Decoupage on wood is a very old craft that was first used in the Victorian era when ladies whiled away their free time doing decorative arts such as decoupage and china painting. The basic methods they used then are the same principles used now. Decoupage boxes for jewelry, decoupaged table tops, and other such fine pieces were a mainstay in Victorian homes.
Step 1 - Create a Smooth Surface
The first step is to smooth the wood surface you are going to decoupage upon. You need to work the surface with sandpaper until it is extremely smooth with no scratches. If there are large bumps or scratches that need to be sanded out, start with a coarse or medium grit sandpaper and move progressively to finer grits to get that smooth surface. Be sure to wipe it clean with a tack cloth to remove all sanding dust. Even a small particle can ruin the surface later.
Step 2 - Get Your Pictures
Cut out the pictures you are going to use for your design. Thinner paper works better for decoupage since it lays flatter and requires less coats of varnish to embed it.
Step 3 - Varnish
Apply a coat of varnish to the entire wooden piece you are going to decoupage. Allow it to dry per the manufacturer's instructions before using your steel wool to buff the varnish smooth. This is just for smoothing, not to remove a lot of varnish, so use a light touch and think 'polishing.' After you have done this you are ready to start applying your paper cutouts.
Step 4 - Arrange Your Images
Arrange the cutouts in various ways until you find a design that you like. Don't leave out this step because once you apply varnish to them, you can't move them around. Once you have decided upon a design, apply varnish to the back of each piece and stick it to the wood. Then, apply more varnish to the entire wooden piece again. Smooth lightly with steel wool once it is completely dry, at least 24 hours.
Step 5 - Finish
Continue to apply coats of varnish, allowing time to dry between coats. Rub your project down with steel wool, dust it off, and re-varnish. Do this until the cutouts are entirely embedded into the surface and you can't see or feel an edge where the paper ends. You want your surface to be completely without impediment.
Decoupage is a long process if done correctly. The varnish technique is the oldest way of doing it and gives a very high-quality result. You can see pieces of decoupage in museums that were done this way. However, if you wish to take an easier route, you can use water-based varnish or products such as Mod Podge to decoupage instead. The result is slightly different but you don't have to wait as long between coats.
Decoupage using varnish is water-proof, so it will resist spills and stains like any good piece of varnished wood. It will last for many years and perhaps become a family heirloom. Pieces done with Mod Podge and its equivalent are more of a 'craft' project and better for children to do as they are not made to last.