plumbingrepairsink
I have seen this done both ways. I put my plumber's putty on the sink in a circle that meets the bottom of the sink or top of the ring.
I have seen others attach the putty to the underside of the flange.
What are the positives and negatives of each and which is right?
On the sink
On the Flange
The toilet flange needs to be on top of the finished floor. Meaning the bottom edge of the flange needs to be on the same plane as the toilet. So if your toilet sits on the tile, the flange needs to be on top of the tile too. The spacing of the toilet exit "horn" and sealing surface is designed for this height.
almost all plumbers agree, here are some sources:
http://www.terrylove.com/forums/showthread.php?51976-Toilet-flange-height
if you have it lower than the finished floor you risk leaking toilet water (the water is the best part) into the floor or worse, in-between the tile, sub-floor, backer board. This is because the wax ring was designed only to take up the air gap, not to provide a "tunnel" or extension of the pipe/flange/toilet horn.
The issues with the compression fitting have been addressed.
The brass flange fitting, the rubber gasket, and the threaded pipe is the "toilet spud". Replacements are available if the rubber is perished or the metal parts somehow damaged.
The flange nut looks pretty well bonded to the threaded portion. Soak well with WD-40 and let it soak in. There are splines inside the spud on which one would apply an internal spud wrench to keep the threaded pipe part from turning. You may find some other chunk of metal that will wedge against the splines, which in turn can be held by a conventional wrench. Holding the spud in place, remove the flange nut with a suitable tool.
Once the flange nut is removed, push the threaded pipe part inwards, but ensure it will not fall into the toilet. The part inside the toilet is conical shaped. Pushing it inwards will give enough free play that the rubber gasket can be pulled out. Once the rubber is out, there will be enough clearance in the toilet hole that the threaded pipe part can now be removed.
Examine the parts and evaluate if replacement is necessary. If the rubber is not too far gone, it may be possible to clean it, treat it with some sort of rubber treatment, and reinstall. If the rubber is cracked, hardened, rotted, or brittle, it will need to be replaced. The nut should be tightened firmly enough to ensure the rubber seals well against the toilet, but not so tight the rubber gets pushed out of position or the toilet gets cracked or broken.
Best Answer
There is no "right way", but the "theory" is:
On a loose fitting (fitting has play inside the hole), placing the putty on the sink will create a better seal on the area actually making contact. On a tighter fitting, placing the putty on the flange will seal the areas closer to the center leaving less room for voids. See this diagram (tight fitting on top, loose fitting on bottom, "risk" for voids/incomplete seal in red):
Honestly, while the "theory" isn't bad, in practice it simply requires that you use enough putty to make a good seal. The net effect is that the putty just needs to be sandwiched between the flange and the sink to prevent water from leaking, either from an (intentionally) stopped sink into the overflow (bathroom) and thus down the drain, or from around the flange into the cabinet below when the flange acts as a reducer or on sinks without overflows (kitchen).
So, whichever way works best for you is the "right way".
Edit: Updated diagram to reflect the proper amount of putty. Edit(2): Updated diagram to reflect proper amount of putty including over-puttying.