The process you are talking about is called cropping.
Widescreen movies on an ipod (as well as on non-widescreen TV's) show black borders on top and bottom. To make the movie fullscreen, parts of the side of the movie need to be cut off (cropped).
Most ipods have a zoom function which will zoom in to the full height of the movie rather than to adjust it to fit. This also cuts off the sides of the movie.
Cropping will keep the aspect ratio, but you loose some of the actual movie. In the past, movies have been made with this in mind (for tv viewing), and all the action is usually in the center area of the screen, but more recent movies are more made for wide-screen viewing.
DVD movies themselves have the black borders hardcoded in the movie, and not all DVD or video converters can remove these easily (if you play the movie on a computer, you will see if the black bars are hardcoded). When you watch a movie with hardcoded black borders on an ipod, the zoom will not work properly, because the black bars are part of the movie file.
There are a few converters (dvd catalyst is one of them) that can automatically detect and remove black borders.