beginner/, which walks you through everything you should need.
The size limit prevents you from storing too much content on a users computer. In most cases, this isn't a problem if you're just storing HTML, CSS, JavaScript and some images, but in your case, if you're storing music, you potentially will hit that limit quickly. Most browsers limit you to storing a maximum of 5 megs (for all content), so you'll need to be mindful of that.
Chrome has a great set of tools for debugging appcache, as you're developing your site, open the Developer Tools and watch the console to see what happens.