In the summer we bought a one day ticket for my son and then exchanged that inside the park for an AP. The price was the normal price minus the one day ticket price (as printed on the ticket)
Annual pass prices are here http://www.dlrpmagic.com/guides/practical/annualpassports/ so you need to deduct the price you have paid for your tickets from this and it will give you your upgrade price. Remember that tickets included in a hotel package usually have a nil value to them so cannot be upgraded to annual passes.
Yes! Or alternatively you pay the full cost up front at Guest Services - telling them that you want the kids free offer, getting the paper pass from them which you then go and exchange at the AP office on entering the park.
I got an email from the annual passport office saying that you can have a free pass for the child under 7 but you have to ask for it at the time of purchasing the adult one as it cannot be given after the transaction is completed.
Also you can upgrade the other tickets and the 15% shareholder discount would apply. However this must be done on the first day of use.