I applied it to the heatsink, since I didn't want the silver to contact any of the bridges on the CPU (heard this might cause some problems). I don't think it matters whether it is applied to one or the other, but a heatsink might be a tad porous and I'd rather make sure the heatsink is coated sufficiently.
I put some saran wrap around a finger and I used that to apply it. Arctic Silver is messy, and my applicator always spews out more than you need... A very thin layer is all I think is needed. My CPU temps are really nice with a FOP32-1.