Essentially, RMXP reads it as such:
The height and width of the image are divided by 4 each, and that value becomes the dimension of the sprite. As such, it reads each of the 16 parts of the sprite sheet as a separate frame
Top row is down-facing, second is left, third is right, fourth is down.
The actual image can be any size as long as it's divisible by four.
Further, to fit with the 8bit style the size of these sprites is doubled, giving it a pixelated look. So the best way to make edits is shrink the image to 50%, edit, then enlarge it to 200%.
(For that reason, if I wanted, I could drop the 3rd-gen-esque style and actually re-do all of Reborn in a much more graphically smooth style, but it's hardly worth the effort compared to actually finishing the game >>)